Can You Settle Your Third-Party Claim While in Coverage Purgatory?

P. Wesley Lambert | Brouse McDowell | November 13, 2017

Most commercial general liability (CGL) policies grant control over the defense and settlement of third party claims to the insurer. Thus, the right to settle, or not settle, a third-party claim against the policyholder resides with the insurer. However, when an insurance company breaches its policy, for example by wrongfully refusing its duty to provide a defense to its policyholder, the policyholder may settle the claim against it without securing the insurer’s consent. Sanderson v. Ohio Edison Co., 69 Ohio St. 3d 582, 635 N.E.2d 19 (1994). Conversely, when the insurance company is honoring its defense obligation, even under a reservation of rights to later contest coverage, the policyholder must respect the policy’s grant of control of the settlement process to the insurer or risk losing coverage for any settlement reached without the insurer’s consent.

But, what happens when the insurer is providing a defense to the insured, and thus technically complying with the policy’s terms, yet has made it clear that it will not actually indemnify the policyholder for any settlement or judgment? These situations leave the policyholder in a sort of coverage purgatory – it is receiving the defense coverage it bargained for, but not the indemnity coverage. Policyholders may want to resolve the claims against them in order to limit their liability, but may also be afraid that doing so will result in a forfeiture of coverage for the settlement amount.

Fortunately, courts have constructed an alternative path for policyholders stuck in these situations, holding that insures may not leave their policyholders in limbo by controlling the policyholder’s defense but unequivocally refusing to indemnify the policyholder for any settlement or judgment. In Ward v. Custom Glass & Frame, Inc., 105 Ohio App.3d 131 (8th Dist. 1995) and Patterson v. Cincinnati Ins. Cos., 2017-Ohio-2981, 2017 WL 2291605 (8th Dist. Aug. 22, 2017), the Eighth District Court of Appeals held that when an insurer clearly indicates that it will not indemnify the policyholder, the policyholder is relieved from the obligation to secure the insurer’s consent prior to settling the claim against it.

In both cases, the policyholder was subject to a third-party claim that the insurer had agreed to defend. However, the insurer in both cases stated, in no uncertain terms, that it would not indemnify the policyholder if there were a judgment against it. Thus, the insurance companies maintained that they had the right to control the policyholder’s defense, and its ability to settle the claim, but that it would not actually fund any settlement or ultimate judgment. The policyholder, left with no other option, settled the claim itself, while at the same time keeping the insurer apprised of the settlement negotiations.

The insurers in both cases argued that the policyholder’s disregard of the policy’s consent to settle provision relieved the insurers from the obligation to cover the settlements. Both courts disagreed. The Ward court was particularly critical of the insurer’s conduct, holding that “[w]hen an insurance company refuses to provide coverage and at the same time seeks to maintain control of the same litigation, it . . . creates a frustration of purpose. Such conduct would compel a person of reasonable faculties to cut his costs and settle a lawsuit to avoid the possibility of a higher judgment.” Ward, 105 Ohio App.3d at 137. Thus, when an insurance company maintains that coverage does not exist, it “must make a clean break from the case and should not subject the insured to a guessing game or by its conduct cause the insured to incur more expenses than necessary.” Id. The Patterson similarly noted the “frustration of purpose” created when the insurer controls the defense of an action while at the same time disclaiming its duty to indemnify. Patterson, 2017-Ohio-2981 at ¶30.

Thus, policyholders trapped in coverage purgatory may look to Ward and Patterson for support when deciding whether they may settle a case against them without violating their policy’s consent to settle provision. It is important to note, however, that in both cases the policyholder kept the insurer apprised of the settlement negotiations and offered them the opportunity to remain involved in the process. While it is unclear whether this impacted the courts’ analysis of the case, policyholders would be well-advised to keep the lines of communication open with their insurer despite the ostensible breach of the policy’s indemnification obligation.

Construction Contracts, Third Party Claims and Tort Law Liability

Carl R. Pebworth | Faegre Baker Daniels | October 5, 2017

What tort obligations does a design professional on a construction project owe to non-parties — like, for example, the persons who will use what has been designed after it is built? Tort law involves the idea of a duty of care that the design professional owes to others arising out of the designer’s professional expertise and certification. Matters involving a design professional’s tort obligations typically raise the following issues:

  • The nature and extent of the professional’s duty of care to others
  • What kinds of damages can be recovered if this duty of care is breached
  • What is necessary to prove that a third party has been damaged by the breach

Contracts and Establishing the Standard of Care

In one Illinois case, a court addressed whether an engineer who had contracted to design a “replacement” for a bridge deck had a professional obligation to “improve” the bridge deck after it failed and third-party motorists were killed. In other words, did the design professional have an independent obligation to go beyond replacing the bridge deck, as the contract stipulated? The Supreme Court of Illinois said no, granting summary judgment as a matter of law in favor of the engineer as to the deceased motorists’ claims.

In this case, there was a contract that prescribed the duty of care that the design professional agreed to meet: “the degree of skill and diligence normally employed by professional engineers or consultants performing the same or similar services.” These contract obligations trumped the standard of care that would exist absent a contract: “the use of the same degree of knowledge, skill and ability as an ordinarily careful professional would exercise under similar circumstances.” While these standards look similar, they differ because one recognizes the limitations that the parties agreed to in their contract limit the engineer’s duty to others. Because the contract specifically required replacement — and not redesign — of the bridge deck, the engineer could not be held liable for failing to go beyond the contractual scope of duty.

The engineer could have been found liable to third parties if he had been negligent in performing services relating to the replacement of the bridge deck — that was in the scope of what the engineer had agreed to do. Moreover, the engineer could have assumed additional liability by voluntarily attempting to improve the bridge deck and delivering a poor or defective product.

Contracts and the Economic Loss Doctrine

A design professional’s obligations to third parties are further limited by the “economic loss doctrine,” which applies to claims that do not involve physical harm. This doctrine prevents a party from pursuing a claim for economic or commercial losses arising from an alleged breach of a duty of care if the design professional’s contract precludes recovery of consequential or tort-based damages. Put simply, the contract’s limitation of damages can preempt economic loss liability even in cases where a professional failed to meet the duty of care.

Another question that arises if a duty of care is present and a third party has suffered damages is whether the breach of the duty has “proximately caused” these damages. Here, many courts — including the Illinois court — look at what the professional has contractually agreed to do. If injury results from something reasonably within that contractually defined responsibility, a design professional can be seen to proximately cause damages that flow from the designer’s failure to competently perform those duties.

In Conclusion: Know (and Perform) Your Contractual Duties

In summary, a design professional’s contract serves to confine and to define the designer’s obligations — not just to the design professional’s client, but also to third parties with whom the designer does not have a contractual relationship. As long as the design professional sticks to what the designer has contracted to do and does that work professionally, the designer cannot be obligated to go beyond those duties.

The Impact of Sopris Lodging v. Schofield Excavation on Timeliness of Colorado Construction Defect Claims

Jean Meyer | Colorado Construction Litigation | January 23, 2017

On October 20, 2016, the Colorado Court of Appeals announced the Sopris Lodging, LLC v. Schofield Excavation, Inc.[1] decision. The Sopris decision significantly altered the potential pitfalls awaiting a general contractor in pursuit of third-party claims as well as potential defenses available for a subcontractor defending against third-party claims.

By way of background, the Sopris construction defect case arose out of the following facts: TDC was the general contractor for the construction of a hotel owned by Sopris Lodging. On March 11, 2011, Sopris Lodging sent TDC a notice of claim regarding alleged construction defects. On May 24, 2013, Sopris Lodging filed a complaint in district court asserting construction defect claims against one of the subcontractors of the hotel, and against the general contractor’s principals, but not the general contractor. Contemporaneous with the filing of the suit, Sopris Lodging and TDC entered into an agreement to toll the statute of limitations on Sopris Lodging’s potential claims against TDC.  In August 2013, Sopris Lodging joined the general contractor to the suit. A year later, in 2014, the general contractor joined a variety of subcontractors as third-party defendants.

In response to the general contractor’s third-party claims, some of the subcontractors moved for summary judgment, asserting that the general contractor’s claims against them were barred by the two year-year statute of limitations set forth in C.R.S. § 13-80-102. The subcontractors argued that the claims against the subcontractors accrued when Sopris Lodging delivered its notice of claim to TDC in March 2011. Because the general contractor did not file its third-party claims until 2014, the subcontractors asserted that the claims against them were time barred.

In response to these arguments, the general contractor asserted that C.R.S. § 13-80-104(1)(b)(II) tolls the statute of limitations for a defendant’s third-party claims until ninety days after a settlement or final judgment on the plaintiffs’ claims against the defendant. However, the trial court ruled that C.R.S. § 13-80-104(1)(b)(II) did not apply and that the general contractor’s claims against the subcontractors were time barred. After the trial court’s ruling, Sopris Lodging settled with TDC, which assigned its claims against the subcontractors to Sopris Lodging.  Thereafter, Sopris Lodging filed this appeal asserting that C.R.S. § 13-80-104(1)(b)(II) did in fact toll TDC’s claims.

The Court of Appeals ruled that if a third-party plaintiff brings third-party claims in the underlying construction defect case, the third-party claims must be timely pursuant to C.R.S. § 13-80-102 and that that the tolling provision set forth in C.R.S. C.R.S. § 13-80-104(1)(b)(II) does not provide for a blanket tolling of third-party construction claims. Rather, C.R.S. § 13-80-104(1)(b)(II) provides for a discrete (ninety day) revival of third-party claims after resolution of the underlying construction defect claims. The Colorado Court of Appeals acknowledged that this analysis could lead to a “somewhat anomalous conclusion” that the statute of limitations applicable to general contractors could expire before the first-party plaintiff filed suit against a general contractor. Nevertheless, the Court of Appeals recommended that where such an outcome is possible, a general contractor has the following options to preserve its claims against subcontractors: 1) when a general contractor receives a notice of claim, the general contractor should send its own notices to subcontractors; 2) in the alternative, where it is possible that third-party claims may expire, the general contractor should enter into a tolling agreement with the subcontractors; or 3) the general contractor could just wait until the resolution of the underlying construction defect case and bring suit during that ninety day revival period set forth in C.R.S. §13-80-104(1)(b)(II).  That said, if a contractor were to use this third option, its claims would still need to be brought within Colorado’s six-year statute of repose.  Colorado courts, however, will not entertain third-party claims against subcontractors that are not timely.

In conclusion, before a general contractor brings suit against a subcontractor, nuanced analysis is necessary to preserve the timeliness of claims against subcontractors.

[1] Sopris Lodging, LLC v. Schofield Excavation, Inc., 2016 COA 158, reh’g denied (Nov. 23, 2016).

How To Protect Yourself Against Surprise Parties To Contracts

Natalie Dolce | GlobeSt.com | April 6, 2016

Under classic contract law, if a party breaches a contract, in most cases only the parties to the agreement have the right to enforce its terms. However, courts are increasingly granting third parties the right to enforce a contract, even when they are a stranger to said contract. Those thoughts are according to Michael Polentz and Payvand Abghari at law firm Manatt, Phelps & Phillips. “The driving force behind the third-party beneficiary doctrine is not the desire to contradict the will of the contracting parties, but to decipher what the parties actually intended where the document itself may not be so crystal clear.” The sources dive deeper into the subject in the commentary below.

The views expressed below are the author’s own.

While courts throughout the country vary on how they may interpret these agreements, the overarching concept is for the contracting parties to have intended for a third party to benefit.  In a California case, Sessions Payroll Management, Inc. v. Noble Construction, Inc., the court held that “a party not named in the contract may qualify as a beneficiary under it where the contracting parties must have intended to benefit the unnamed party and the agreement reflects that intent.”  The mere fact that a third party is incidentally named, or that the contract benefits them, does not entitle them to enforce it; the intent of the parties to benefit such third party must be clearly established in the language of the contract and the circumstances of the transaction.

The implications of the third-party beneficiary doctrine are far reaching. For example, in the construction industry, while the majority rule is that a property owner is not an intended beneficiary of a subcontract between a general contractor and a subcontractor, at least one California court has ruled this to be the case.  In Gilbert Financial Corp. v. Steelform Contracting Co., a building owner entered into a construction contract with a general contractor, who then entered into a subcontract with a roofer.  After the project was completed, the roof began to leak. The owner sued the roofer directly, claiming that the owner was a third-party beneficiary to the roofer’s subcontract with the general contractor.

On appeal, the court concluded that since the general contractor’s prime contract with the owner required it to furnish all necessary labor and materials to complete the project, and since the roofer entered into the subcontract for the purpose of furnishing labor and materials for the roof, then clearly the roofer must have realized it had assumed the general contractor’s duties for this phase of the project and that the owner was the ultimate, intended beneficiary of its performance under the subcontract.

While more recent California rulings have taken deliberate steps to discourage parties in construction defect matters from placing blame on outside parties with whom there is no “privity”, the rules are not always steadfast and parties are encouraged to take protective measures against unintended liability to outsiders.

To make their intentions clear, contracting parties often include a “no third-party beneficiary” clause in hopes such language will insulate them from third-party claims. However…

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Architects and Design Professionals Can Be Held Liable For Defects Based On Third Party Claims

Joseph M. Fenech, Esq. | Low, Ball & Lynch

A homeowners association, on behalf of its members, sued a condominium developer and various other parties for construction design defects that allegedly made their homes unsafe and uninhabitable for a significant portion of the year. Two defendants were architectural firms that allegedly designed the homes in a negligent manner but did not make final decisions regarding how the homes would be built. Applying the Supreme Court’s decision in Bily v. Arthur Young & Company (1992) 3 Cal.4th 390, and relying on the Weseloh Family LTD. Partnership v. K. L. Weseloh Construction Company, Inc. (2004) 125 Cal.App.4th 152, the trial court sustained a demurrer in favor of the defendant architectural firms, reasoning that an architect who makes recommendations but not final decisions on construction has no duty of care to future homeowners with whom he has no contractual relationship. The Court of Appeal reversed, concluding that the architect owes a duty to homeowners in these circumstances, both under common law and under the Right to Repair Act (Civil Code Section 895 et seq.) The Supreme Court agreed and held that the homeowner may state a cause of action against a design professional for negligence.

Skidmore, Owings & Merrill LLP (SOM) and HKS, Inc., (HKS) were architectural firms (“defendants”) who provided architectural and engineering services to the Beacon Residential Condominiums (“the Project”), a residential community in San Francisco.

The Beacon Residential Community Association (BRCA) sued SOM and HKS. BRCA alleged numerous construction defects as a result of negligent architectural and engineering design and observation. BRCA also complained of “solar heat gain,” excessively high temperatures resulting from the defendants’ approval of inexpensive and nonfunctional windows, and a design lacking adequate ventilation within the residential units. The defendants were named in three causes of action: Civil Code Title 7 – Violation of Statutory Building Standards for Original Construction; Negligence Per Se in Violation of Statute; and Negligence of Design Professionals and Contractors.

The defendants demurred to the complaint, arguing that under Bily v. Arthur Young & Co.(1992) 3 Cal.4th 370 and Weseloh Family Ltd. Partnership v. K.L. Wessell Construction Co., Inc. (2004) 125 Cal.App.4th 152, they owed no duty of care to BRCA or its members. The trial court sustained the demurrers and dismissed the case. The trial court reasoned that liability could not be premised on negligent design because without privity of contract, BRCA was required to show that the design professionals had “control” in the construction process and assumed a role beyond that of providing design recommendations to the owner. The court believed that BRCA failed to meet its burden.

The Court of Appeal reversed, holding that BRCA could state a claim based on design liability that was recognized both under common law and statutory law. The Court distinguished Weseloh, in which judgment was affirmed in favor of design engineers who were sued after a retaining wall failed. There, the outcome was premised on the evidentiary record before the court and was of limited guidance. The Court said that no California court has yet extended Weseloh to categorically eliminate negligence liability of design professionals to foreseeable purchasers of residential construction. The Court also observed that in Cooper v. Jevne(1976) 56 Cal.App.3d 860, an architect’s duty of reasonable care is logically owed to those who purchase an allegedly defectively designed and built condominium.

The Supreme Court granted review. It began its discussion by pointing out that although liability for the supply of goods and services historically requires privity of contract between the supplier and the injured party, the significance of privity has been greatly eroded over the past century. The declining significance of privity had found its way into construction law. The Court noted that it had previously found that manufacturers of defective ladders, elevators, and tires could be liable to persons who were not in contractual privity with them but foreseeably injured by their products. Courts usually apply the same rule to someone responsible for part of a house; e.g., a defective railing.

In addition, the Court said that these third party liability principles had always been applied to architects where the architect plans and supervises the construction work and provides protection to any person who is foreseeably harmed. Generally, liability for deficient goods and services hinges on whether there is a relationship between the buyer and seller. However, the Supreme Court recognized that in certain circumstances a contractual relationship is not necessarily required. In this ruling, it relied on 50-year old precedents in Biankanja v. Irving(1958) 49 Cal.2nd 647. In Biankanja, the California Supreme Court outlined several factors which determine whether a duty of care is owed to non-contracted third parties. Biankanjaanalyzed many factors, including whether the declared harm was foreseeable from a defendant’s conduct and how close of a connection there was between the conduct and the injuries.

The Court recognized that even though the design firms did not actually build the project, they conducted weekly inspections, monitored contract compliance, monitored design elements when issues arose, and advised the owners of any non-conforming work. In applying theBiankanja factors to these circumstances, the Supreme Court determined the homeowners were intended beneficiaries of the design work, and the design in the project bore a close connection to the alleged injuries. As a result, the Supreme Court held that the allegations in the complaint were sufficient, and if proven, established that the defendants owed a duty of care to the homeowners association.

COMMENT AND EVALUATION

This case will affect how design professionals…

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