Is It Legal To Require Indemnification On Project Application Or As Condition Of Approval?

Ryan Michael Leaderman and Paloma Perez-McEvoy | Holland & Knight

Highlights

  • Local agencies routinely require project applicants to agree to indemnification on application forms or as conditions of approval. These agreements or conditions of approval typically include language requiring an applicant to agree to defend, indemnify, protect and hold harmless the local agency in any action arising from the application.
  • In San Luis Obispo Local Agency Formation Commission v. City of Pismo Beach (San Luis Obispo), the Second Appellate District Court of Appeal of California struck down San Luis Obispo Local Agency Formation Commission’s assertion that it had an “implied power” to contract for fees by inserting an indemnity agreement into its annexation application.
  • The court’s decision is significant because it holds the door open to potentially challenge such practices if there is a statutory limitation on a local agency’s authority to impose fees, as was the case in San Luis Obispo.
  • The Subdivision Map Act (Gov. Code § 66410 et seq.) expressly permits, with certain qualifications, a local agency to impose indemnity provisions in applications or conditions of approval for claims arising out of the subdivision. For a subdivision, there is statutory authority that would allow a local agency to impose indemnification.

Local agencies routinely require project applicants to agree to indemnification on application forms or as conditions of approval. These agreements or conditions of approval typically include language requiring an applicant to agree to defend, indemnify, protect and hold harmless the local agency in any action arising from the application. Indemnification obligations would expose an applicant to various unknown costs that may occur after the processing of the application, even for expenses that are not under his or her control.

In a recent Second Appellate District Court of Appeal of California decision, San Luis Obispo Local Agency Formation Commission (LAFCO) v. City of Pismo Beach (City), Case No. B296968 (March 3, 2021) (San Luis Obispo), the court struck down LAFCO’s assertion that it had an “implied power” to contract for fees by inserting an indemnity agreement into its annexation application. The court’s decision is significant because it holds the door open to potentially challenge such practices if there is a statutory limitation on a local agency’s authority to impose fees, as was the case here.

Case Background

In San Luis Obispo, the City and a developer submitted an application to LAFCO to annex a parcel of land into the City. The application included an indemnification clause that provided that the developer and City would indemnify LAFCO for “damages, costs, expenses, attorneys’ fees, and expert witness fees…arising out of or in connection with the application.”1 Following denial of the annexation application, the City refused to pay for LAFCO’s attorneys’ fees and costs associated with a lawsuit that took place following the processing of the application. In response, LAFCO brought action against the City, asserting breach of contract. LAFCO contended that the indemnification agreement was “given in consideration for not requiring anticipated attorney fees to be paid as part of the application fee at the beginning of the process.”2

The court held that LAFCO had no authority to impose such fees for post-administrative proceedings. The statutory authority for local agency formation commissions only permits the imposition of fees or fee increases associated with application processing,3 and application processing does not include indemnification for post-application processing. Further, LAFCO did not have the implied power to require attorneys’ fees and there was no valid indemnification agreement.4 “Here attorney fees in post-administrative actions are not ‘specifically provided for by statute.’ Nor is there a valid agreement for such fees. LAFCO’s remedy is with the Legislature.”5 Here, an “agreement” to indemnify was not an actual agreement since there was no consideration.

The holding applies specifically to the statutory authority granted by California Gov. Code § 56383 to local agency formation commissions to impose fees on project applicants, but may invite challenges of other local agencies that routinely insert indemnity provisions into their applications or conditions of approval if there is a limitation on a local agency’s statutory authority to impose fees on application filing and processing. Local agencies routinely require indemnification for processing an entitlement application or as a condition of approval. Key questions are whether the local agency has the legal power to potentially require an applicant to indemnify the agency, and whether there is statutory authority to impose such fees for indemnification.

Conclusion and Takeaways

State law does not expressly provide for the assignment of attorneys’ fees for local planning agencies. However, unlike local agency formation commissions, Gov. Code § 65104 grants the legislative body of a city or county6 broad authority to establish “any fees to support the work of the planning agency … not to exceed the reasonable cost of providing the service for which the fee is charged.”  The grant of authority to the legislative bodies of local planning agencies to authorize fees is more broad than the statutory language in Gov. Code § 56383 applicable to local agency formation commissions. While Gov. Code § 65104 does not expressly provide for attorneys’ fees, it broadly applies to the “work of the planning agency.” Arguably, the work of the “planning agency” could include defending a project from legal challenge. Critically, assuming that indemnification of attorneys’ fees would “support the work of the planning agency,” Gov. Code § 65104 mandates that the legislative body impose such fees subject to Gov. Code § 66016’s procedures for imposition of fees.7

However, even if the provision of attorneys’ fees are not enacted through local ordinance or resolution pursuant to Gov. Code § 66016, the Subdivision Map Act (Gov. Code § 66410 et seq.) expressly permits a local agency to impose indemnity provisions for claims arising out of subdivision application processing or approval or as a condition of approval.8  Otherwise, for non-subdivision planning cases, the imposition of fees on an ad hoc basis through an application form or conditions of approval without the requisite legislative authority, as seen with San Luis Obispo, could be subject to potential challenge. If cities and counties interpret Gov. Code § 65104 as a means to potentially impose indemnification, in an effort to survive a legal challenge it is likely that local agencies will formalize indemnification requirements pursuant to local statute or resolution, as opposed to applying them on an ad hoc basis.

For more information or questions on the indemnification on application forms or as conditions of approval, please contact the authors.

Notes

1 San Luis Obispo, No. B296968, slip op. at 3 (Cal. Ct. App., March 3, 2021).

2 Id., slip op. at 4.

3 “[Gov. Code] section 56383 contemplates that the fees charged thereunder will be limited to those necessary to the administrative process, not to post-decision court proceedings.” San Luis Obispo, slip op. at 6. “The clear mandate of [Gov. Code] section 56383, subdivision (c) is that the executive officer must settle the costs charged under the section at the end of the administrative proceedings. The section does not provide for costs that may accrue thereafter.” Id.

4 See Code of Civ. Proc. § 1021.

5 Id., slip op. at 7.

6 Gov. Code § 65104 also applies to charter cities.

7 See Gov. Code § 66016(b) (“Any action by a local agency to levy a new fee or service charge … shall be taken only by ordinance or resolution.”). See also Gov. Code § 66016(a) (restricting the amount of the new fee or service charge to the amount for which the fee or service charge is levied, and in the event the fee or service charge creates revenues in excess of actual cost, those excess fees shall be used to reduce the fee or service charge creating the excess).

8 Gov. Code § 66474.9

Continuous and Progressive Damage Raised Factual Question as to the Timing of “Occurrence”

Jeffrey S. Crowe | Sheppard Mullin Richter & Hampton

Thomas Guastello v. AIG Specialty Insurance Company, — Cal.Rptr.3d –, 2021 WL 650878 (Cal. Ct. App., Feb. 19, 2021), Fourth Appellate District Court of Appeal, Case No. G057714.

Various stakeholders in the Pointe Monarch housing development in Dana Point, California, accused subcontractor C.W. Poss Inc. (“Poss”) of negligently designing and constructing retaining walls.  One such party, Thomas Guastello, sued Poss for damage to a perimeter wall in the backyard of Guastello’s property.  According to Guastello, in January 2010, a retaining wall close to his property designed and constructed by Poss failed and caused soil to collapse and damage a perimeter wall on Guastello’s property.

Poss’ liability insurer, AIG Specialty Insurance Company (“AIG”), disclaimed a duty to defend or indemnify Poss against Guastello’s suit.  AIG concluded that Guastello’s alleged property damage occurred in 2010 – many years after the 2003-2004 coverage period of Poss’ general liability insurance policy.  AIG’s policy offered occurrence-based coverage, meaning that it covered certain damages that occurred during its policy period.

Guastello obtained a default judgment against Poss in excess of $700,000.  He then sued AIG asserting claims as a judgment creditor under Insurance Code section 11580.  The trial court granted AIG’s motion for summary judgment, finding that Guastello’s property damage occurred “well past the expiration of the policy.”

The Court of Appeal reversed.  As a threshold matter, the Court of Appeal agreed with the trial court that Guastello could not pursue a direct action against AIG based on AIG’s alleged failure to defend Poss.  As the Court noted, a third party lacks standing to assert a claim that an insurer owed and breached a duty to defend its insured.  Nevertheless, the Court found that triable issues of fact regarding the timing of the property damage to Guastello’s property negated summary judgment.

In so holding, the Court recounted that “[a]n ‘occurrence’ policy provides coverage for damages that occur during the policy period, even if the claim is made after the policy has expired,” and that “it is well established that the time of the relevant ‘occurrence’ or ‘accident’ is not when the wrongful act was committed but when the complaining party was actually damaged.”  Quoting Whittaker Corp. v. Allianz Underwriters, Inc., 11 Cal.App.4th 1236, 1241 (1992).

According to the Court, Guastello submitted evidence in opposition to AIG’s motion supporting that damage to his property began during the 2003-2004 policy period.  More specifically, Guastello submitted a declaration from a civil engineer opining that Poss’ negligent construction of the retaining wall led to damage to the retaining wall itself and to the surrounding property, including Guastello’s property.  The engineer opined that, while Poss’ retaining wall failed completely in 2010, there had been continuous and progressive destabilization and damage to Guastello’s property since 2003.  These facts and allegations led the Court to conclude that Guastello had raised a triable issue of material fact as to when the “occurrence” took place, and thus, the timing or triggering of AIG’s coverage under Poss’ liability insurance policy.

New York Court Finds Insurers Cannot Recover Defense Costs Where No Duty to Indemnify

Tred R. Eyerly | Insurance Law Hawaii

    In a case of first impression, the Supreme Court of New York, Appellate Division, found the insurer had no right to reimbursement of defense costs paid to defend the insured. Am. W. Home Ins. Co. v. Gjoaj Realty & Mgt. Co., 2020 N.Y. App. Div. LEXIS 8286 (N.Y. App. Div. Dec. 30, 2020).

    Gjonaj Realty was sued by Viktor Gecaj when he fell from a ladder at the premises managed by Gjonaj Realty. The matter was not tendered to American Western Home Insurance Company until four years after the accident and after a judgment of $900,000 had been entered against Gjonaj Realty after its default. American denied coverage after late notice was given. Thereafter, the Supreme Court in the underling action vacated the default judgment. American then agreed to defend under a reservation of rights.

    The Appellate Division reversed the vacatur of the default judgment and reinstated the default against the insured. American then advised Gjonaj Realty that it was denying coverage and reserving its right to recover any fees and costs incurred in defending the underlying action. 

    American sued Gjonaj Realty for a declaratory judgment, establishing that it had no duty to defend, no duty to indemnify, and was entitled to reimbursement of defense costs. The Appellate Division agreed American had no duty to indemnify and no duty to defend.

    Regarding reimbursement, a handful of cases in New York had affirmed orders allowing an insurance company to recoup its defense costs upon a determination that no duty to indemnify existed. Here, the policy and the supplementary payment provision expressly promised the insureds that the insurer would bear all the costs “to defend the insured against any suit” to which the policy applied. The policy, however, was silent as to any reimbursement by the insurer for the costs of defense incurred prior to a declaratory judgment determine that there was no duty to defend or indemnify the insured in the underlying action. Had the insurer wanted to include language that allowed it to recover the costs of defending claims that were later determined not covered, it could have done so. But it did not do so here. Therefore, American could not recover its defense costs in the underlying action absent an express provision to that effect in the policy.

    Nor could the insurer recover under an equitable argument that the insureds would be unjustly enriched if the insurer had to bear the costs of defense. New York law precluded claims of unjust enrichment where the policy governed the subject matter at issue. Where the insurer and insured were contractually bound by the terms of the policy, any resort to equitable remedies as a basis for an award of defense costs was unavailing. Further, there was no unjust enrichment here. Given New York’s policy imposing upon insurers a broad duty to defend, there could be no finding that the insured was unjustly enriched as a result of the defense provided by the insurer for claims that were later found to be outside the policy. 

    Other than dicta, there is no Hawaii appellate decision on the right of the insurer to obtain reimbursement of defense costs. See Lexington v. Nautilus, 132 Haw. 283, 293, 321 P.3d 634, 644 (2014) (suggesting if an insurer defending under a reservation of rights determined it has not duty to defend, the insurer may recoup its expenses from the insured). While the Hawaii federal district court has come out on both sides of the issue, one decision noted that “a ruling on reimbursement would be a major decision on Hawaii insurance law that could have a tremendous impact on the duty to defend in hundreds of other cases.” Exec. Fisk Indem., Inc. v. Pac. Educ. Servs., 451 F. Supp. 2d 1147, 1163 (D. Haw. 2006). 

Allocating Covered and Uncovered Damages in Jury Verdict

David Adelstein | Florida Construction Legal Updates

When a liability insurer defends an insured from a third-party claim, they oftentimes do so under a reservation of rights.  A reservation of rights letter is issued to the insured that identifies certain coverage exclusions or reservations relative to the insurance policy that may impact the insurer’s duty to indemnify the insured for damages.  In other words, just because the insurer is defending its insured does not mean it will be indemnifying its insured for damages asserted in the third-party claim.

Under Florida law, the party claiming insurance coverage has the initial burden to show that a settlement or judgment represents damages that fall within the coverage provisions of the insurance policy. An insured’s inability to allocate the amount of a judgment between covered and uncovered damages is therefore generally fatal to its indemnification claim. However, the burden of apportioning or allocating between covered and uncovered damages in a general jury verdict may be shifted to the insurer if the insurer did not adequately make known to the insured the availability and advisability of a special verdict.

QBE Specialty Ins. Co. v. Scrap Inc., 806 Fed.Appx. 692, *695 (11th Cir. 2020) (internal citations omitted).

This is an important concept because even when the insurer is defending its insured under a reservation of rights, it may put its insured on notice that because of coverage concerns, the insured needs to include special interrogatory questions in the verdict form for the trier of fact (jury) to answer to determine covered versus uncovered damages.  If the insured fails to do so, it will give the insurer a very strong argument to avoid any indemnification obligation it has with respect to the judgement.  This mean the insured is on the hook to deal with the judgment without insurance coverage.

For example, in QBE Specialty Ins. Co., an insured was sued for a nuisance stemming from its metal shredding operations.  The insured’s liability insurer defended the insured under a reservation of rights.  During the course of the case, the insurer notified the insured that it needed special interrogatory questions in the verdict form because of coverage concerns.  The jury awarded $750,000 in nuisance damages against the insured.  There was no allocation for covered versus uncovered damages.  The insurer then filed a separate declaratory relief coverage action claiming it was not obligated to indemnify the insured for the $750,000 in damages.  The Eleventh Circuit Court of Appeals, affirming the trial court, agreed because “in the absence of an allocated verdict form in the underlying trial, [the insured] never provided the district court with a plausible method for separating those damages awarded by the jury that are covered by [the insurer’s] policies from those that are not.”  QBE Specialty Ins. Co., supra, at *696.

First-Step Analysis: Bringing Insurance Litigation Proceedings in USA

Mary Beth Forshaw | Simpson Thacher

Preliminary and jurisdictional considerations in insurance litigation

Fora

In what fora are insurance disputes litigated?

Most insurance disputes are litigated in state or federal trial courts. An insurance action may be subject to original federal court jurisdiction by virtue of the federal diversity statute, 28 USC section 1332(a). In this context, an insurance company, like any other corporation, is deemed to be a citizen of both the state in which it is incorporated and the state in which it has its principal place of business.

If an insurance action is originally filed in state court, it may be removed to federal court on the basis of diversity. Absent diversity of parties or some other basis for federal court jurisdiction, insurance disputes are litigated in state trial courts. The venue is typically determined by the place of injury or residence of the parties, or may be dictated by a forum selection clause in the governing insurance contract.

Some insurance contracts contain arbitration clauses, which are usually strictly enforced. If an insurance contract requires arbitration, virtually every dispute related to or arising out of the contract typically will be resolved by an arbitration panel rather than a court of law. Even procedural issues, such as the availability of class arbitration and the possibility of consolidating multiple arbitrations, are typically resolved by the arbitration panel.

Practitioners handling insurance disputes governed by arbitration clauses should diligently comply with the procedural requirements of the arbitration process. Arbitration provisions in insurance contracts may set forth specific methods for invoking the right to arbitrate and selecting arbitrators. Careful attention to detail is advised, as challenges to the arbitration process are commonplace. An insurance dispute that originates in arbitration may ultimately end up in the judicial system as a result of challenges to the fact or process of arbitration.

Causes of action

When do insurance-related causes of action accrue?

Insurance litigation frequently involves a request for declaratory judgment or breach of contract claims, based on allegations that an insurer breached its defence or indemnity obligations under the governing insurance policy. Insurance-based litigation may also include contribution, negligence or statutory claims. For any insurance-related claim to be viable, it must be brought within the applicable statute of limitations period, which is governed by state law. In determining whether a claim has been brought within the limitations period, courts address when the claim accrued. For breach of contract claims, the timing of claim accrual may depend on whether the claim is based on an insurer’s refusal to defend or failure to indemnify. When a claim arises from an insurer’s failure to defend, courts typically endorse one of the following positions:

  • the limitations period begins to run when the insurer initially refuses to defend;
  • the limitations period begins to run when the insurer refuses to defend, but is equitably tolled until the underlying action reaches final judgment; or
  • the limitations period begins to run once the insurer issues a written denial of coverage.

When a claim arises from an insurer’s refusal to indemnify a policyholder, courts have held that the claim accrues either when the underlying covered loss occurred or when the insurer issues a written denial of coverage.

A legal finding that a policyholder’s claim is time-barred is equivalent to a dismissal on the merits.

Preliminary considerations

What preliminary procedural and strategic considerations should be evaluated in insurance litigation?

At the outset of insurance litigation, practitioners must conduct a careful evaluation of possible causes of action in light of the available factual record in order to assess procedural and substantive strategies. When an insurance dispute turns on a clear-cut question of law and could appropriately be resolved on a motion to dismiss or a motion for summary judgment, dispositive motion practice should be considered. For example, if an underlying claim for which coverage is sought alleges an occurrence that arose after the insurance policy at issue expired or alleges facts that fall squarely within the terms of a pollution exclusion, the insurer may file a dispositive motion to seek swift resolution of its coverage obligations. In contrast, where an insurance dispute presents contested issues of fact, practitioners should be vigilant about formulating case management orders and discovery schedules. Insurance-related discovery is often contentious, expensive and time-consuming, and may give rise to disputes regarding privilege or work product protection. In this respect, document retention policies must be implemented and in some cases, confidentiality stipulations may be appropriate. Finally, a preliminary assessment of any insurance matter should involve consideration of whether it is appropriate to request trial by jury or whether to implead third parties, including entities such as co-insurers, third-party tortfeasors or insurance brokers.

Damages

What remedies or damages may apply?

Many insurance coverage lawsuits seek relief in the form of a judicial declaration that articulates the scope of coverage under the insurance policies in dispute. In essence, one or more parties request that the court enter a ruling that coverage is available or unavailable before addressing the appropriate remedy or damages. If the court issues a ruling declaring coverage to be exhausted or otherwise unavailable, the appropriate remedy or damages may be dismissal of the action with or without costs imposed on the insured.

Where courts find coverage to be available, they often go on to address the issue of remedy or damages in a separate phase of the case. The most common measure of damages in insurance litigation is contractual damages, which may be awarded in connection with a breach of contract claim. The amount of contractual damages is typically based on the coverage due under the relevant policies (or, for a claim of rescission, the amount of premiums to be refunded). In complex insurance litigation, such as that involving multiple layers of coverage with injuries or damage spanning an extended period of time, the damages calculation may be more involved, often requiring expert testimony.

Aside from basic contractual damages, additional amounts may be recovered in certain insurance disputes. For example, some jurisdictions may allow consequential damages based on economic losses that flow directly from the breach of contract or that are reasonably contemplated by the parties. Additionally, some jurisdictions permit attorneys’ fees awards under certain circumstances.

Whether attorneys’ fees awards are available may be governed by state statute, relevant case law or, in some cases, the insurance agreements themselves. Arbitration clauses, in particular, may provide for the payment of the prevailing party’s attorneys’ fees and costs. While attorneys’ fees may be difficult to recover, the threat of an attorneys’ fees award may affect the dynamics of settlement negotiations.

Infrequently, the possibility of tort-based or punitive damages can arise in insurance litigation. These damages may come into play in the context of claims alleging that an insurer acted in bad faith or violated state unfair or deceptive practices statutes.

Where monetary damages are awarded in an insurance action, a corollary issue is the imposition of pre-judgment (or post-judgment) interest. The imposition and rate of interest may be determined by the parties via explicit contractual language. Absent governing language, the question of whether a prevailing party is entitled to pre-judgment or post-judgment interest and, if so, the applicable interest rate, is typically governed by state law. When pre-judgment interest is allowed, determination of the accrual date is paramount because opposing positions can differ by many years, and resolution can have a significant impact on the total damages award. Courts have utilised different events for determining the interest accrual date, including when payment was demanded, when payments are deemed due under the applicable policy and when the complaint was filed.

Under what circumstances can extracontractual or punitive damages be awarded?

Certain states permit policyholders to seek extracontractual or punitive damages when an insurer allegedly has acted in bath faith or violated unfair or deceptive practices statutes. Bad faith allegations frequently relate to an insurer’s refusal to defend or settle an underlying matter, but can also stem from other conduct, such as claims-handling practices. Some jurisdictions do not recognise tort claims arising out of an insurer’s breach of contract. In those jurisdictions, a policyholder’s recovery typically is limited to contractual damages, with no opportunity for punitive damages. Some courts in those jurisdictions, however, may allow recovery of extracontractual damages (eg, lost income or related economic losses) against an insurer if the losses were foreseeable and arose directly out of the breach of contract.

In jurisdictions that recognise bad faith tort claims against an insurer, policyholders face several obstacles when seeking punitive damages. In most but not all cases, a punitive damages claim is not actionable without an adjudication that the insurer has breached the insurance contract. Even where an insurer is held to have breached a contract, and a policyholder has established bad faith or statutory violations, punitive damages are extremely difficult to recover. Most jurisdictions strictly require the party seeking punitive damages to meet a high burden and to prove ‘wilful or malicious’ conduct, ‘malice, oppression or fraud’ or ‘gross or wanton behaviour’ by the insurer. Furthermore, some jurisdictions impose an elevated burden of proof, requiring that bad faith be shown by ‘clear and convincing evidence’.

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18 December 2019