MCLE Article: Supplemental Appropriations

Insurers and insureds continue to fight over the meaning of narrowly crafted court decisions on the payment of attorney's fees in contract disputes

By Michael R. Sohigian

Michael R. Sohigian is a Los Angeles lawyer whose practice focuses on business litigation, real property, employment law, and insurance law.

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A common provision of the standard commercial (formerly "comprehensive")1 general liability insurance (CGL) policy excludes coverage for contractual damages.2 Insureds--and some insurers--are surprised to learn this exclusion does not affect coverage for awards of attorney's fees under Civil Code Section 1717 and Code of Civil Procedure Sections 1032 et seq. Section 1717 provides for awards of attorney's fees to parties prevailing in contract actions in which the contract at issue contains a provision for attorney's fees. Sections 1032 and 1033.5(a)(10)(A) allow recovery of attorney's fees under contract as costs.3 California's courts have held that an insurer is obligated--under the supplementary payments provisions (SPP) that are part of the standard CGL policy--to reimburse its insured for awards of attorney's fees under Sections 1717 and 1032 et seq.4

However, a 2006 opinion by the First District of the California Court of Appeal held that an award of fees under statute--as opposed to a contractual provision--does not trigger the insurer's duty under the SPP to pay an attorney's fee award. This decision may significantly limit the scope of an insurer's obligations under the SPP.5 Also, and curiously, case law would apparently deny a judgment creditor the right to recover attorney's fees under Insurance Code Section 11580(b)(2), the so-called Direct Action Statute.

A typical SPP might provide that the insurer "will pay, with respect to any claim or 'suit' we defend...[a]ll costs taxed against the insured in the suit."6 Courts have faced the question whether, despite the exclusion of contract damages, a party proceeding on a claim defended by an insurer under a CGL policy might be entitled to recover (or, in the insured's case, be reimbursed for) an award of attorney's fees.

Prichard v. Liberty Mutual Insurance Company7 was an appeal of an action brought by an insured for, among other types of relief, a declaration of the defendant's obligation to defend an underlying action for defamation. In its opinion, the court of appeal cited Insurance Company of North America v. National American Insurance Company (INA)8 for the proposition that "[i]n a word, the insurance contract obligates the insurer to pay ‘costs' whenever it must defend the suit, independent of whether those costs would otherwise be covered by way of the insurer's indemnity obligation."9 The Liberty Mutual policy involved in Prichard was a CGL policy with an SPP. The court interpreted the INA case as holding "that costs awarded against the insured because of prevailing party attorney fee clauses applicable in the underlying litigation were part of the supplementary payments section of the policy."10

The Prichard court recognized the potentially unfair result of indemnifying an insured "for exposure on claims the defense of which he never paid a premium for. The problem, however," the court observed, "is in the insurance contract, not the law. If the ISO [Insurance Services Office] forms are written so that attorney fees awarded as part of prevailing party clauses can be considered costs associated with the insurer's defense obligation, there is nothing we can do about it."11

INA was a suit by one insurance carrier against another to recover payments made on a judgment entered against a defendant whom both carriers insured. Among other issues the court considered was whether the defendant's contribution of $289,983.72 to pay an award of attorney's fees and costs in the underlying action was against the policy limits or was a "cost taxed against the Insured in any suit defended by the Company…in addition to the applicable limit of liability" under the policy's SPP.12 The court affirmed the trial court's ruling that the payment fell under the SPP, because the underlying plaintiff's entitlement was based on a prevailing party clause in a contract between the plaintiff and the insured defendant.13

The Rights of Judgment Creditors

The Prichard court treated INA as holding that an insured is entitled to recover under the SPP of its CGL policy for an award of attorney's fees. The actual INA holding, however, differs from Prichard's characterization of it. The court in San Diego Housing Commission v. Industrial Indemnity Company14 accurately distinguished INA as involving the rights of insurers rather than insureds.15 In San Diego Housing, the question for the court concerned "the rights of a judgment creditor of an insured, in an action against an insurer seeking insurance policy proceeds under [the Direct Action Statute], to recover under the liability insurance policy's supplementary payments provision."16 The judgment on which the direct action was based was a default judgment obtained against the insured after the defendant refused to provide a defense.17

Insurance Code Section 11580, the Direct Action Statute, sets forth requirements for policies insuring:

Against loss or damage resulting from liability for injury suffered by another person other than (i) a policy of workers' compensation insurance, or (ii) a policy issued by a nonadmitted Mexican insurer solely for use in the Republic of Mexico; [or a]gainst loss of or damage to property caused by draught animals or any vehicle, and for which the insured is liable, other than a policy which provides insurance in the Republic of Mexico, issued or delivered in this state by a nonadmitted Mexican insurer.18

The statute's requirements include "[a] provision that whenever judgment is secured against the insured or the executor or administrator of a deceased insured in an action based upon bodily injury, death, or property damage, then an action may be brought against the insurer on the policy and subject to its terms and limitations, by such judgment creditor to recover on the judgment."19 The terms of the Direct Action Statute thus subject the recovery of a judgment creditor in a direct action against the judgment debtor's insurer to the terms and limitations of the policy.

The SPP in San Diego Housing provided the insurer would pay "in addition to the applicable limit of liability…all costs taxed against the insured in any suit defended by the Company and all interest on the entire amount of any judgment therein which accrues after entry of the judgment and before the Company has paid or tendered or deposited in court that part of the judgment which does not exceed the limit of the Company's liability thereon."20 The court viewed the SPP as part and parcel of the duty to defend, which it concluded was owed only to the insured, and not to any third party. Thus, the SPP did not inure to the benefit of the direct action plaintiff.21 Accordingly, the court held the judgment creditor could not recover an award of attorney's fees under the Direct Action Statute.22

San Diego Housing involved somewhat unusual facts. The opinion's denial of a judgment creditor's right under the Direct Action Statute to recover an award of attorney's fees from the judgment debtor's insurer under the SPP might properly be limited to those facts.

Notably, in San Diego Housing the insurer did not defend its insured in the underlying action. This allowed the court to separate with a bright line the duty to defend from the duty to indemnify. The San Diego Housing holding was based in large measure on the court's analysis of the duty to defend. It might not apply to a judgment creditor's right to recover under the Direct Action Statute for an award of fees made in an action the insurer defended, since the insurer's performance of its duty to defend would presumably include the duty to perform under the SPP.

Bad Faith

Moreover, the holding in San Diego Housing probably could not be applied to a claim against a nondefaulting judgment debtor. Since Prichard found that the insurer that owes a duty to defend also owes a duty to indemnify its insured for an award of attorney's fees and other costs taxed against it under the SPP, if a judgment creditor enforces the judgment against an insured judgment debtor, the insurer owes its insured a duty to pay the costs award--including attorney's fees--under the SPP. Refusing to do so could expose the insurer to liability to its insured for breach of the duty of good faith and fair dealing--in other words, bad faith--implied in the insurance contract. In addition to bad faith exposure to its insured, the insurer could also be subject to defending this type of claim assigned by its insured to the judgment creditor.23

An insurer might take the position that, as a result of San Diego Housing, the judgment creditor is not entitled to recover an award of attorney's fees or costs under Section 11580. However, as long as a likelihood exists that the judgment creditor might enforce the judgment against the insured, the insurer would risk exposure to the insured's bad faith claim, since the insurer would be contractually obligated under Prichard to reimburse its insured for the award of costs and fees.

Additionally, the court of appeal in Hand v. Farmers Insurance Exchange24 held that an insurer may be liable to a judgment creditor under the Direct Action Statute for bad faith when the insurer refuses to pay a judgment obtained against its insured. In Hand, the court of appeal reversed a grant of summary judgment in a bad faith claim brought by a judgment creditor under the Direct Action Statute against an insurer that had refused to pay a final judgment.25 Citing Murphy v. Allstate Insurance Company26 as authority, the Hand court held that the implied covenant of good faith and fair dealing protected a third-party claimant under the Direct Action Statute.27 According to Hand, "[O]nce having secured a final judgment for damages, the plaintiff becomes a third party beneficiary of the policy, entitled to recover on the judgment on the policy. At that point the insurer's duty to pay runs contractually to the plaintiff as well as the insured. And the plaintiff having also become a beneficiary of the covenant of good faith, the duty to exercise good faith in not withholding adjudicated damages necessarily is owing to the plaintiff also."28 Thus, the insurer risks liability to a judgment creditor if, in bad faith, it withholds payment of damages adjudicated in a final judgment.

The Hand court distinguished Coleman v. Gulf Insurance Group,29 in which the California Supreme Court affirmed an order sustaining, without leave to amend, demurrers to a third-party claimant's action against an insurance company alleging it filed a frivolous appeal in order to coerce the plaintiff to settle for a low sum. The court's ruling was based on the grounds that the judgment the Coleman plaintiffs obtained was not final when the insurer committed the alleged bad faith, since the conduct at issue was the insurer's pursuit, on the insured's behalf, of an appeal from the judgment: "Lacking a final judgment, the Coleman plaintiffs did not enjoy the status of judgment creditor beneficiaries under section 11580."30

If solid grounds exist for appeal, the insurer might file a notice of appeal and protect its insured against efforts to enforce the judgment by posting an appeal bond. At the same time, the insurer can make good faith arguments on appeal for reversal of the judgment due to a lack of substantial evidence or for reduction of the attorney's fees award based on, for example, the necessity to allocate the fees for efforts to recover from settling defendants. Also, the insurer can request the court of appeal to reject Prichard's holding allowing for recovery of benefits for which insureds have not bargained--though a better strategy may be to make this argument in a declaratory relief action against the insured rather than in an appeal of the judgment against it.

Willful Statutory Violations

The insurer may be spared these concerns in claims alleging a statutory violation by its insured. Last year, in Combs v. State Farm Fire & Casualty Company,31 the court of appeal affirmed summary judgment for State Farm against its insured's demand for reimbursement under his policy's SPP for the attorney's fees and costs that he was ordered to pay in an underlying action.

Combs was sued in federal district court by Fair Housing of Marin (FHOM), which alleged that Combs, in his management of an apartment complex in San Rafael in Marin County, violated federal and state law prohibiting racial discrimination. State Farm had issued an Apartment Policy to Combs, under which it provided him with a defense to the suit with a full reservation of rights. At various times during the litigation, Combs demanded State Farm settle the claims, but State Farm refused, citing Insurance Code Section 533, which provides "[a]n insurer is not liable for a loss caused by the wilful act of the insured."32

The court struck Combs's answer and entered a default against him as a discovery sanction. The court then held a default prove-up hearing and found "direct evidence of racial animus…amply present on this record" and "the record on liability" to be "damning." The court awarded compensatory and punitive damages against Combs and, later, the attorney's fees and costs, which eventually totaled about $639,000.33

State Farm refused to indemnify Combs for the damages or the attorney's fees and costs. Combs sued State Farm, asserting that the insurer was obligated under the Apartment Policy's SPP to reimburse him for the attorney's fees and costs. Combs moved for summary adjudication of the issue, State Farm filed a cross-motion, and the trial court denied Combs's motion and granted relief for State Farm. In doing so, the court concluded that "Combs' adjudicated liability for intentional race discrimination in the FHOM action precludes insurance coverage for the default judgment, including the award of attorneys fees, under section 533."34

Combs appealed, conceding he was not entitled to have State Farm pay any portion of the award of compensatory or punitive damages. He sought a reversal of the trial court's adjudication of the issue of reimbursement for the attorney's fees and costs under the SPP. The court of appeal affirmed the original judgment.35

In its ruling, the court distinguished cases from other jurisdictions, stating they were based solely on the interpretation of policy provisions without any consideration of Section 533. The court also dismissed Combs's argument, based on Gray v. Zurich Insurance Company,36 that Section 533 precludes only indemnification but does not affect the duty to defend, and that the payment of costs taxed against the insured is a function of the insurer's defense obligation, not its indemnity obligation:

[T]he fact that the supplemental payment of costs taxed against the insured is viewed as arising from the insurer's defense obligation, and under the supplementary payments provision of the insurance policy arises with respect to claims that the insurer defends, does not mean that section 533 permits the insurer to indemnify the insured for such costs and fees….

As indicated above, section 533 prohibits coverage for any loss caused by the willful misconduct of the insured. Liability for the adversary's costs and attorney fees in this case is a loss caused by and incurred as a result of the insured's intentional racial discrimination….Like the duty to indemnify, the obligation to pay costs taxed to the insured arises only after liability is established. The attorney fees of the opposing party become payable only if and when the insured has been found liable, in this case as a statutory consequence of its liability….[D]espite its contractual agreement to pay these costs, section 533 prohibits State Farm from doing so.37

Some might try to limit the Combs holding to its facts, which involved Combs's acts of racial discrimination as well as his conduct supporting the court's decision to strike his answer and enter a default as a sanction. Too, the misconduct in Combs was willful;38 it is unclear whether the case holding would apply to less culpable--that is, merely intentional--violations of a statute. Even the most expansive reading of Combs would probably restrict its limitation of the insurer's obligation to pay attorney's fees and costs under the SPP to cases in which the insured's liability is based solely on the insured's intentional conduct.39

But Combs plainly limits the rights of insureds under the SPP. Prichard and INA continue to impose on insurers liability for awards against their insureds of attorney's fees under terms of a contract to which the insureds are parties, regardless of policy provisions excluding coverage for contractual liabilities. However, despite the terms of the SPP, Combs allows insurers to refuse to pay attorney's fee awards made in connection with a finding of an insured's statutory violations.

Policyholders and their attorneys should be aware of their rights under Prichard and INA to have their insurers reimburse them for contract-based awards of attorney's fees. Likewise, judgment creditors and their attorneys should recognize their probable right to recover such awards from the insurers of judgment debtors. On the other hand, Combs relieves insurers of the obligation to reimburse insureds for awards of attorney's fees and costs in a significant category of cases. Insurers' attorneys will no doubt press hard to solidify these limitations of insurers' duties and exposure regarding a variety of claims.

Endnotes

1 Compare Bank of the West v. Superior Court, 2 Cal. 4th 1254, 1258 (1992) (construing advertising injury coverage under "[c]omprehensive general liability insurance policies") with Buss v. Superior Court, 16 Cal. 4th 35, 39 (1997) (resolving "issues relating to standard commercial general liability insurance policies, which were formerly called comprehensive general liability insurance policies").
2 See, e.g., Medill v. Westport Ins. Corp., 143 Cal. App. 4th 819, 49 Cal. Rptr. 3d 570, 575 (2006) (affirming summary judgment for insurer based on exclusion for "[d]amages arising out of breach of any contract, whether oral, written or implied, except employment contracts with individuals").
3 Insurance Co. of N. Am. v. National Am. Ins. Co. (INA), 37 Cal. App. 4th 195, 206-07 (1995).
4 See, e.g., Prichard v. Liberty Mut. Ins. Co., 84 Cal. App. 4th 890, 911 (2000).
5 Combs v. State Farm Fire & Cas. Co., 143 Cal. App. 4th 1338 (2006).
6 See Prichard, 84 Cal. App. 4th at 911.
7 Id. at 890.
8 INA, 37 Cal. App. 4th 195.
9 Prichard, 84 Cal. App. 4th at 895.
10 Id. at 912.
11 Id. at n.22 (italics in original).
12 INA, 37 Cal. App. 4th at 206 n.6.
13 Id. at 206-07.
14 San Diego Hous. Comm'n v. Industrial Indem. Co., 95 Cal. App. 4th 669 (2002).
15 Id. at 688-90.
16 Id. at 672-73.
17 Id. at 673, 675.
18 Ins. Code §11580(a)(1), (2).
19 Ins. Code §11580(b)(2).
20 San Diego Housing, 95 Cal. App. 4th at 676.
21 Id. at 691-92.
22 Id. at 673.
23 See, e.g., Jane D. v. Ordinary Mut., 32 Cal. App. 4th 643, 650 (1995).
24 Hand v. Farmers Ins. Exch., 23 Cal. App. 4th 1847 (1994).
25 Id. at 1851.
26 Murphy v. Allstate Ins. Co., 17 Cal. 3d 937 (1976).
27 Hand, 23 Cal. App. 4th at 1856-57.
28 Id. (citation omitted).
29 Coleman v. Gulf Ins. Group, 41 Cal. 3d 782 (1986).
30 Hand, 23 Cal. App. 4th at 1857 n.6.
31 Combs v. State Farm Fire & Cas. Co., 143 Cal. App. 4th 1338 (2006).
32 Id. at 1341-42.
33 Id. at 1341.
34 Id. at 1342.
35 Id. at 1341.
36 Gray v. Zurich Ins. Co., 65 Cal. 2d 263, 277-78 (1966).
37 Combs, 143 Cal. App. 4th at 1344-46 (citations and internal quotations omitted).
38 Id. at 1343.
39 See Prichard v. Liberty Mut. Ins. Co., 84 Cal. App. 4th 890, 911-12 (2000) (holding insurer obligated under SPP to pay all costs taxed against insured in "mixed action"--lawsuit alleging covered and uncovered claims).

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