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Ö INTO THE FIRE: Can Interstate Fire V. Cleveland Wrecking be Used to Sue Subcontractors for Recovery of Developerís Defense Costs Paid by Insurers?

Construction practitioners are well advised to take the time to read the case of Interstate Fire and Casualty Insurance Co. v. Cleveland Wrecking Co. (2010) 182 Cal.App.4th 23. Ericksen Arbuthnot is currently handling litigation in which the developer is using the Interstate case to pursue subcontractors for defense costs after settlement of the case.

Facts:

Webcor Construction, Inc., the general contractor at a construction project in San Francisco, hired Cleveland Wrecking to perform demolition work, and hired Delta Steel Erectors to install metal stairs. Both Cleveland and Delta executed subcontracts with Webcor requiring them to indemnify and defend Webcor and requiring them to obtain insurance naming Webcor as an additional insured for claims arising out of their work under the contracts.

Frisby, an employee of Delta, was allegedly injured by demolition operations conducted by Cleveland. The employee sued Webcor and Cleveland for his injuries and pursued a worker's comp claim against his employer Delta. Webcor tendered its defense to Cleveland, which rejected the tender. Webcor also tendered its defense to Delta's insurer, Interstate, as a named additional insured under the Interstate policy.

Webcor cross-complained against Cleveland for, among other things, express contractual indemnity (based on the indemnity clause and rejected tender) and breach of contract (based on the insurance clause and the claim that Cleveland failed to obtain insurance as required under the subcontract with Webcor). The Frisby claims were settled by Delta's insurer (Interstate) and the settlement was found to be in "good faith" by the court (see C.C.P. § 877.6). The Webcor cross-complaint causes of action for express indemnity and breach of contract were dismissed without prejudice and the "parties reserved their rights with respect to an Interstate subrogation claim in a separate action."

Interstate then filed a subrogation action against Cleveland, asserting that Interstate was subrogated to Webcor's claims against Cleveland to recover defense costs paid on behalf of Webcor that were outside the coverage afforded by Delta's policy. Cleveland demurred to the complaint and the court ultimately dismissed the Interstate complaint, finding that the good faith settlement in the Frisby action cut off any claim for indemnity as a result of Cleveland's negligence. Since Webcor had suffered no damage as a result of the breach of contract, as the subrogee of Webcor, Interstate did not have grounds to pursue equitable claims against Cleveland.

Context:

The vast majority of construction contracts in California require subcontractors to name the owner/developer/General Contractor of the project as additional insured(s) under the subcontractor's insurance policy. When a suit is filed, the builder will typically tender its defense to the subcontractors who worked on the project. Often, insurers to whom defense is tendered do not respond to the tenders, reject the tenders, or simply wait for the claims to be settled and defense costs to be resolved by other insurers. This complicates both the defense and the insurance situation.

The Emerging Trend:

Historically, an insurer participating in the defense under an Additional Insured (AI) endorsement would file a timely contribution action against non-participating insurers to seek to recover money paid on claims outside its policy or in excess of its proportional share. In contrast, the method of recovery pursued in Interstate seems almost designed to increase costs and inconvenience to all parties, with the apparent goal of pressuring insurers with AI endorsements to be more receptive to developer's AI tenders.

Relying on the Interstate case, developers argue that when a "participating AI insurer" (i.e., a subcontractor's insurer who is defending a developer/general contractor under an AI endorsement) deems it has paid defense costs for claims not covered under the AI provision, the insurer may later pursue the developer for recovery of those unrelated defense costs. Developers argue that, in response: (a) developer may subrogate the insurer to the developer's contractual rights against subcontractors, allowing the insurer to pursue the subcontractors directly; or (b) the developer may pursue the subcontractors directly for any recovery the insurer may obtain against the developer for paying costs relating to such non-covered claims. In other words, the subcontractors whose insurers refused the AI tender from the developer are told they will be held liable for the share of defense cost their insurer would have paid for developer's defense, if the AI tenders to the insurers had been accepted.

Developers also rely on Buss v. Superior Court (Transamerica Ins. Co.) (1997) 16 Cal. 4th 35, and Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal. 4th 489. Buss dealt with the insurer's right to pursue its own insured for defense costs paid on non-covered claims. Blue Ridge deals instead with recovery of settlement payments after a unilateral reservation of right to recover such payments from the insured.

Analysis:

This new path to a subrogation action may be creative, but it is a waste of valuable resources. Waiting to bring a subrogation action a increases costs and the number of matters pending before an already overloaded judicial system.

There is a simpler and less expensive course - and one just as likely to generate appellate law more directly on point than Interstate, Buss, and Blue Ridge. The AI insurer who is paying developer's defense costs and believes it has paid for defense of claims not covered under the policy could intervene in the already pending construction defect action. By doing so, the insurer could cost-effectively avoid or resolve any overpayment as part of the overall resolution of a single action, whether by settlement or trial.

Another potential solution is to file a concurrent declaratory relief action for contribution against other insurers under whose policies name the developer as an additional insured. The parties could appoint a special master to conduct case management and discovery. That special master could propound interrogatories to the parties requiring them to disclose whether the builder has tendered its defense to the subcontractors and their insurers and how the parties responded to the tender. That would at least help to avoid the last-minute treatment of these issues that is commonly seen in construction defect cases now.

Brian Sanders is a partner and shareholder in Oakland. He can be reached at 510.832.7770 or .