Subcontractors Found Liable to Reimburse Insurer Defense Costs in Equitable Subrogation Action

In Pulte Home Corp. v. CBR Electric, Inc. (No. E068353, filed 6/10/20), a California appeals court reversed the denial of an equitable subrogation claim for reimbursement of defense costs from contractually obligated subcontractors to a defending insurer, finding that all of the elements for equitable subrogation were met, and the equities tipped in favor of the insurer.

After defending the general contractor, Pulte, in two construction defect actions as an additional insured on a subcontractor’s policy, St. Paul sought reimbursement of defense costs solely on an equitable subrogation theory against six subcontractors that had worked on the underlying construction projects, and whose subcontracts required them to defend Pulte in suits related to their work. After a bench trial, the trial court denied St. Paul’s claim, concluding that St. Paul had not demonstrated that it was fair to shift all of the defense costs to the subcontractors because their failure to defend Pulte had not caused the homeowners to bring the construction defect actions.

The appeals court reversed, holding that the trial court misconstrued the law governing equitable subrogation. Because the relevant facts were not in dispute, the appeals court reviewed the case de novo and found that the trial court committed error in its denial of reimbursement for the defense fees. The appeals court found two errors: First, the trial court incorrectly concluded that equitable subrogation requires shifting of the entire loss. Second, the trial court applied a faulty causation analysis – that because the non-defending subcontractors had not caused the homeowners to sue Pulte, thereby necessitating a defense, St. Paul could not meet the elements of equitable subrogation.

The trial court had also questioned the propriety of St. Paul seeking equitable subrogation over equitable contribution, but in a footnote, the Pulte court explained that, as between St. Paul and the subcontractors, the claim was for equitable subrogation and not equitable contribution. The Pulte court said that “[c]ontribution is available only between obligors who share the same level of liability. Thus, had St. Paul sued defendants’ insurance companies, contribution would be the appropriate cause of action. Alternatively, if St. Paul were not an insurance company but one of the subcontractors hired by Pulte to work on the developments, it could have sued defendants for contribution.” (Citing Aerojet-General Corp. v. Transport Indem. Co. (1997) 17 Cal.4th 38, 72.) Therefore, the Pulte court held that an insurer versus subcontractor claim for defense costs is one for equitable subrogation.

Regarding the trial court’s error in concluding that equitable subrogation requires shifting of the entire loss, the Pulte court stated that: “If that were the rule, we agree it would be unfair to burden only a small subset of the subcontractors that worked on a project with the entire cost of defending a construction defect action alleging defects in every trade. However, a cause of action based on equitable subrogation allows an insurer to step into the shoes of its insured and recover only what the insured would be entitled to recover from the defendants. (Rossmoor Sanitation, Inc. v. Pylon, Inc. (1975) 13 Cal.3d 622, 633-634) [“[a]n insurer on paying a loss is subrogated in a corresponding amount to the insured’s right of action against any person responsible for the loss”].) Under the principles articulated in Crawford v. Weather Shield Mfg., Inc. (2008) 44 Cal.4th 541 and the subcontracts at issue here, defendants’ duty to defend the general contractor arose when the general contractor tendered its defense to them, and that duty covered the cost of defending claims related to their work. Under these circumstances, St. Paul is subrogated to the general contractor’s entitlement to the portion of defense costs each defendant owed as a result of its duty to defend the general contractor.”

As to the trial court’s second error, causation, the Pulte court stated that: “[T]he trial court employed a flawed causation analysis when balancing the equities of this case (the seventh element of equitable subrogation). The appropriate inquiry is whether defendants’ failure to defend the general contractor caused St. Paul to incur the defense costs, not whether that failure caused the underlying lawsuits.”

The Pulte court found that the trial court had incorrectly relied on Patent Scaffolding Co. v. William Simpson Constr. Co. (1967) 256 Cal.App.2d 506, because that was a case about indemnity for property damage. Instead, the Pulte court said that where the claim is for defense reimbursement, Interstate Fire & Casualty Ins. Co. v. Cleveland Wrecking Co. (2010) 182 Cal.App.4th 23, and Valley Crest Landscape Development, Inc. v. Mission Pools of Escondido, Inc. (2015) 238 Cal.App.4th 468, provide the applicable standard.

The Pulte court listed the eight elements of a cause of action for equitable subrogation: “(1) 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; (2) the claimed loss was one for which the insurer was not primarily liable; (3) the insurer has compensated the insured in whole or in part for the same loss for which the defendant is primarily liable; (4) the insurer has paid the claim of its insured to protect its own interest and not as a volunteer; (5) 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; (6) the insurer has suffered damages caused by the act or omission upon which the liability of the defendant depends; (7) 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 (8) the insurer’s damages are in a liquidated sum, generally the amount paid to the insured.” (Quoting Interstate Fire, supra, 182 Cal.App.4th at pp. 33-34.)

The issue came down to elements two, three and seven – primacy of liability and superior equities. The Pulte court said that in balancing the equities, Interstate Fire and Valley Crest had enumerated four further factors: (1) cause of the loss, (2) nature and scope of the contractual promises; (3) receipt of premiums; and (4) public policy.

The first factor was met because, relying on Interstate Fire and Valley Crest, the Pulte court said that “the primacy of the subcontractor’s liability for defense costs incurred in an action relating to a construction project [is] greater than that of a general liability insurer not involved in the construction project.”

As to the contractual promises, the equities tipped in favor of St. Paul because the subcontractors had agreed to indemnify Pulte against the specific loss incurred: “An entity which, like [the subcontractor], agrees to indemnify the other party to the underlying transaction has a liability of greater primacy than an independent insurer that insures against loss. [] The parties directly involved in the transaction are better able to evaluate and control the risk. Therefore, for purposes of weighing the equities in an equitable subrogation case, . . . the Agreement between the parties who were connected to the incident giving rise to the loss. . . creates the greater equitable responsibility for indemnification, as compared to that of the general liability insurer. . . .” (Quoting Interstate Fire, supra, 182 Cal.App.4th at p. 44.)

Receipt of premiums was deemed a “neutral” factor. And public policy favored subrogation because “denying subrogation would incentivize subcontractors to breach their agreements with general contractors.” Consequently, the Pulte court stated: “[W]e conclude the equities tip slightly in St. Paul’s favor because it had nothing to do with causing the plaintiff homeowners’ property damage, whereas defendants’ work was at least alleged to have contributed to the damage—and those allegations are what precipitated the defense costs.”

Although the underlying bench trial involved evidence of the amounts at issue, the appeals court declined St. Paul’s request to fix numbers on the subcontractors’ respective liabilities, instead stating that any allocation was up to the discretion of the trial court. Nor was it a jury question – the Pulte court rejected an argument that the subcontractors would be entitled to a jury trial on remand, pointing out that the claim was purely equitable in nature, with no right to a jury trial.

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June 16, 2020