A recent case questioned the legal basis for an intervening insurance company, on behalf of its suspended developer insured, to directly sue subcontractors for various causes of action including: indemnity, breach of warranty, declaratory relief, negligence, and most notably breach of contract for failure to obtain additional insured endorsements and duty to defend. In the case, the insurance company is not the contracting party – as in most cases – yet is suing as though it is a direct party to the contract. This gives rise to the question:
Does an intervening insurance company have any legal basis for bringing breach of contract causes of action against subcontractors?
The short answer, Yes. An intervening insurance company has a legal basis for bringing a breach of contract cause of action against subcontractors. Although there are no cases directly on point, Western Heritage Ins. Co. v. Superior Court, (2011) 199 Cal.App.4th 1196, does provide insight into the rights and remedies of an intervening insurance company. Western Heritage involved claims of negligence and breach of contract against Grateful Home Care, Inc. (GHC) and its employee (Reyes) which resulted in the death of GHC resident. Western Heritage Insurance Company (WHIC) insured GHC and its employees. Upon tendering the case to WHIC, WHIC proffered a defense for both GHC and Reyes. Reyes’ counsel filed an answer on her behalf. However, it was later stricken and default entered against Reyes because it appeared she permanently left the country.
A defaulted party, like a suspended corporation, has no legal rights or remedies before a court until the default is set aside or the suspended corporation pays its taxes. (Mackie v. Mackie (1960) 186 Cal. App.2d 825; Cal. Rev. & Tax Code § 23301.) Since a default was entered against Reyes, WHIC requested to intervene on Reyes’ behalf to protect its own interests as insurer of GHC’s employees. The trial court denied WHIC’s motion to intervene on the theory that a defaulted party is unable to contest liability. Therefore, the insurance company is not permitted to defend its insured’s liability, but is allowed to litigate damages assessed against the insured.
The Court of Appeal overturned the trial court’s denial. It did so on the following basis:
“It is therefore apparent that an intervening insurer is not limited to those defenses to which its insured might be restricted due to the procedural default. The entire purpose of the intervention is to permit the insurer to pursue its own interest, which necessarily include the litigation of defense its insured is procedurally barred from pursuing.”
Accordingly, an intervening insurance company may utilize the same defenses available to its insured had the insured not been procedurally barred. This leads to the subsequent question:
Is a breach of contract cause of action considered a “defense?”
The answer is dependent on the terms of the insurance policy. Many insurance policies commonly use commercial general liability forms regarding assignments. If a policy contains a broad assignment of rights, an insurance company may stand in the shoes of its insured and sue for breach of contract (including failure to obtain additional insured endorsements, and breach of a duty to defend). The breach acts as a defense to any potential liability the insured may face, and thus the potential liability of the insurance company itself.
On the other hand, if an insurance policy does not contain a broad assignment of rights, a determination as to whether the breach of contract claim is a defense would be necessary. We turn to Bramalea and Patent Scaffolding for guidance. These cases ponder and suggest if a windfall or affirmative recovery will occur, then the claim must cease. In addition, should the claim being sought by the insurance company not be directly and contractually linked to the damages sought by plaintiffs, it would be unjust to allow the insurance company to bring such a claim. (Bramelea California, Inc. v. Reliable Interiors, Inc. et al.(2004) 119 Cal.App.4th 468; Patent Scaffolding Co. v. William Simpson Const. (1967) 256 Cal.App.2d 506, 511.)
Suppose the intervening insurance company sues for 1) Breach of Contract – Additional Insured Obligations, 2) Breach of Contract – Duty to Defend, and 3) Breach of Express Warranty. Where the breach of contract action can be directly linked to the damages sought by plaintiffs (i.e. breach of express warranty), this is considered a defense, and allows an intervening insurance company to continue the claim. Otherwise, it would prevent the intervening insurance company from arguing but for the breach of express warranty by the subcontractor, it would not be defending against plaintiffs’ claims for damages to their property.
Conversely, where the breach of action is for failure to provide additional insured endorsements (AIE) to the contractor, or a breach of contractual duty to defend (we are presuming here a duty to defend is inherent and taken as a given), we believe a court will find this claim to be an affirmative recovery action and not a defense. This leads into a two part question on whether the court will determine the claim an affirmative recovery or a defense.
Is there a link to the damages sought by plaintiffs and the claim, and under what theory does the insurance company claim it has a right to bring such a claim?
On one hand, the argument may stand if an insurance company is entitled to sue, and later receives a judgment for breach of contract for a subcontractor’s failure to provide an AIE to the contractor and/or its failure to defend the contractor, it could be considered unjust and a windfall to the insurance company. An insurance company is paid a premium to defend its insured against losses. Based on the above-mentioned theory of recovery, the insurance company is now recouping those loses and keeping the premiums paid (i.e. a windfall). On the other hand, an insurance company may have an argument it is a third party beneficiary to the contract in that it is excess to any AIEs and a subcontractor’s duty to defend the claims. These arguments as a third party beneficiary would be speculative and challenging. Either way, it will be a question for the trier of fact.
What should a subcontractor do if sued by an intervening insurance company for breach of contract?
A subcontractor should ensure the intervening insurance company does have a legal basis for suing under the theory of breach of contract. Although it appears an intervening insurance company does have the right to bring breach of contract causes of action, some may be outside the rights afforded to the insurance company.
Michelle L. Wiederhold is an Associate with Kring & Chung, LLP’s Sacramento, CA office. She can be contacted at (916) 266-9000 or [email protected].