Court Holds that Insurer is Liable for Contractual Prevailing Party Attorney’s Fees Following Unsuccessful Defense Fee Reimbursement Action

In Hearn Pacific v. Second Generation Roofing (no. A142203, filed 5/2/16), a California Court of Appeal held that despite prosecuting an indemnity action against a subcontractor for reimbursement of defense costs in the name of its insured developer, the developer’s insurer was the real party in interest and could not avoid liability for the subcontractor’s contractual attorney’s fees when the subcontractor defeated the reimbursement claim.

North American Specialty Insurance Company insured a developer, Hearn Pacific Corporation. When Hearn was sued for construction defects, it cross-complained against a roofing subcontractor, Second Generation Roofing, alleging breach of contract, professional negligence, express indemnity, implied indemnity, equitable indemnity, breach of warranties, comparative negligence and contribution. In the course of litigating, the developer assigned its rights against the roofer under the subcontract to the insurer, while reserving its own rights to the extent of any out-of-pocket defense costs, settlements or deductibles and self-insured retentions.

The case was settled except as against the roofer, and the developer’s cross-complaint was amended to add a number of claims regarding the defense costs and settlements that had been paid. In addition, the amended cross-complaint against the roofer included allegations regarding the rights to recovery of defense costs that were paid by the insurer.

Specifically, the developer’s amended cross-complaint cited Greco v. Oregon Mutual Insurance Co. (1961) 191 Cal.App.2d 674; Searles Valley Minerals Operations Inc. v. Ralph M. Parsons Service Company (2011) 191 Cal.App.4th 1394; and Code of Civil Procedure sections 368.5 and 385, all for the proposition that “if [an] assignment occurs after suit has been filed, the action may be continued in the name of the assignor, or the court may permit the assignee to be substituted therein (Code Civ. Proc., § 385), and a judgment in favor of the assignor under these circumstances, when no change of party plaintiff has occurred, will be sustained.” Moreover, “the fact that [the developer] did not literally pay its defense costs, after [the roofer] refused to, does not absolve . . . [the roofer] from [its] obligation to pay [the developer’s] defense costs.” Thus, rather than the insurer intervening or filing its own action, the cross-complaint continued under the name of the developer, with the tacit acknowledgement that it was being done on behalf of the insurer as the assignee of the developer.

But the roofer obtained a defense verdict, and moved the court for an award of attorney’s fees under an attorney fee provision in the subcontract. The court granted the motion, awarding the roofer approximately $200,000 in attorney’s fees and costs. However, the judgment was uncollectible because it was entered against the developer only, and the developer’s corporation had been dissolved. As a result, the roofer moved the court to amend the judgment to name the insurer as the real party in interest, because the developer was judgment-proof.

Although the motion was denied in the trial court, the appeals court directed the trial court to amend the judgment to add the insurer as owing the amount awarded for attorney’s fees. The appeals court first rejected the insurer’s argument that amending judgments to add parties is limited to alter ego cases, pointing out that Code of Civil Procedure section 368.5 (former section 385), which allows an action to be continued in the name of the original party, specifically addresses any transfer of interest and that “[t]he statute was not meant to be used as a shield,” granting the court power substitute the transferee as the real party in interest, “so that a judgment creditor does not get left holding a judgment that proves difficult or impossible to collect.”

As to the insurer’s liability for the attorney fee award, the Hearn court found that consistent with the law governing contractual attorney’s fees generally. Namely, that any assignee becomes directly liable for prevailing party attorney’s fees under a contract. The Hearn court stated that “an assignee’s acceptance of the benefits of a contract containing a fee clause, by bringing suit, constitutes an implied assumption of the attorney fee obligations, unless there is evidence the parties did not intend to transfer those fee obligations.” The court said that holds true even if there is only a partial assignment of contractual rights. Further, “even outside the attorney fee context, an assignee’s voluntary acceptance of the benefits of a contract may obligate the assignee to assume its obligations as a matter of law, even if the assignment agreement expressly excludes the obligations.” Thus, “Hearn’s insurer cannot evade responsibility for paying Second Generation Roofing’s costs and legal fees solely because of its tactical choice to keep Hearn’s name, not its own, on the case caption. We do not think the discretion afforded a trial court to continue an action in the transferor’s name under section 368.5 was meant as a get-out-of-jail-free card, to insulate the real party in interest from exposure to liability for costs and fees when the litigation they pursue concludes unfavorably.”

Moreover, the Hearn court also said that the result would have been the same had the insurer pursued the action in its own name on a subrogation theory:

“As previously explained, the transfer of Hearn’s interests in the subcontracts made North American the real party in interest in this suit, and the existence of another potential remedy under subrogation principles is irrelevant to the application of section 368.5. Second Generation Roofing also points out, correctly, that an insurer who pursues a subrogation claim steps into the shoes of its insured and, if unsuccessful, assumes the insured’s liability for contractual attorney fees to the prevailing party. (See Employers Mutual Liability Ins. Co v. Tutor-Saliba Corp. (1998) 17 Cal.4th 632, 639–642; Allstate Ins. Co. v. Loo (1996) 46 Cal.App.4th 1794, 1799–1801.) So it would make little sense to refrain from making North American expressly liable for the attorney fees and costs awarded here based on the possibility North American might have pursued recovery against Second Generation Roofing on a subrogation theory.”

The Hearn court likewise rejected an argument that the roofer’s sole recourse for a judgment against an insurer would be by way of a direct action under Insurance Code section 11580(b), on a theory that such actions are limited to damages covered by the policy, and do not include attorney fee awards. (Citing San Diego Housing Com. v. Industrial Indemnity Co. (2002) 95 Cal.App.4th 669, 691–693.) The Hearn court said that “the statute is irrelevant, and in no way displaces a litigant’s right to amend a post-judgment order to add the name of a judgment debtor who was the true party to the action, even when that party is an insurer.” The court pointed out that the roofer was not trying to collect on a judgment but to amend the judgment to add the insurer as the real party in interest, directly liable in its own name as the assignee of the insured. Plus, the Hearn court also pointed out that it is common for judgment creditors to join assigned claims for bad faith in direct actions against insurers, and that Insurance Code section 11580(b) does not limit alternative rights or remedies against insurers.

The Hearn court went on to reject claims that the action was not ripe, that the roofer had delayed and, in particular, that the assignment was not valid, ultimately remanding the case on an order to amend the judgment to add the insurer’s name to the judgment.

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May 5, 2016