Court of Appeals Weighs in on Contribution Actions Between Insurance Carriers in Construction Defect Actions

Date: November 28th, 2012 by Paul T. McBride No Comments

A recent insurance law decision by the California Court of Appeals, St. Paul Mercury Insurance v. Mountain West Farm Bureau Mutual Insurance, (2012) 210 Cal.App.4th 645, clarifies the role and obligations of insurance carriers for subcontractors involved in construction defect litigation. This decision potentially sounds a very ominous note for both subcontractors and their carriers as it makes clear the peril inherent in refusing the general contractor’s demand for a defense at the outset of a case.

Jacobsen Construction was the general contractor on a condominium project in Jackson Hole, Wyoming. Teton Builders was the rough framing subcontractor. Jacobsen was insured by St. Paul Mercury (“Mercury.”) Teton was insured by Mountain West. Mountain West issued an additional insured endorsement to Jacobsen, agreeing to defend Jacobsen from any claims arising from Teton’s work.

Jacobsen completed 90% of the project and then was fired by the developer. Jacobsen sued the developer for breach of contract. The developer cross-complained against Jacobsen for construction defects at the project. The developer’s expert filed a report citing numerous construction defects, many of which involved the framing. Jacobsen cross-complained against Teton and other subcontractors in the construction defect action. Jacobsen tendered its defense to Mountain West as an additional insured on Teton’s policy. Mountain West refused to accept the additional insured tender. However, it did retain defense counsel to defend Teton and did participate in settlement negotiations in the case.

The construction defect case eventually settled for $3,070,000. Of this total amount, Jacobsen (through Mercury) contributed $2,265,000. Teton contributed only $100,000. The settlement agreement released all claims by and between Jacobsen and Teton, but reserved all claims by Jacobsen’s insurer, Mercury, against Teton’s insurer, Mountain West. Mercury spent $1,780,000 defending Jacobsen in the action.

Mercury filed an equitable contribution action against Mountain West, contending that both it and Mountain West were jointly obligated to defend Jacobsen, and that Mercury paid more than its fair share of both defense costs and indemnity costs for Jacobsen. Accordingly, it demanded that Mountain West reimburse Mercury for a portion of defense and indemnity costs Mercury incurred in the case.

At a bench trial, the Court found:

1) That Mountain West had a duty to participate in the defense of Jacobsen and failed to do so.

2) That Mountain West’s fair share of the $1,780,000 spent by Mercury in defending Jacobsen was 43%, or $731,000.

3) That Mountain West fair share of the $3,070,000 total paid to settle the case was also 43%, or $1,320,000.

The trial court’s assessment of 43% as Mountain West’s fair share of both defense and indemnity was based on evidence produced at trial by Jacobsen’s expert showing that a large percentage of the construction defect claims in the case related to the framing.

On appeal, the court sustained the trial court’s finding, reasoning as follows:

1) Mountain West claimed that, by retaining defense counsel to defend Teton in the case, it defended the framing allegations and discharged its defense obligation to Jacobsen. The Court rejected this argument, stating that the additional insured endorsement issued by Mountain West to Jacobsen required Mountain West to directly participate in the defense of Jacobsen, which means paying a fair share of Jacobsen’s attorney and expert fees.

2) Mountain West claimed it was unfair to saddle it with 43% of Jacobsen’s defense costs when it was one of 18 subcontractors who were named as cross-defendants. The court rejected this argument because equitable contribution requires a co-insurer to pay its fair share, not its pro rata share. Given how much of the claim was based on alleged framing defects, it was fair for the trial judge to allocate 43% of the settlement and of defense costs to the framer’s insurance company.

3) The court held that, by failing in its duty to defend Jacobsen, Mountain West was precluded from challenging the reasonableness of either the settlement amount paid by Jacobsen’s insurance carrier, or the amount of defense costs incurred and paid by Jacobsen’s insurance carrier.

The lessons to be drawn from this case by subcontractors and insurance carriers are:

1) If you are an insurance carrier who has issued an AI endorsement, you refuse a tender of defense from the general contractor at your own peril;

2) If you are a subcontractor who has been issued a Crawford tender of defense from the general contractor, put pressure on your insurance carrier to honor its AI endorsement if it issued one, since developer will use this case, in combination with Crawford, to come after you for your “fair share” of its defense costs at the end of the case;

3) If you are an insurance carrier who has issued an AI to the general contractor, simply hiring a defense counsel for your subcontractor insured will not discharge your defense obligations to the general contractor, even though your defense counsel is defending the allegations relating to your insured’s work. You must also pay your fair share of the developer’s attorney’s fees;

4) If you are a subcontractor who has retained your own defense counsel to defend the case, it is unclear whether doing so will allow you to satisfy your Crawford defense obligation to the general contractor. The general contractor will use this case to argue that you must also pay your share of its defense costs. You will argue back that you are not an insurance carrier and that this case only interprets the obligations of insurance carriers;

5) The fair share of the general contractor’s defense costs to be borne by any particular subcontractor will be determined by evaluating the plaintiffs’ defect report and cost of repair estimate and determining how much of the claims and costs relate to a particular subcontractor’s work. The framer may be required to pay the most; and

6) Finally, if you are an insurance carrier who has refused an AI tender, be mindful that a settlement of the case which reserves AI issues not only leaves you open to a suit for defense costs, it can also leave you open to a suit for reimbursement of indemnity costs.

Paul T. McBride is a Partner with Kring & Chung, LLP’s Sacramento, CA office. He can be contacted at (916) 266-9000 or pmcbride@kringandchung.com.

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