Insurance Law News - February 2012

• Issues Regarding Bad Faith Must Be Resolved Before Insurer Can Compel Arbitration of Independent Counsel Fees
• Judgment Creditor Cannot Recover Costs and Interest in Direct Action against Guarantee Association

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Issues Regarding Bad Faith Must Be Resolved Before Insurer Can Compel Arbitration of Independent Counsel Fees

Issues regarding an insurer’s alleged bad faith delay in defending must be resolved in the trial court before the insurer can compel arbitration of independent counsel fees pursuant to Civil Code section 2860(c). (Janopaul + Block Companies, LLC v. Superior Court (2011) 200 Cal.App.4th 1239)

Facts

Janopaul + Block Companies, LLC (Janopaul) owned a hotel and undertook to restore it. Janopaul hired The Sundt Companies, Inc. (Sundt) to serve as general contractor for the project.

Following completion of the project, various parties filed suit against Janopaul for construction defects at the project. Janopaul initially tendered its defense to Sundt, apparently pursuant to an indemnity agreement in the general contract. Janopaul later tendered its defense to Sundt’s general liability insurer, St. Paul Fire and Marine Insurance Company (St. Paul), apparently on the ground that Janopaul was an additional insured on the St. Paul policy.

Over two years after Janopaul’s original tender to St. Paul, and after Janopaul threatened to sue St. Paul for failure to defend, St. Paul finally agreed to defend Janopaul subject to a reservation of rights. St. Paul further agreed that Janopaul’s personal counsel could serve as Janopaul’s “independent counsel.”

Over the next year, a dispute arose between St. Paul and Janopaul's independent counsel regarding independent counsel's billing rates and practices. St. Paul filed a petition to compel arbitration of the fee dispute under California Civil Code section 2860(c), which provides that disputes involving fees charged by independent counsel “shall be resolved by final and binding arbitration by a single neutral arbitrator selected by the parties to the dispute.” In response, Janopaul filed a motion to dismiss the petition. Before briefing had been completed on the petition to compel arbitration and the competing motion to dismiss the petition, Janopaul filed a bad faith action against St. Paul. The trial court granted St. Paul’s petition to compel arbitration, denied Janopaul’s motion to dismiss the petition, and stayed the bad faith case. Janopaul then sought relief in the appellate court.

Holding

The Court of Appeal reversed, holding that when an insured files a bad faith action alleging an insurer’s unreasonable delay in defending, that issue must be resolved in the trial court before any arbitration of independent counsel fees under Civil Code section 2860(c). The appellate court reasoned that if Janopaul establishes an unreasonable delay by St. Paul in providing a defense to Janopaul, then St. Paul will have forfeited and/or be estopped from asserting all rights under the policies of insurance, including any rights under section 2860. Since Janopaul’s complaint for bad faith raised claims “substantially broader than merely a dispute over the amount of attorney fees” which is subject to mandatory arbitration, and since those claims had not been resolved before the trial court granted St. Paul’s petition under section 2860, the trial court erred in staying the bad faith case and in ordering the parties to arbitration.

Comment

The appellate court’s decision requires a preliminary determination in the trial court whether the insurer had a duty to defend the insured and if so, whether the insurer breached that duty and engaged in bad faith conduct. If those issues are resolved in favor of the insurer and the dispute between the insurer and the insured ultimately boils down to the amount of attorney fees the owes for the insured’s defense in the underlying action, then at that time the insurer can move to arbitrate that dispute pursuant to Civil Code section 2860(c).

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Judgment Creditor Cannot Recover Costs and Interest in Direct Action against Guarantee Association

A liability policy’s “supplemental payment” clause did not allow a third-party judgment creditor to recover costs and interest in a direct action brought against the California Insurance Guarantee Association. (Clark v. California Ins. Guarantee Assn. (2011) 200 Cal.App.4th 391)

Facts

Kenneth Clark (Clark) filed a personal injury lawsuit against D.J. Scheffler, Inc. (Scheffler). Scheffler’s commercial general liability insurer, Reliance Insurance Company (Reliance), provided Scheffler with a defense against Clark’s lawsuit.

Clark obtained a substantial verdict against Scheffler. However, before a judgment was entered against Scheffler, Reliance was declared insolvent. As a result, the California Insurance Guarantee Association (CIGA) assumed Scheffler's defense. Ultimately, a final judgment was entered in favor of Clark and against Scheffler for damages, costs and interest. CIGA paid Clark the full damage portion of the award, but did not pay all of the costs and interest.

Clark as judgment creditor then filed an action against CIGA pursuant to California Insurance Code section 11580 to recover the remaining costs and interest. Clark argued that he was entitled to recover the costs and interest from CIGA pursuant to the Reliance policy’s “supplemental payment” clause, which provides that in any suit the insurer defends, the insurer will pay all costs and interest assessed against the insured. CIGA countered that a judgment creditor bringing a direct action against the debtor's liability insurer has no right to recover costs and interest an insurer would have been obligated to pay to the insured under the supplemental payments provision. The trial court agreed with CIGA and entered judgment in favor of CIGA.

Holding

The Court of Appeal affirmed, agreeing that costs and interest are not recoverable by a third party judgment creditor in a direct action against the insurer under a liability policy’s supplemental payment provision. Citing San Diego Housing Com. v. Industrial Indemnity Co. (2002) 95 Cal.App.4th 669, the appellate court reasoned that a third party judgment creditor is merely an incidental beneficiary of contractual obligations that flow only to the insured, such as the duty to defend. The court reiterated San Diego Housing's holding that costs and interest recoverable under a supplemental payments provisions are linked to the insurer's duty to defend, and are owed only to the insured. Thus, unless the third party judgment creditor has an assignment of the insured’s rights under the insurance contract, the third party judgment creditor has no right to recover under the supplemental payments clause of the insured's policy.

Comment

The appellate court closely followed its prior ruling in San Diego Housing, which held that a third party judgment creditor may not enforce an award of costs in a direct action against the insurer.  Absent an assignment of the insured’s rights, the third party judgment creditor may not enforce rights owed to the insured under a supplemental payment clause.

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