This post is a continuation of the series “Minnesota CGL: Getting a Handle on Large Construction Defect Claims.” This post (Part V) addresses the obligation of a subcontractor and its commercial general liability (CGL) insurer with regard to the defense costs (attorney’s fees) the general contractor incurs in the defense of a construction defect lawsuit. Such defense costs may be covered under the “insured contract” provisions of the subcontractor’s policy or the supplementary payments coverage.
It is not uncommon for a subcontractor to obligate itself to indemnify the general contractor against the attorney’s fees the general contractor incurs in defense of a construction defect claim arising out of the subcontractor’s work. Attorney’s fees are the second largest expense – and sometimes the largest expense – associated with litigation. “While litigants in the United States ordinarily must bear their own attorney’s fees in lawsuits regardless of the merits (see, e.g., Morrison v. Swenson, 274 Minn. 127, 137-38, 142 N.W.2d 640, 647 (1966) (discussing the “American Rule”), there are exceptions such as where one party (e.g., subcontractor) expressly agrees in a contract to defend the other party (e.g., general contractor). Parties to a construction project recognize the importance of coupling the indemnity obligation with a promise to pay for the indemnitee’s defense. Indeed, one court has noted that “[a]s a matter of common sense, protection from potentially ruinous defense costs of the indemnitee is as vital to an insured as protection from the indemnitee’s tort liability.” Maryland Casualty Co. v. Nationwide Ins. Co., 65 Cal. App.4th 21 at p. 33, 76 Cal.Rptr.2d 113 (1998). Accordingly, “most construction agreements or contracts require downstream contractors or subcontractors to protect upstream contractors” by way of indemnity provisions, Richmond & Black, Expanding Liability Coverage: Insured Contracts and Additional Insureds, 44 Drake L.Rev. 781, at p. 790 (1996), and many “include language that can be read to require a defense as well as indemnity.” Id. at 793.
Some jurisdictions have held that a contractual promise to indemnify another party automatically includes an obligation to pay the attorney fees incurred by the indemnitee (general contractor) in the defense of a lawsuit. Minnesota has not specifically addressed the question. Prior to the 2001 revisions to the “insured contract” provisions of the standard CGL policy (discussed below), at least one jurisdiction held that attorney’s fees were not covered by the indemnitor’s CGL policy. See, Progressive Cas. Ins. Co. v. Brown’s Crew Car of Wyo., Inc., 27 F. Supp.2d 1288, 1290-91 (D. Wyo. 1998). In Progressive, the court held that a contractual promise to pay another party’s defense costs did not involve a claim for liability to pay for “bodily injury” within the meaning of the indemnitor’s CGL policy and, therefore, defense costs were not included in the “insured contract” provisions. See also, 7A Appleman, Insurance Law and Practice, § 4497.02, p. 128 (1979) (“contract of indemnification of a contractor by a subcontractor does not bind the subcontractor’s insurer to defend a liability action against the contractor, but merely to indemnify the general contractor for liability sustained”).
However, Minnesota and several other jurisdictions recognized that if the indemnity agreement constituted an “insured contract” and expressly required the indemnitor to pay the indemnitee’s defense costs, the indemnitor’s CGL policy would afford coverage for those costs. See, Soo Line Railroad Co. v. Brown’s Crew Car of Wyoming, 694 N.W.2d 109 (Minn. Ct. App. 2005). Typical indemnity clauses obligate the indemnitor (subcontractor) to “hold harmless and indemnify landlord for any loss, costs or expenses, including attorney fees and costs,” or “hold harmless, defend and indemnify” the indemnitee (general contractor. In Soo Line, two employees of Soo Line Railroad Company (Soo Line) were injured while riding in a car operated by Brown’s Crew Car of Wyoming, Inc. (Brown’s). Brown’s was transporting train crews for Soo Line pursuant to an agreement under which Brown’s agreed to indemnify and hold harmless Soo Line from “all claims, demands, costs and expenses including attorney and court costs for any accident, injury, property damage or any other loss incurred by . . . [Soo Line] . . .regardless of the nature of the claim or the theory of recovery . . . including claims that . . . [Soo Line] was at fault, negligent, or strictly liable.” At the time of the accident, Brown was insured under a Commercial Auto policy with Progressive. The injured Soo Line employees sued Brown’s, the driver’s estate, and two restaurants where the driver had consumed alcohol prior to the accident. Soo Line was joined as a third-party defendant. Soo Line tendered the defense of the third-party claims to Progressive and Brown’s. Both refused the tender. Soo Line defended the negligence suits and, although paying nothing in settlement, incurred legal expenses.
Soo Line brought an action to recover its attorney’s fees and costs. The first issue was whether the indemnity agreement between Brown’s and Soo Line constituted an “insured contract” thereby requiring Progressive to reimburse Brown’s for the latter’s liability to Soo Lines under the indemnity agreement. On that issue, the Minnesota Court of Appeals held that “a general indemnity agreement that includes an assumption of tort liability constitutes an insured contract.” Progressive next argued that Soo Line’s attorney’s fees did not constitute “damages” within the meaning of the policy. The court rejected this argument, holding that “Soo Line’s defense costs and attorney fees [were] inseparable from the automobile accident,” a tort claim and, thus, “Progressive [was] liable for all damages, including legal expenses, its insured must pay arising from a claim for tort liability.” The court further noted that the policy did not define “damages.” Relying upon Minnesota Mining & Mfg. Co. v. Travelers Indem. Co., 457 N.W.2d 175, 179 (Minn.1990), “damages” “can reasonably be interpreted to cover any claim asserted against the insured arising out of property damage, which requires the expenditure of money, regardless of whether the claim can be characterized as legal or equitable in nature.”
Other jurisdictions reached the same conclusion as the Minnesota Court of Appeals in Soo Line. See, e.g., Perkins State Bank v. Connolly, 632 F.2d 1306 (5th Cir. 1980); American Home Assur. Co. v. Hapag Lloyd Container Line, 385 F. Supp. 2d 316 (S.D. N.Y. 2005); Kaydon Acquisition Corp. v. Custum Mfg., Inc., 317 F. Supp. 2d 896 (N.D. Iowa 2004); Eutectic Corp. v. M/V Gudmundra, 367 F. Supp. 681 (S.D. N.Y. 1973); Brown v. Financial Indemnity Co., 366 So. 2d 1273 (Fla. App. 1979); Parker v. Stern, 499 S.W.2d 397 (Mo. 1973). Cf Ryland Mortgage Co., Inc. v. Travelers Indemnity Co. of Illinois, 177 F. Supp.2d 435, 437 (D. Md. 2001) (no dispute that contractual liability coverage extended to indemnitor’s defense costs, notwithstanding fact that provision did not expressly include defense costs). These holdings were supported by an August 1996 Fire Casualty & Surety Bulletin published by the National Underwriters Association. In this bulletin, the NUA addressed the issue of “whether the contractual coverage offered under the CGL form extends defense cost coverage to the entity whose liability has been assumed by the insured through an insured contract.” The bulletin concluded that when an insured contract included the assumption of the indemnitee’s attorney fees and costs, such expenses were covered “damages” under the policy.
In 2001, ISO changed the “insured contract” provisions of the CGL policy and essentially incorporated the conclusion reached by the Minnesota Court of Appeals in Soo Line Railroad Co. v. Brown’s Crew Car of Wyoming, 694 N.W.2d 109 (Minn. App. 2005) and above-cited cases. The standard CGL policy now provides that “for the purposes of liability assumed in an ‘insured contract,’ reasonable attorneys’ fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages because of ‘bodily injury’ or ‘property damage,’ provided: “[l]iability to such party for, or for the cost of, that party’s defense has also been assumed in the same ‘insured contract’, and such attorneys’ fees and litigation expenses are for defense of that party . . . in which damages to which this insurance applies are alleged.”
It is important to recognize that the defense cost reimbursement provisions of the “insured contract” coverage do not extend “insured” status to the general contractor and, thus, do not obligate the subcontractor’s CGL insurer to assume the defense of the general contractor. The subcontractor’s CGL insurer has no right to appoint defense counsel, much less control or otherwise participate in the defense of the general contractor under these provisions. Rather, this provision simply obligates the subcontractor’s CGL insurer to reimburse the named insured subcontractor for its liability to the general contractor for the latter’s defense costs. Similarly, the subcontractor’s CGL insurer has no obligation to advance defense fees to the general contractor during the course of the main litigation. Additionally, because defense costs are “deemed to be damages because of ‘bodily injury’ or ‘property damage,’” the payment of such defense costs will serve to reduce the limits of liability available to the subcontractor under its CGL policy. See, Croskey et al., Cal. Practice Guide: Insurance Litigation, ¶ 7:1475, p. 7E-26 (2001) (“Because defense costs assumed by the insured are covered as ‘damages,’ they reduce indemnity limits on all claims covered by the policy . . .”).
It is also important to recognize the distinction between the attorney’s fees the general contractor (a) incurs in the defense of the underlying action (which, as noted above, may be covered by the subcontractor’s policy) and (b) those incurred in the prosecution of an indemnity claim against the indemnitor-subcontractor (which are not be covered). The case of Seifert v. Home Insurance Company, 505 N.W.2d 83 (Minn. Ct. App. 1993), rev. denied (Minn. Oct. 28, 1993), illustrates the difference between these two types of attorney’s fees. In that case, the Regents of the University of Minnesota (“Regents”) contracted with NewMech Company to remodel a building on the university campus. In 1987, Seifert, an employee of NewMech was injured on the job site and sued several parties including the Regents. In January 1989, the Regents tendered the defense of the lawsuit to NewMech, but NewMech did not accept the tender. The Regents commenced a third-party indemnity claim against NewMech under the construction contract. On January 7, 1990, after determining that NewMech had purchased a policy with St. Paul Companies, the Regents tendered the claim to St. Paul Companies. St. Paul Companies accepted the tender and settled with Seifert for $2,500. St. Paul Companies also reimbursed the Regents for the attorney’s fees it incurred in the defense of the underlying lawsuit between January 7, 1990 and the date of the settlement ($5,693.76), but refused to reimburse pre-tender fees. In April 1992, the Regents brought a motion for summary judgment on the indemnification claim, contending that it was entitled to attorney’s fees and costs from NewMech in excess of $105,000, consisting of the fees it spent in the defense of the underlying case and the fees it incurred in prosecuting its indemnity claim against New Mech. The construction contract in Seifert “required NewMech to obtain insurance to cover its indemnification obligation to the Regents” and “NewMech purchased insurance to cover ‘any claim arising out of the insured hold harmless agreement.” Seifert, 505 N.W2d at 86. (Because the indemnity obligation was coupled with an obligation to insure, the indemnity agreement was enforceable under Holmes v. Watson-Forsberg Co., 488 N.W.2d 473, 475 (Minn. 1992)). The Minnesota Court of Appeals denied the Regents’ claim for fees related to its pursuit of the indemnity claim. Id. The court interpreted the indemnity clause language — which obligated New Mech to indemnify the Regents against all “claims, damages losses and expenses including attorney’s fees” — to only require NewMech to reimburse the Regents for those fees the latter incurred in connection with its defense of the underlying lawsuit, not fees incurred to establish a right of indemnity. Id. at 86. The court also held that the Regents were not entitled to recover pre-tender defense fees. The law firm representing the Regents did not tender the lawsuit to NewMech for almost a year after commencing representation and “a tender of defense is a condition precedent to the creation of an obligation to indemnify.” Id. at 87 (citing Jack Frost, Inc. v. Engineered Bldg. Components Co., 304 N.W.2d 346, 353 (Minn. 1981)). As a result of the court’s various rulings, the Regents were only entitled to recover the attorney’s fees it incurred in the defense of the underlying lawsuit between January 1989 and January 1990, a small fraction of the $105,000 it originally sought.
In addition to the “insured contract” defense cost reimbursement provisions, the standard CGL policy also provides “Supplementary Payments” coverage. The Supplementary Payments provision obligates the subcontractor’s CGL insurer to defend the general contractor if the “indemnitor has assumed the liability of the indemnitee in a contract or agreement that is an ‘insured contract’ and the “obligation to defend, or the cost of the defense of, the indemnitee has also been assumed by the indemnitor in the same ‘insured contract.’” In order to invoke this coverage, a series of conditions must be satisfied. Among other requirements, there must be no conflict of interest between the subcontractor and the general contractor and both parties must ask the insurer to conduct and control the defense. In addition, the parties must further agree that the insurer may assign the same counsel to defend both of parties. Unlike the “insured contract” defense cost provisions, payment of the general contractor’s defense costs under the supplementary payments provision does not reduce the limits of liability. As noted by one court, the supplementary payments provision “recognizes that in some circumstances it is in the insured’s interest to have the insurer pay for the [general contractor’s] idefense without having that payment reduce payments from the insurer for the tort liability the insured has assumed [as is the case under the “insured contract” provisions]; and it is in the insurer’s interest to minimize its obligation with the efficiency of a combined defense where feasible and where agreeable to the insured.” Berg v. Gulf Underwriters Ins. Co., 756 N.W.2d 478 (Table), 2008 WL 2522341 (Wis. Ct. App. IV Dist. 2008).
Mr. Johnson has represented CGL insurers, general contractors, subcontractors and suppliers in large commercial and multi-unit residential construction defect claims for twenty years. He successfully handled the seminal construction defect case in Minnesota, Wooddale Builders, Inc. v. Maryland Cas. Co., 722 N.W.2d 283 (Minn. 2006), and has authored several articles on insurance coverage for construction defect claims including Contractual Risk Transfer, Hold Harmless and Indemnity Agreements and Additional Insured Coverages (Wells Fargo March 15, 2009) and Liability Allocation Issues: “Other Insurance” & the Wooddale Home Builder Construction Decision (Minnesota Defense Lawyers Association Insurance Law Institute, Jan. 25, 2007).
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