Insurance Law News - October 2009

• “Contractors Warranty Endorsement” Limits Insurer’s Duty to Indemnify General Contractor Who Fails to Obtain Indemnity Agreements and Certificates of Insurance from Subcontractors
• Insurer That Denies Defense to Insured May Not Later Intervene In Third-Party Suit

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"Contractors Warranty Endorsement" Limits Insurer’s Duty to Indemnify General Contractor Who Fails to Obtain Indemnity Agreements and Certificates of Insurance from Subcontractors

The California Court of Appeal has held that a general liability policy’s “contractors warranty endorsement” relieved the insurer of any duty to indemnify a general contractor who had failed to obtain indemnity agreements and certificates of insurance from its subcontractors. (North American Capacity Insurance Company v. Claremont Liability Insurance Company (2009) 177 Cal.App.4th 272)

Facts

A property owner hired JDG Group, Inc. (JDG) to act as general contractor for construction of a large home in Los Angeles. JDG in turn hired numerous subcontractors, some of whom did not provide indemnity agreements in favor of JDG and/or evidence of insurance to JDG.

In 1998 construction began, and in April 2001, the City issued a certificate of occupancy for the home. In May 2001, the owner moved into the home, but as of September 2001, construction of the home was still underway. Because the home was not completed in a timely manner, JDG paid the owner liquidated damages from May 2001 through the end of September 2001. At the end of September 2001, the owner’s representative filed a notice of completion.

The owner later sued JDG, alleging that the home suffered from various construction defects causing water intrusion. JDG sought defense and indemnity from both Claremont Liability Insurance Company (Claremont), which provided general liability coverage to JDG from January 2001 to January 2002, and North American Capacity Insurance Company (NAC), which provided general liability coverage to JDG from January 2002 to January 2003. Both Claremont and NAC agreed to defend JDG under a reservation of rights.

The owner eventually settled his claims against JDG for a total of $1.1 million. Of the $1.1 million settlement amount, NAC contributed $800,000 and Claremont contributed the remaining $300,000. NAC then filed an equitable contribution action against Claremont, claiming that Claremont owed a larger share of the settlement.   

The trial court found that of the $1.1 million settlement amount paid on behalf of JDG, $909,574 was attributable to subcontractors who had failed to provide indemnity agreements in favor of JDG and/or evidence of insurance to JDG. The trial court ruled that this $909,574 amount was not covered under the Claremont policy. That was because the Claremont policy contained a “contractors warranty endorsement” which barred coverage for work done by JDG’s subcontractors unless JDG obtained both (1) an indemnity agreement from the subcontractor and (2) a certificate of insurance showing that the subcontractor was insured. The trial court thus ruled that the $909,574 amount was not covered under the Claremont policy, but was covered under the NAC policy.  

The trial court found that the remaining $190,426 of the overall settlement amount was covered under both the NAC policy and the Claremont policy, and that per the insurers’ agreement that amount should be allocated based on “time on the risk.” The trial court determined that the “time on risk” should be calculated from the date the construction project was completed (end of September 2001) through expiration of the NAC policy (January 2003). As such, Claremont’s “time on risk” (beginning with project completion in September 2001 and ending with policy expiration in January 2002) was 21%, and NAC’s “time on risk” (beginning with policy inception in January 2002 and ending with policy expiration in January 2003) was 79%. Thus, of the remaining $190,426 of the settlement amount, Claremont was responsible for 21%, or $40,028, and NAC was responsible for 79%, or $150,398.

The net effect of the trial court’s ruling was that NAC (which had contributed $800,000 to the settlement) was not entitled to recover anything from Claremont (which had contributed $300,000 to the settlement). NAC appealed.

Holding       

The Court of Appeal affirmed.

The appellate court agreed that, with regard to the $909,574 portion of the settlement which was attributable to subcontractors who had failed to provide indemnity agreements in favor of JDG and/or evidence of insurance to JDG, there was no coverage under the Claremont policy. The Claremont policy’s “contractors warranty endorsement” clearly informed JDG that obtaining indemnity agreements and certificates of insurance from subcontractors was a condition precedent to coverage under the Claremont policy. It did not matter that JDG might have hired the subcontractors before JDG obtained the policy through Claremont. The Claremont policy simply did not cover any liability JDG might have arising from work done by contractors from whom JDG had failed to secure both an indemnity agreement and a certificate of insurance.

The appellate further agreed that, with regard to the remaining $190,426 portion of the settlement covered under both policies, the trial court had properly allocated 21% ($40,028) to Claremont and 79% ($150,398) to NAC. The insurers had agreed that the trial court could use the “time on the risk” method in allocating damages that were covered under both policies. Further, the insurers apparently agreed that Claremont would not be liable for any property damage occurring prior to “completion” of the home, and the trial court could properly find that the home was “completed” in September 2001 (when the notice of completion was filed) rather than May 2001 (when the owner moved in). Thus, the trial court correctly determined that the $190,426 portion of settlement which was covered under both policies should be allocated $40,028 to Claremont and $150,398 to NAC.

Comment 

This case is consistent with an earlier case, Scottsdale Ins. Co. v. Essex Ins. Co. (2002) 98 Cal.App.4th 86, in which the appellate court upheld a similar “contractors warranty endorsement.” This type of endorsement acts as a condition precedent to coverage, i.e., the general contractor does not have coverage for damage caused by a subcontractor unless the general contractor has obtained an indemnity agreement and a certificate of insurance from the subcontractor. In essence, this removes the risk of the subcontractor’s defective performance from the general contractor’s insurer, and places that risk on the subcontractor and its insurer.

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Insurer That Denies Defense to Insured May Not Later Intervene In Third-Party Suit

The California Court of Appeal has held that an insurer that refuses to defend its insured in a third-party lawsuit cannot later file a complaint in intervention in that litigation, because the insurer, having denied coverage, does not have a direct interest in the outcome of the lawsuit. (Hinton v. Beck (2009) 176 Cal.App.4th 1378.)

Facts

Jonni Hinton sued Eldon Beck for personal injuries he sustained in a farming accident. Beck tendered his defense to his liability insurer, Grange Insurance Group, which refused to defend or indemnify him.

Hinton and Beck then entered into an agreement whereby Hinton would not execute any judgment against Beck in exchange for an assignment of Beck’s rights against Grange. Hinton served a statement of damages in excess of $6 million on Beck and then filed a request for entry of default. At that point, Grange sought permissive intervention pursuant to Code of Civil Procedure section 387(a). Although the trial court initially allowed Grange’s complaint in intervention, it later reconsidered the matter and granted Hinton’s motion to strike Grange’s complaint. Grange appealed the order.

Holding

The Court of Appeal affirmed, finding that the trial court did not abuse its discretion in striking Grange’s complaint in intervention. The Court of Appeal noted that trial courts have discretion to allow intervention under section 387(a) when (1) the intervenor has a direct and immediate interest in the litigation, (2) the intervention will not enlarge the issues in the case, and (3) the reasons for intervention outweigh opposition by the existing parties. Focusing entirely on the first factor, the court concluded that Grange did not have a direct and immediate interest in the litigation because it had already denied coverage and refused to defend Beck.

To support this conclusion, the court compiled various California cases which held that an insurer that disclaims liability on its policy has no interest justifying intervention. When an insurer refuses to defend, the insured is relieved of his obligation to allow the insurer to manage the litigation, and the insurer loses its right to control the litigation; the insurer in essence rejects its opportunity to contest the liability of its insured. The insurer cannot later inject itself into the litigation, because it lost its right to control the litigation when it refused to defend or indemnify.

The court rejected Grange’s argument that it had a direct and immediate interest in the lawsuit because it might ultimately be required to pay the judgment against Beck pursuant to Insurance Code section 11580. Nearly all of the cases cited by Grange to support this theory involved situations where the insurer had not in fact denied coverage. Also, in the one case in which the insurer did deny coverage (Noya v. A.W. Coulter Trucking (2006) 143 Cal.App.4th 838), the court stated in dicta that the insurer had a direct interest, but the court still denied the insurer’s motion to intervene.

The Hinton court noted Grange’s arguments based on the second and third factors — namely, that intervention would not enlarge the issues in the case and that the reasons for intervention outweigh opposition by the existing parties. However,the court concluded that Grange’s lack of a direct interest in the litigation was “dispositive,” and thus did not reach the two remaining factors.

Comment

It is unclear what remains of the three-factor test for allowing intervention under section 387(a). Although the Hinton court claimed to apply the three-factor test, it totally disregarded the second and third factors. Thus, at least under Hinton, the “direct and immediate interest” factor is a threshold inquiry, and courts will not even look to the second or third factors unless a direct interest exists.

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