Court of Appeal Puts the “Equity” in Equitable Subrogation
Subrogation as a concept is well understood in insurance circles. According to the Institute of Risk Management Institute’s glossary of insurance terms subrogation is “the assignment to an insurer by the terms of [a] policy or by law, after payment of a loss, of the rights fo the insured to recover the amount of the loss from one legally liable for it.” In other words, if an insurer comes out of pocket for something someone else broke, the insurer can turn to that responsible party for reimbursement of its out of pocket costs.
Typically, subrogation is, as stated in IRMI’s glossary of insurance terms, a matter of contract and the rights and responsibilities of parties are set forth within the terms of a policy. However, subrogation may, as stated in IRMI’s glossary, also be matter of law. And this is where equitable subrogation comes in.
“Equitable subrogation,” according to IRMI, is “the right of subrogation granted under common law when one party has made a payment on behalf of another and becomes entitled to whatever recovery rights the other party has against a responsible third party.”
In Pulte Home Corporation v. CBR Electric, Inc. (2020) 50 Cal.App.5th 216, the 4th District Court of Appeal examined a trial court decision finding against an insurer’s equitable contribution claim against several subcontractors in a construction defect lawsuit.
The Pulte Home Case
Pulte Home Corporation was the developer, owner and general contractor of three single-family developments in Murrieta, California. Pulte contracted with various subcontractors to perform work at the developments. Under the terms of Pulte’s subcontracts the subcontractors agreed to defend and indemnity Pulte against “all liability, claims, judgments, suits, or demands for damages to persons or property arising out of, resulting from, or relating to” their work.
In 2013 and 2014, two groups of homeowners filed lawsuits against Pulte alleging various construction defects at the developments. Pulte tendered defense of the lawsuits to its subcontractors and their insurers pursuant to the indemnity provision in the subcontractors and later filed a cross-complaint against 34 subcontractors for express indemnification and breach of contract. Pulte was defended during the litigation by its insurance carrier, St. Paul Mercury Insurance Company.
During the course of litigation, Pulte and several of the subcontractors settled with the plaintiffs for approximately $80,000. The defense costs leading up to the settlement totaled approximately $253,000.
In separate lawsuit, St. Paul sued the subcontractors for reimbursement of an equitable portion of the defense costs it incurred under an equitable subrogation theory. Following a bench trial, the trial court denied St. Paul’s claim on two grounds.
First, the trial court found that St. Paul had not established a “causal connection” between the subcontractors and damages suffered by the homeowners because the subcontractor’s failure to defend Pulte had not “caused the homeowners to file their lawsuit[s] against Pulte and thereby necessitate th[e] defense costs to be incurred.” Second, the trial court found that equitable subrogation is an all-or-nothing claim, and that St. Paul had failed to show that it could shift the entire costs of defense to the subcontractors.
St. Paul appealed.
The Appeal
On Appeal, the 4th District explained that:
Subrogation is defined as the substitution of another person in place of the creditor or claimant to whose rights he or she succeeds in relation to the debt or claim. By undertaking to indemnify or pay the principal debtor’s obligation to the creditor or claimant, the “subrogee” is equitably subrogated to the claimant (or “subrogor”), and succeeds to the subrogor’s rights against the obligor. In the case of insurance, subrogation takes the form of an insurer’s right to be put in the position of the insured in order to pursue recovery from third parties legally responsible to the insured for a loss which the insurer has both insured and paid.
“Equitable subrogation,” explained the Court of Appeal, includes eight elements:
- The insured suffered a loss for which the defendant is liable, either as the wrongdoer whose act or omission caused the loss or because the defendant is legally responsible to the insured for the loss caused by the wrongdoer;
- The claimed loss was one for which the insurer was not primarily liable;
- The insurer has compensated the insured in whole or in part for the same loss for which the defendant is primarily liable;
- The insurer has paid the claim of its insured to protect its own interest and not as a volunteer;
- The insured has an existing, assignable cause of action against the defendant which the insured could have asserted for its own benefit had it not been compensated for its loss by the insurer;
- The insurer has suffered damages caused by the act or omission upon which the liability of the defendant depends;
- Justice requires that the loss be entirely shifted from the insurer to the defendant, whose equitable position is inferior to that of the insurer; and
- The insurer’s damages are in a liquidated sum, generally the amount paid to the insured.
As to the first element, the Court of Appeal explained that the trial court had incorrectly interpreted the first element to require St. Paul to show that its insured Pulte suffered a loss for which the subcontractors were “entirely” responsible. Acknowledging that the trial court’s decision appeared to have also relied on the seventh element, “that the loss be entirely shifted from insurer to the defendant,” the Court explained that “the word ‘entirely’ in that context refers not to the total amount the plaintiff (or subrogee) paid, but refers instead to “the claimed loss” (in the second element) that the subrogee is seeking from the defendant on the ground the defendant is primarily liable (third element) for that loss”:
We conclude the trial court’s interpretation of how subrogation operates, which defendants urge us to adopt, is incorrect. While it is true that a subrogee insurer can seek the entire cost of defense – for example, if the insurer is an excess insurer and is claiming the general liability insurer is primarily responsible for the entire loss – a subrogee is not required to do so. In other words, subrogation entirely shifts the claimed loss, but the claimed loss doesn’t have to be entire loss the subrogee suffered.
As to the trial court’s finding that St. Paul had not established a “causal connection” between the subcontractors and damages suffered by the homeowners because the subcontractor’s failure to defend Pulte had not “caused the homeowners to file their lawsuit[s] against Pulte and thereby necessitate th[e] defense costs to be incurred,” the Court of Appeal again disagreed:
Rather than ask whether defendants’ failure to accept Pulte’s tender caused Pulte (and later St. Paul) to incur those costs, the trial court instead asked whether defendants’ failure to accept Pulte’s tender caused the construction defect actions themselves. Under such a causation analysis, a subcontractor’s breach of its duty to defend could never have a causal connection to defense costs. This is because its duty to defend does not arise until after the general contractor is sued and tenders its defense. Such an analysis would have the undesirable result of cloaking subcontractors with impunity for breaching their contractual duties. The proper inquiry is whether defendants’ breach caused Pulte to incur the loss St. Paul is claiming in this litigation (i.e., defendants’ share of the defense costs). The answer to that question is yes.
Conclusion
So there you have it. As the Pulte court stated: “Equitable subrogation is, as the name suggests, based on equity.” While an insurer may attempt to shift the entirety of its defense costs to others whom it believes are responsible, it is not required to. Further, a defendant’s obligation to reimburse an insurer an equitable portion of its defense costs does not hinge on whether the defendant’s failure to defend an insurer’s insured caused the insurer to incur defense costs, but rather, whether the acts or omissions of the defendant caused or allegedly caused the lawsuit to be filed to begin with.
California Construction Law Blog | Nomos LLP 
One Response to “Court of Appeal Puts the “Equity” in Equitable Subrogation”
I am not an attorney.
But I was a three decade commercial general contractor, and now a 10 year independent PM/CM committed to making the development and construction process work better for all participants.
My primary takeaway of your expert summary and analysis is focused on this short paragraph I copied from above:
“During the course of litigation, Pulte and several of the subcontractors settled with the plaintiffs for approximately $80,000. The defense costs leading up to the settlement totaled approximately $253,000.”
So the agreed upon actual “fix” was $80,000, but the legal fees to get to that fix cost $253,000 (before the appeals) – i.e. over three times the cost to actually fix the problem(s).
In my reading as a former contractor, that ratio is a horrible return on cash investment, not to mention the emotional and business distraction investments. In hindsight, I bet that both sides may have settled much quicker on a $160,000 fix to avoid that litigation – but . . . maybe not.
Construction, even when performed by the best and most qualified companies, is a human endeavor subject to mistakes (e.g. are you familiar with “punch lists?”).
In my experience (my former company averaged 100 completed projects per year over our last 10 years) and opinion, it was always more productive to recognize our mistakes, own up to them and fix them, even when it meant “over-fixing” them, to avoid residual disappointments or litigation.
In summary, I recommend:
1. Insurance is complicated; talk to your agent to be sure you have sufficient coverage to deal with the unanticipated (e.g. nobody plans to get in a car accident one block from their home).
2. Fixating on being “right” doesn’t always (or usually) yield the best outcome. You’re in business for the long haul. Analyze and weigh the upsides and downsides of every dispute as a business return on investment, not an emotional one. Your accountant and balance sheet doesn’t care or reflect that you “caved” to limit your potential loss and moved on.
3. Find and retain attorneys who advise and know how to keep you out of litigation.
Or so I think . . .
Marty Wilson
MDW Group, Inc.