Selected litigation issues implicating additional insured endorsements

Lucey, Michael T

I.

INTRODUCTION

The additional insured endorsement plays an indisputably large role in a great deal of business agreements. Traditionally, parties are required to procure insurance for those for whom they work and the additional insured endorsement provides the vehicle to satisfy this need. The disputes surrounding the coverage afforded under an additional insured endorsement, as well as a party's liability for failure to procure the proper insurance, or any at all, has developed a body of law often inconsistent with the intents of both insureds and insurers.

This article will provide an overview of several issues involving additional insured endorsements. The questions presented and the different paths the courts have taken to resolve disputes over these endorsements present issues not only for coverage lawyers, but also presented for the drafters of business contracts and for those who draft insurance policy language. An understanding of how courts resolved the disputes in the cases to be discussed should be instructive to the lawyers whose clients rely upon them to avoid lawsuits in the first instance. The first section of this article explores the breadth different courts have assigned to the coverage of the additional insured endorsement. The second section deals with breach of a contract to procure insurance, with an emphasis on applicable principles in the area of construction law where this issue frequently appears. Closely related, perhaps only by the courts' interpretations of how an underlying contract should assist in the interpretation of the insurance policy, is the issue of apportionment between insurers which is the focus of the third part of this article. Finally, in the fourth section, the insurer's duty of good faith and fair dealing to an additional insured is illustrated by the judicially created rules for apportioning insurance proceeds, in the third party context, between insureds and additional insureds.

II.

THE SCOPE OF THE ADDITIONAL INSURED ENDORSEMENT

While insurers have created a seemingly infinite number of versions of additional insured endorsements, many still fail to avoid disputes over the scope of the insurance provided to the additional insured. As seen below, insurers, who charge little or nothing for the endorsements, understandably maintain that the endorsements provide limited coverage. That is, coverage applies only to the extent that the additional insured is found vicariously liable for acts of the named insured. Predictably, when additional insureds are faced with the specter of liability, they seek broad protection, especially for situations in which the additional insureds themselves are alleged, or found, to be partly or solely negligent for causing the casualty.

A logical way to study judicial treatment of different additional insured endorsements is to divide them into two categories: (1) decisions which have found a broad grant of coverage, and (2) those which have found that the coverage afforded is limited. Inconsistent rationales appear to have been employed to reach these results.' A. Narrow Interpretations

A narrow reading of the additional insured endorsement was employed in Harbor Insurance Co. v. Lewis.2 There, the underlying suit was based on an accident in which a boy suffered severe injuries when he was struck by a train operated by the Reading Railroad Company. The accident occurred in an area located near a fence that the City of Philadelphia was found to have negligently maintained. Returning a $3 million verdict for the boy's parents, the jury determined that the city and railroad were jointly and severally liable for the boy's injuries. Harbor initiated a declaratory relief action seeking a determination of the rights of the parties under the additional insured endorsement issued to the city under the railroad's general liability policy. The operative language of that endorsement provided: "It is agreed that the insurance afforded by this policy shall apply to the following additional insureds but only to the extent of liability resulting from occurrences arising out of negligence of Reading Company and/or its wholly-owned subsidiaries."3

The city contended that the boy's accident arose out of the railroad's negligence and, therefore, the city should be covered for any liability resulting from the accident. Harbor argued that the endorsement provided coverage only for the vicarious liability of the additional insureds such as the city. In other words, Harbor contended the policy provided coverage only when an additional insured is found liable for the negligence of the named insured. Noting that the jury found the negligence of both the railroad and the city to be contributing and concurrent causes of the boy's injuries and considering the endorsement "in its entirety," the court concluded that the endorsement did not provide blanket coverage to the additional insureds when the railroad is found negligent: "Harbor issued a railroad liability policy, not as [sic] policy that covers all the various acts of the additional insureds whenever an 'occurrence' arises in which both an additional insured and the named insured are found jointly negligent."4

Calling customary practices in the insurance industry "quite" probative of the parties' intent, the Harbor court seemed particularly impressed with the insurer's argument that no additional premium was charged for the endorsement: It would be unreasonable to assume that Harbor intended to increase the risks insured against without exacting more consideration. It would be even more unreasonable to assume that Harbor intended to open itself up to a wide variety of risks, with the sole limitation on those risks being that they must arise out of an "occurrence" in which Reading was held negligent.5 Another narrow reading of standard additional insured language occurred in Northbrook Insurance Co. v. American States Insurance Co.6 There, the New York Bakery and Bagel Store occupied a tenant space in a shopping center owned by Fine Properties. Fine was named as an additional insured in the bakery's $500,000 bodily injury and property damage policy issued by American States. The endorsement provided that the "persons insured" provision includes as "an insured" Fine Properties "but only with respect to liability arising out of the ownership, maintenance or use of the premises designated [in the endorsement]."7

Under the lease agreement between the bakery and Fine, the latter agreed to maintain an alley behind the bakery where a part owner (and employee) of the bakery slipped, fell, and suffered injuries. Holding that the American States policy provided coverage for liability arising out of hazards "associated with the named's insured business,"8 the court found that the ownership, maintenance, and use of the insured premises did not include the alleyway behind the bakery. The court considered and flatly rejected the argument that the lease agreement between Fine and the bakery had any bearing on the outcome of the case. It determined that "failure to maintain the alley is a claim unrelated to the business of the bakery."9

In a different setting, the court in National Union Fire Insurance Co. v. Glenview Park District" investigated the "arising" language in the context of a provision in a general liability policy excluding coverage for the additional insured's negligence. There, National Decorating Service contracted with Glenview to paint an ice rink. National Union issued a policy to National Decorating which provided coverage for Glenview as an additional insured.

During the project, a National Decorating employee fell from a scaffold and sustained serious injuries. After Glenview tendered its defense to National Union, the insurer filed a declaratory relief action against Glenview and the injured worker. It sought a determination that it was not obligated under its primary policy to provide defense or indemnity to Glenview because the policy excluded coverage for damages arising from the negligence of the park district. The court held that the endorsement specifically limited Glenview's coverage to those situations in which the negligent acts or omissions of National Decorating had been established. It decided that the provision did not render the policy meaningless as to Glenview, but merely qualified the circumstances of its application. The court found that the language of the negligence exclusion was susceptible to but a single reasonable interpretation and that the exclusion was valid.

B. Broad Interpretations

A typical example of a broad interpretation, and of the difficulty occasioned by the wording of an additional insured endorsement, is presented by Philadelphia Electric Co v. Nationwide Mutual Insurance Co.co. In Philadelphia Electric, a tree trimmer employed by Davey Tree suffered a severe injury when electricity arched off of power lines adjacent to where he was working. He sued the Philadelphia Electric Company (PECO), which in turn filed a declaratory relief action against Nationwide Mutual Insurance Company and the Davey Tree Company seeking a judicial declaration that Nationwide and Davey Tree were contractually obligated to defend and indemnify PECO. By the terms of a purchase order agreement under which it performed the work, Davey Tree obligated itself to maintain certain insurance coverage and to name PECO as an additional insured. Dutifully, Davey Tree had obtained a certificate of insurance to that effect from its insurer, Nationwide. The certificate provided: "The Philadelphia Electric Company, its officers, agents and employees are added as Additional Insureds for any work performed by the Davey Tree Expert Company on their behalf."'2 Construing this language broadly, the court rejected Nationwide's argument that the parties intended that PECO was to be covered only for vicarious liability for Davey Tree's negligence and not for PECO's own negligence. The court wrote: The contract language in this case contemplates a wider scope of coverage than the language in Harbor [Insurance Co. v. Lewis]. If the parties had intended coverage to be limited to the vicarious type suggested by the defendants, language clearly embodying that intention was available - that is the lesson of Harbor. Here, the language of the Certificate of Insurance should be read to include all liability arising in connection with Davey Tree's work, including PECO's own negligence.

. . In sum, to the extent PECO is held liable in the [underlying] litigation, Nationwide must indemnify PECO.l3 Another broad interpretation of similar language was provided in Township of Springfield v. Ersek.l4 There, an insured endorsement named the township as an additional insured with respect to liability arising out of the operations performed by the named insured. Because the operations of the named insured were broadly defined in the policy, the court held that regardless of whether the negligence which gives rise to the claim rested with the named insured or the additional insured, the insurer had a duty to defend the township. The court noted that had the insurer sought to restrict coverage only to claims arising from the negligence of the named insured, it could have stated so in the additional insured endorsement language. The court cited Philadelphia Electric as support for its position and noted that, at least in Ohio, the "arising out of" language has been defined as "causally connected with, not proximately caused by."'5

A comprehensive, well-organized, and illustrative discussion of typical additional insured endorsements was presented by the district court in Pennsylvania Turnpike Commission v. Transcontinental Insurance Co." In Pennsylvania Turnpike, Inorganic Coating Incorporated entered into a contract with the Pennsylvania Turnpike Commission (PTC) to perform construction of several overpasses in Pennsylvania. Inorganic subcontracted with Corcon Industrial Painting to paint three overpass bridges. Pursuant to its subcontract agreement, Corcon obtained a general liability insurance policy with Transcontinental Insurance Company naming the PTC as an additional insured. During the painting operations, one Corcon employee was killed and another severely injured as a result of an automobile accident. Predictably, a lawsuit followed which alleged negligence on the part of the PTC and Inorganic. Transcontinental subsequently undertook the PTC's defense, but refused to indemnify it for any liability, asserting that the policy did not cover the PTC for its independent acts of negligence.

The Transcontinental additional insured endorsement provided that the PTC was an additional insured on the Corcon policy, "but only with respect to liability arising out of `your work' for that insured by or for you."'7 The policy defined "your work" to include "work or operations performed by you or on your behalf;" and the "providing of or failure to provide warnings or instructions."'8 The court explained that by replacing the phrase "your work" with the corresponding terms from the policy, "the court must construe the endorsement to provide coverage to the PTC, as an additional insured, but only with respect to liability arising out of work or operations performed by Corcon or on Corcon's behalf for the PTC."'9

The PTC argued that the "arising out of" clause encompassed liability which, "but for Corcon's contractual obligations to the PTC, would not have occurred."zo The argument was that because the two men would not have been on the underpass that night, but for the PTC contract, their injuries can reasonably be said to arise out of Corcon's work. Transcontinental asserted that the court must view the language in the context of the complaints in the underlying actions which alleged the accident was caused, at least in part, by PTC's negligence in controlling other parts of the job. Accordingly Transcontinental argued, the accident could not have been caused by Corcon's work. The court held that the Transcontinental endorsement was ambiguous "with respect to whether an additional insured is covered for its independent acts of negligence."2' It stated: "A fair and reasonable reading of the endorsement could support a showing of either proximate or `but for causation."22 Rather simplistically, the court explained that the "endorsement could have been made more clear by the inclusion of express language exempting the additional insured from coverage for its independent acts of negligence."23 In examining more than twelve separate cases from within and outside of Ohio, the court held that the "but only . . . your work" terminology did not, either explicitly or implicitly, require a showing of proximate causation as a condition precedent to triggering Transcontinental's duty to indemnify the PTC.

C. Comment

A review of the decisions does not lead one to believe that generalizations regarding the scope of the additional insured endorsement are possible with any degree of accuracy. What is apparent is that the drafters of the endorsements seem to have little interaction with the drafters of the contracts which require the procurement of insurance. This "creates" ambiguity in the context of the contracts against which the endorsement is sometimes judged.

III.

BREACH OF CONTRACTS REQUIRING PROCUREMENT OF AN ADDITIONAL INSURED ENDORSEMENT

Even simple business arrangements demand the marshalling of resources and the organization and mobilization of people and equipment. Constructing buildings inevitably requires the coordination of owners, architects, a general contractor, and subcontractors. Because entities in many business relationships often must work closely together in related but different disciplines, their roles are defined by contract. Almost universally these contracts contain provisions which require one entity to procure additional insured status for another. More often than not these contracts contain indemnity provisions that under certain interpretations come into play with regard to the insurance procured. Typically, subcontractors agree to provide additional insured endorsements on their own policies which name the general contractor, the developer, and owner. General contractors are, in turn, required to provide the developer and the owner additional insured protection and finally the developer is required to name the owner as an additional insured.24 Interesting liability issues arise when an entity breaches this part of the contract and that breach is discovered when a lawsuit by a third party is filed.

While some contend that the law is fairly settled in dictating that the liability of insurance carriers that are not a parties to an underlying contract is governed solely by the terms of the insurance policy,25 little research is required to find an exception to that rule. In Northbrook Insurance Co. v. American States Insurance Co.,26 a shopping center owner and a bakery entered into an agreement whereby the bakery was to name the owner as an additional insured on its American States policy. The bakery obliged. When an employee injured himself in the alley behind the bakery, American States contended that the additional insured endorsement, which provided coverage for "liability arising out of the maintenance or use of the tenant's premises,"27 did not cover the alley. The appellate court looked to the lease between the owner and the bakery. It required the owner to maintain the alley. The court noted that "[flailure to maintain the alley is a claim unrelated to the business of the bakery, and the American States policy therefore does not cover such a claim against [the owner]."28

In light of the general rule, albeit with its exceptions, the question that arises when an entity breaches its obligation to procure insurance, is how will damages be measured and apportioned. An illustration is provided in Borough of Wilkinsburg v. Trumbull-Denton Joint Venture.29 The Borough brought an action against a general contractor for failing to name the Borough as an additional insured. During the course of the construction of a highway, the general contractor contracted with the Borough to use off-duty police officers to regulate traffic. The contract called for the general contractor to name the Borough as an additional insured on the contractor's liability policy. After a suit was filed against the Borough, it was discovered that the general contractor had failed to name the Borough as an additional insured. Wilkinsburg tendered defense of the action to its own insurer who brought an action against the general contractor for reimbursement.

Rejecting the contractor's argument that the claim was not properly a subrogation claim because the Borough's own carrier paid the loss, the appellate court held that the issue in the case was whether the general contractor was liable for breaching its contract with the Borough, not whether the general contractor was responsible for the accident. The court held that breach of the agreement to obtain insurance made the general contractor liable for the full amount of the award against the Borough. Interestingly, there was no inquiry into whether any additional insured protection would have provided coverage had it been obtained. Presumably, such a discussion would be appropriate in a situation in which there is an issue as to coverage.30 In Aetna Casualty & Surety Co. v. Spancrete of Illinois, Inc.,31 an employee of a subcontractor sustained injuries at a site managed by the general contractor whom the employee sued. The general contractor filed a complaint against the subcontractor asserting two claims under the Illinois Structural Act and one claim for breach of contract for failing to fulfill its obligation to name the general contractor as an additional insured as required by the agreement. Aetna agreed to defend the first two counts, but not the third, and then sought declaratory relief to the effect that it had no duty to defend or indemnify the subcontractor for the third count.

While the liability policy included blanket contractual liability coverage, the court held that the general contractor's action was not based on the subcontractor's contractual assumption of liability. Rather, it was premised on the subcontractor's breach of the contract between it and the general contractor to procure insurance.3

In an interesting Delaware case,33 the court determined that a subcontractor was not obligated to pay damages incurred by a project owner when the subcontractor failed to have the owner included as an additional insured on the policy. As in most cases, an injured employee of the subcontractor sued the owner who was defended by his own insurer. That insurer sought reimbursement from the subcontractor and its insurer. While under the original terms of the contract the subcontractor would have been required to indemnify the owner for the owner's negligence, this language was eliminated and initialed by both the owner and subcontractor. The court held that striking this term of the contract unambiguously indicated the parties' intent that the subcontractor would not indemnify the owner for the owner's own negligence.

During trial of the underlying action, the owner and the general contractor settled. The court noted that "[n]owhere in the record is it asserted that Office Structures (the owner) is vicariously liable for the negligence of the other defendants."34 That being the case, the owner was liable only for its own negligence and not vicariously. Because the indemnity provision in the contract requiring the subcontractor to indemnify the owner for the latter's own negligence had been stricken, the subcontractor had no indemnity obligation.

Next, the owner argued that the subcontractor breached its duty to procure insurance providing coverage for the loss. The court noted that the contract did not require the subcontractor to provide insurance which covered the owner's negligence, so no duty to indemnify arose from that provision. The contractor next noted decisions holding that the presence of a contractual requirement to procure particular insurance suggests that both parties intended that one party indemnify the other for the latter's negligence. Thus, the owner argued that the subcontractor did indeed agree to indemnify the owner. Again, citing the deleted language, the court rejected this contention.

In Hartford Insurance Group v. Royal Globe Co.35 the court dealt head-on with the issue of whether coverage might be created for a third party solely by an insured's breach of a contract requiring it to name the third party as an additional insured. There the court unambiguously held that, absent an endorsement in the policy, an insurer had no duty to defend a general contractor who was sued by an employee of the insured subcontractor.

In Hartford, an employee of a subcontractor, Western, sued the general contractor, Stearns-Roger, for injuries the employee suffered on a construction site. The contract between Western and Stearns-Roger required Western to furnish insurance with specified coverages. Western failed in this regard, at least as far as the record disclosed to the appellate court.36 Stearns-Roger's insurer, Hartford, brought a declaratory relief action against Western's insurer, Royal Globe, seeking to be relieved of providing Stearns-Roger a defense and indemnity. As a preliminary matter, although Hartford contended that StearnsRoger was an "insured" under the Royal Globe policy, there was nothing on the record to indicate that an additional insured endorsement had ever been issued. In fact, Stearns-Roger did not appear on the certificate of insurance or endorsements contained in Hartford's exhibits. The court held that because Royal Globe never contracted with Stearns-Roger to make it a named insured, that obligation resting with Western, Stearns-Roger was not an "insured or named insured" under the policy.37

Hartford next contended that while the allegations of the complaint may not have triggered Royal Globe's duty to defend, the "true facts," showing that the accident was caused by employees of Western, obligated Royal Globe to defend because the employees of its insured caused the accident. The argument was that after the trial the defending insurer will sue the non-defending insurer, in this case Royal Globe, for contribution. Thus, a multiplicity of suits would be avoided if the non-defending insurer, who would be liable, is obligated to defend in the first instance.38

The court rejected Hartford's "true facts" argument as inapplicable because the complaint sought damages from Stearns-Roger on a separate negligence theory. The court also rejected Hartford's argument that under the contractual liability endorsement, Royal Globe had a duty to defend Stearns-Roger. First, the court decided that Stearns-Roger was not an insured. Next, it found that even if Stearns-Roger was an insured under the contractual liability provision, Royal Globe would have no duty to defend because the contractual obligations assumed by Western were to indemnify and hold Stearns-Roger harmless for acts or omissions of Western. None of the damages recovered would be sums which Stearns-Roger had to pay to the injured employee by reason of a contractual obligation, because Stearns-Roger did not assume any contractual obligation.

In Liberty Mutual Insurance Co. v. United National Insurance Co.,39 a general contractor was sued by a subcontractor's employee when the subcontractor failed to obtain worker's compensation insurance as required by its contract with the general contractor. The subcontractor previously purchased worker's compensation coverage, but the employee was injured at a time when that coverage had lapsed. After a finding that the employee's injury was work-related, the subcontractor's liability insurer denied compensation. In order to prevent delay of benefits to the employee, the state Director of Labor and Industrial Relations found the injured person to be an employee of the general contractor as well the subcontractor. The Director ordered the general contractor, through its worker's compensation carrier Liberty Mutual, to pay the employee's medical and disability benefits "even though Subcontractor was found to be primarily liable and Contractor/Liberty Mutual secondarily liable."' Liberty Mutual then filed suit against the subcontractor, seeking to recover the benefits.

Liberty argued that the subcontractor's general liability policy provided coverage because the subcontractor was contractually obligated to indemnify the contractor for damages as a result of bodily injury. The subcontractor's insurer argued that the duty to pay arose from the subcontractor's obligation under worker's compensation laws and the policy specifically excluded liability for damages for which the insured may be held liable under worker's compensation law. The court strictly adhered to the policy language, holding that Liberty Mutual could assert no greater contractual rights under the subcontractor's policy than those available to the subcontractor. The court held that the comprehensive liability insurer was not obligated under the policy for the failure of its insured to obtain adequate worker's compensation insurance as required by the subcontract.

In PPG Industries, Inc. v. Continental Heller Corp.,4' Heller should have been named as an additional insured under PPG's liability policy. After a PPG employee was injured and filed an action against Heller, it came to light that PPG had not named Heller as an additional insured. Heller's excess carrier defended the claim, paid a $70,000 award to the injured employee, and filed a subrogation suit against PPG alleging its failure to include Heller as an additional insured for operations covered by the contract. While PPG admitted that it did not secure the required insurance pursuant to the contract, it protested that the insurance requested would not have protected Heller because the underlying action did not result from PPG's operations. PPG also argued that since Heller's insurer had paid the claim, Heller suffered no damage. Therefore, as subrogee, the insurer could not seek reimbursement for the $70,000. After a lengthy discussion of Arizona subrogation law the court disagreed: "[T]here is no reason why PPG should be relieved of its unquestioned liability for providing primary insurance under . . . the subcontract merely because Continental Heller had taken the precaution of insuring itself with excess coverage."42

A. Comment

It seems there is an answer to the foregoing problems in drafting the contract by which one requires another to procure insurance. Contract drafters must first, and foremost, satisfy themselves that the contract conforms to the law of the practitioner's jurisdiction. For example, if a jurisdiction does not allow one to indemnify another for the other's sole negligence, a contract provision that purports to create such a right, will frustrate any argument that a loss not covered by an additional insured endorsement should be covered by the indemnity agreement. Likewise, if the practitioner is seeking to obtain coverage via the insurance contract language, inapplicable terms in the business contract will likely thwart their argument.

If one lesson can be gleaned from the case law for drafters of business contracts regarding additional insured endorsements, it is that the contract language must be carefully considered and designed to provide insurance applicable to the anticipated losses. An indemnity provision should be crafted to cover the remainder. In this respect, the requirement that one party name another as an additional insured most certainly should contain a statement about the breadth of the insurance to be procured. It should specify which insurance is primary and delineate that it provides coverage not only to the full extent of the indemnity obligation, but is intended to cover the additional insured's own negligence, including his sole negligence. While no contract language will be perfect when a loss arises which was not contemplated by the drafter, following these principles should minimize deviation from the intent of the additional insured.

IV.

APPORTIONMENT BETWEEN INSURERS WHEN ADDITIONAL INSURED'S PRIMARY POLICY COVERS SAME LOSS

What happens when the additional insured's own primary policy covers the same loss that is covered by the policy with the additional insured endorsement?43 Inevitably, insurers disagree over which policy is primary or excess. If they can agree there, they disagree over what proportion each insurer should pay. There is no consensus in the courts.

The California Supreme Court authored the arguably definitive, although brief, decision on this issue in Rossmoor Sanitation, Inc. v. Pylon, Inc.44 Rossmoor employed Pylon to construct a sewage pump station. This necessitated the installation of two sewer lines. The contract, by which Pylon employed Rossmoor, required Pylon to indemnify Rossmoor against all claims for damages "arising out of the work."45 As might be expected, Pylon agreed to obtain insurance for itself and to name Rossmoor as an additional insured. Pylon fulfilled this obligation through a policy issued by United States Fire Insurance Company. Rossmoor maintained an independent policy issued by its own carrier, INA. Both policies contained "other insurance clauses," each stating that apportionment shall be made if the insured has insurance against a loss covered by the policy.

A pipe trench cave-in occurred, killing one worker and injuring the other. In the tort action brought against Rossmoor by the injured worker and the decedent's heirs, a judgment of approximately $267,000 was entered which INA satisfied. Rossmoor then brought a declaratory relief action against both Pylon and U.S. Fire seeking indemnity for the sums paid. U.S. Fire crosscomplained, seeking apportionment of the sums between the carriers pursuant to the "other insurance" clauses of the respective policies. Concentrating its analysis on the construction contract between the parties, the trial court found that INA was subrogated to Rossmoor's right of indemnification because Rossmoor had a right of indemnity against Pylon in that contract. Pylon and U.S. Fire argued that the terms of the insurance contract requiring proration in a case of other insurance should control rather than the right to indemnification which existed between the parties insured by the contracts. The supreme court did not agree. Holding that the case turned on the interpretation of the contract and not on "theoretical non-contractual rights of indemnification between insureds," the court wrote: The fact that there is other insurance is a mere fortuitous circumstance. We view one factor as compelling, however: to apportion a loss in this case pursuant to the other insurance clauses would effectively negate the indemnity agreement and impose liability on INA when Rossmoor bargained with Pylon to avoid that very result as part of the consideration for the construction agreement.46 The court justified this holding by illustrating that the U.S. Fire policy was part of the consideration for the construction job such that the right of indemnity controls.

Another California case, although it applied Washington law, dealt with a similar issue. In Shell Oil Co. v. National Union Fire Insurance Co.,47 SIP Engineering contracted to provide engineering work at Shell's refinery. The contract required SIP to defend and indemnify Shell for any claims or liabilities arising out of SIP's or its subcontractors' work, "but excepting when the injury . . . or damage is caused by the sole negligence of a party otherwise indemnified [Shell] ."48 Another paragraph in the contract required SIP to maintain insurance "satisfactory to Shell," which named Shell as an additional insured.49 SIP fulfilled this obligation by providing a $1 million comprehensive general liability policy from National which provided that: [I]f specifically required to be included as a named insured, this policy shall include as a named insured any person or organization to whom the named insured is obligated by virtue of a contract, entered into before loss, to provide insurance such as afforded by this policy, but only to the extent required by said contract and not to exceed the coverages and limits of liability afforded by this policy.50

Three other insurers provided $5 million of excess coverage for the same persons as the National policy.

An employee of a SIP subcontractor was severely injured from a high voltage electrical shock. The injured worker sued SIP and Shell for negligence in federal court in Seattle. While SIP tendered its defense to National, Shell did not immediately tender its defense. Instead, it defended through in-house and retained counsel.

By the time Shell formally demanded coverage and defense, National had resolved to offer its policy limits on behalf of SIP, and did so in the judicially required mediation immediately following. National and its excess carriers paid SIP's share of the settlement, $2 million, and Shell paid another $2 million.

Shell pursued its own claim for coverage and defense against National and the excess carriers. The trial court ruled that Shell had been covered for defense and indemnification by reason of the contract between SIP and Shell. The excess insurers thereafter settled with Shell for $950,000. The matter proceeded to trial against National, where the court determined that Shell was entitled to half of the National policy limit, $500,000, plus prejudgment interest and attorneys' fees.

In the appellate court, National argued that because SIP did not have to indemnify Shell when Shell was solely negligent, the insurance contract which specifically relied on the indemnity contract limited the coverage provided to Shell. The court undertook a painstaking dissection of the contract language requiring procurement of insurance and the indemnity obligation. In the final analysis, the court disagreed with National's contention that the provisions of the agreement excluded insurance for Shell's sole negligence. In holding that "Shell's interpretation is the reasonable one and National's is unreasonable,51 the court held that "insofar as Shell was to be a direct beneficiary of the contract insurance requirements, restricting the CGL to indemnifiable claims, and thus excluding from it those involving Shell's sole negligence, would have left Shell unprotected for those claims for which it most needed insurance."52

A. Comment

At first blush, the holdings of Rossmoor and Shell appear to be at odds. Rossmoor held that the parties' contract required Pylon to procure insurance which would cover Rossmoor's passive negligence and that the contract could be considered in determining the coverage afforded by the U.S. Fire policy. Shell held that the contract language did not limit the insurance that SIP was to provide so that the policy language itself could be viewed without limitation. While it is possible to reconcile some aspects of these cases, it is probably safe to say that there is enough confusion in this area that some direction from the courts would be instructive, at least. Nevertheless, as it now stands, it appears that the first appropriate inquiry is into the contract language requiring the procurement of a certain scope of insurance, as well as the indemnity provisions within the contract. If those provisions conflict with the insurance procured, then an analogy may be made to either the situation presented by Rossmoor or that presented by Shell.

In Rossmoor, the California Supreme Court looked to extrinsic evidence, in the form of the underlying construction contract, and beyond the other insurance provisions to answer the question of which policy was primary. The court employed a quite opposite methodology in Crown Center Redevelopment Corp. v. Occidental Fire & Casualty Co.53 There, a long and complex decision arose out of the disaster at the Hyatt Regency Hotel in Kansas City. Two elevated sidewalks in the hotel lobby collapsed and killed over 100 people, injuring 200 others. The court reviewed two lines of insurance, one procured by the owners of the hotel, the "Commercial" line, and the others, the "Occidental" line, procured by the operator of the hotel. Each line's primary policies named the purchaser of the line as an additional insured. The court displayed some measure of disgust with the way insurance companies draft "other insurance" clauses, which the court believed caused the difficulty that the clauses themselves seek to avoid.54

The first two layers of the Commercial line, a $1 million primary policy and a $10 million excess policy, named Hyatt as an additional insured. The remaining $90 million of excess coverage was "following form" coverage. The Occidental line of insurance was purchased by Hyatt. The $1 million primary policy named the owners as additional insureds with the remaining five levels of excess insurance, totaling $200 million, following form.

With regard to the Commercial line, the second level excess insurer, American, urged the court to consider extrinsic evidence to determine the intent of the parties that the Occidental line was to be primary to the entire Commercial line. Specifically, American contended that the parties intended that Hyatt was to be insured under the Commercial line only against liability for ongoing construction, not for the operation of the hotel. Holding that the allegations put forward by the complainants encompassed the coverage provided under either scenario, the court refused to consider extrinsic evidence and relied only on the insurance contracts. Labeling the other insurance clauses "mutually repugnant,"55 the court found that the Occidental line was primary as well. The court rejected other insurers' similar arguments that one line of coverage was excess, while the other was primary.

Adhering to the trial court's decision, the court held that once the $1 million of primary insurance was exhausted on both the Commercial and Occidental primary policies, the issues of which company or companies were obligated to pay and in what amounts, were properly settled by looking at the total limits of coverage afforded by each line, and therefrom fashioning an allocation ratio. The court took the $122 million total paid in liability claims, and split it in proportion to the total coverage available.56 V.

APPORTIONMENT BETWEEN THE NAMED INSURED

AND AN ADDITIONAL INSURED WHEN THE INSURANCE

PAYS A CLAIM IS IN EXCESS OF THE POLICY LIMITS

An often vexing issue facing insurers arises when they confront the dilemma of how to apportion indemnity monies on behalf of an insured and an additional insured when the claims exceed the policy limits. With all but exceptional policies, claims paid on behalf of additional insureds reduce the per occurrence and aggregate limits of insurance available under the policy. This is so because insurers usually provide additional insured endorsements for little or no cost and it is unreasonable to assume that insurers providing these endorsements expect to increase the potential risks for which they assume liability.57 However, because an insurer owes a duty of good faith and fair dealing to an additional insured just as it does to its named insured, a difficult question is presented when an insurer has the option to expend all of the policy limits without settling all claims against all insureds: May an insurer prefer a named insured over an additional insured or vice versa?

It is an accepted canon of insurance law that settlements undertaken by an insurer that exhaust policy limits terminate the insurer's defense obligations when those settlements are made in good faith and in the best interests of the insured.58 As this section of this article illustrates, courts have held, almost uniformly, that settlements undertaken by an insurer which exhaust policy limits do not terminate the insurer's obligation to provide a defense, if the settlement unfairly treats insureds competing for settlement monies. Several courts have held that settlements inconsistent with the best interests of the insured may not be entered into merely as a means of terminating the insurer's duty to defend, without the insurer risking a bad faith claim.59

According to at least one commentator, the leading case addressing apportionment between a named and an additional insured is Smoral v. Hanover Insurance Co.60In Smoral, the plaintiff fell asleep and crashed a car owned by Syracuse Jerome Motors. A passenger suffered severe injuries and sued the driver as well as the two owners of the car. Hanover Insurance Company defended the owners as well as the driver. As a permissive user, the driver became an additional insured on the Hanover policy under New York law.

Seeing no defense to the action and believing the passenger's damages exceeded the $50,000 policy limit, Hanover agreed to pay the limits in return for a release of the car owners. The release specifically reserved all rights against the driver. Hanover gave no notice of the settlement negotiations to the driver and the driver never consented to Hanover's settlement. The case appeared before the trial judge and after some negotiation the driver's excess insurer settled the case for an additional $32,500. Thereafter, the driver, and his insurer as subrogee, brought an action to recover the $32,500 and attorneys' fees.

The court held that Hanover breached its duty of good faith and fair dealing to the driver when the insurer preferred its named insureds over the additional insured: Good faith in this connection means more than an absence of intent to harm. It means an adequate protection of the interests of the assured. While this duty has most frequently been considered where the interests of the company have been preferred to the detriment of the insured, the same considerations would apply with equal force where the company preferred one of its insureds over another. It is absolutely no answer for the company to say that it paid the full amount of its policy if in so doing it fully protected one of its insureds and left the other completely exposed.61 The court held that the insured was entitled to recover that proportion of the policy limits that he should have been allotted had the insurer treated him as the court believed its contract required it to do.62 As explained below, this solution is not without criticisms.

The court in Shell Oil v. National Union Fire Insurance Co.,63 discussed earlier, faced a similar issue. By the time Shell demanded coverage from National Union, the insurer had resolved to offer its policy limits on behalf of SIP. National Union settled the case and Shell pursued its own claim for coverage and defense against National Union and the excess carriers. On motion for summary adjudication, the court ruled that Shell had been covered by the National Union policy, at least in part, for the defense and indemnification of the injured worker's action. The excess insurers settled with Shell and the matter proceeded to trial against National. The trial court determined that Shell was entitled to $500,000, half the National Union policy limit.

Arguing that the payment of policy limits on behalf of one co-insured necessarily satisfies the insurer's obligations to the other co-insured, National Union appealed. Citing Smoral, and the inclusion of the implied covenant of good faith and fair dealing in every insurance contract, the court held that National Union's disbursement of its entire policy limits to SIP "did not discharge National 's policy obligations to Shell but rather constituted an actionable breach of those duties..64In addition, the court held: "The [trial] court's consequent award of damages equal to half the policy limits, conservative in the view of Shell's sole negligence, is unexceptionable."65

Although not discussed in his treatise, perhaps because of its recent origin, it seems as though at least one commentator would take issue with the trial court's determination in Shell Oil. In criticizing the Smoral decision in which the court held that the damages issue presented difficult questions and instructed the trial court on remand to determine the plaintiff's damages based on the "proportion of the settlement funds [that] should have been, in good faith, allotted to relieving or reducing [the plaintifFs] liability,"6' commentator Windt wrote: The result reached in Smoral on the damages issue is subject to criticism. Whether or not an insured is damaged as a result of an insurer's partial settlement should depend on the relative liabilities of the insureds. If, as was apparently the case in Smoral, the insured on whose behalf the settlement was not made is primarily liable and the other insureds are secondarily liable, so as to give rise to a right of indemnification by the latter against the former, the insurer should have no liability. This is true because, regardless of when or how the insurance company paid its policy limits, the insured who was the primary tortfeasor would still have been solely liable for the value of the plaintiff's claim in excess of the policy limits. The only circumstance, therefore, under which an insurer might be exposed to liability in that type of situation is if, having an opportunity to settle the entire case for a reasonable amount in excess of its policy limits, it fails so to advise the primary tortfeasor so as to afford an opportunity to make the necessary contribution. In that event, the insurer will have breached one of its obligations arising out of its duty to settle, and it may be liable in accordance with the rules discussed in [the section of this book dealing with an insurer's duty to settle when settlement offer is in excess of policy limits.]67

Perhaps this reasoning came into play in Underwriters Guarantee Insurance Co. v. Nationwide Mutual Fire Insurance Co.68 There the court faced a situation similar to that in Smoral. In Underwriters, a car owed by Nationwide's insured struck and killed a bicyclist. The bicyclist had substantial uninsured motorist coverage and his uninsured motorist carrier paid $13 million to the bicyclist's estate. It then brought a subrogation action against the car's owner and the driver. Nationwide's $100,000 liability policy also insured the driver of the car, a permissive user, as an additional insured. The driver of the car had her own policy with Underwriters. Nationwide settled with the underinsured motorist carrier for its entire policy limits and then instituted this declaratory judgment action attempting to obtain a court determination that it had no duty to defend the additional insured under the policy. The Nationwide policy provided that "after the liability limits of this policy have been exhausted by payment, we will not be obligated to defend any suit or pay any claim or judgment."69

Holding that Nationwide's contract language was unambiguous, the appellate court upheld the trial court's grant of Nationwide's motion for summary judgment. In distinguishing the Smoral case, the Underwriter's court noted that "[n]either the complaint nor the answer raised any issue of bad faith in the procurement of the settlement. If the settlement were contrary to contractual duties of Nationwide as a result of the insurance company's bad faith in negotiating a settlement, it should have been pled."7

The Smoral reasoning was considered and flatly rejected in Vitek, Inc. v. Floyd.71 Vitek marketed temporomandibular joint (TMJ) jaw implants. Alleged defects in the product resulted in the filing of numerous lawsuits in many jurisdictions. Charles and Ann Homsy were sued as directors and officers of Vitek by over four hundred plaintiffs. Vitek filed for protection under Title VII of the United States Bankruptcy Code and the bankruptcy court appointed a trustee. The trustee organized counsel for the plaintiffs in most of the suits to form the equivalent of a federation and also initiated discussions with representatives of Vitek's several insurance carriers in an effort to obtain and distribute the proceeds.

After several months of negotiations, the trustee filed a number of motions with the bankruptcy court seeking authority to compromise with most of Vitek's insurers. Under the terms of these agreements, the carriers would be required to remit all remaining proceeds up to the limits of their policies in full satisfaction of the carriers' obligations. In return, the carriers were to be protected by an injunctive order of the bankruptcy court precluding them from incurring additional liability and defense costs. As directors and officers, the Homsys were additional insureds, and objected to the settlements. They argued that as co-insureds they were being deprived of their rights under the policies. Specifically, the Homsys would be enjoined from suing the carriers, but they would not themselves be protected from third party suits.

The bankruptcy court approved the settlement, but the district court disagreed. It found that the proceeds of the insurance policies were owed both to the Homsys and Vitek as co-insureds. The Fifth Circuit Court of Appeals disagreed with the district court. It held that it was inconsistent for the bankruptcy court to grant protection for the proceeds, ostensibly owned by the Homsys, when the Homsys themselves were not part of the bankruptcy: "If the Homsys own a portion of the [p]roceeds, that portion cannot be deemed property of the [e]state; and perforce there can be no justification for shielding such portion under the bankruptcy court's injunctive orders, the reach of which extends only to the property of the [e]state."72

Interestingly, the Vitek court declined to recognize what appeared to be a well-established rule that an insurer may not prefer one insured over another: More relevant for our purposes, however, is the failure by either the Homsys or the district court to cite us to any binding authority for the proposition that "[a]n insurance company cannot prefer one of its insureds over another." The district court anchored its opinion on this principle, yet provided us with neither statutes nor case law indicating that the laws of the State of Texas embrace such a principle. Neither did the district court explain exactly how the principle applies in this case. For their part, the Homsys referred us to two cases - one from New York and one from an intermediate appellate court in Texas that purportedly support the principle: Smoral v. Hanover Insurance Company and Texas Farmers Insurance Company v. Sorino. But these cases are distinguishable.73 The court distinguished Smoral: Far from standing for a broad principle that an insurer may never prefer one of its insureds over another (and thus may be enjoined from entering a settlement that would do so), however, the Smoral case merely indicates that an insured may seek damages under a breach of good faith cause of action if he believes that an unfair settlement has been effected.74

A. Comment The Vitek reasoning stands apart as most persuasive. An additional insured should not be left unprotected by an insurer who expends the policy limits protecting the interests of one insured while leaving the other open to liability. However, an insurer should not lose an opportunity to extricate less than all of the insureds when it reasonably determines it will not be able to settle the case on behalf of all insureds. Smoral, where the court found that Hanover had breached its duty of good faith and fair dealing on somewhat egregious facts, does not state a general rule. As the Vitek court recognized, there really is no language in the Smoral opinion which creates a broad rule that an insurer may not prefer one insured over another in all circumstances. When the insurer's preference of one insured over another does not work to realistically prejudice the other insured, there is really no justification to foreclose the insurer from "preferring" one insured over another. Indeed, in seeking to avoid "preferring one insured over another," the insurer may well breach its obligation to the other insured for not settling when it had an opportunity. This issue might be implicated when an insurer loses the opportunity for all the insureds to settle the case with the insurer's contribution as well as a contribution of their own. An insurer acting in good faith and frankly communicating with all of its insureds in an attempt to resolve as many of the claims as possible can, in most situations, avoid this pitfall. Nevertheless, when the interests of the insureds are not congruent, fashioning such a settlement may be extremely difficult.

VI.

CONCLUSION The additional insured endorsement has developed into a tool indispensable to business. It provides the most effective way for a business to satisfy itself that the additional risks undertaken when it joins forces with another business have been spread to an acceptable extent. It is the business of lawyers drafting contracts and of those drafting insurance policies to craft and evolve language which not only recognizes the intent of the insured, but also effectuates the intent of the insurer. Only through an understanding of the liabilities assumed, can insurance be priced correctly. If this certainty costs more, the market will decide if the cost is worth the benefits.

'Shepardize the cases cited for this article carefully before citing them to a court. The cases were selected because they provide instructive illustrations, not necessarily because they are well-reasoned or even thoughtfully considered. 2562 F. Supp. 800 (E.D. Penn. 1983).

31d. at 802.

41d. at 805. Warning! OCR inputs differ greatly

4Id. at 805 5Id. 6495 N. at 450 (Minn. Ct. App.1993). 7Id. at 452. 8Id. at 453. 91d. at 454.

10632 N.E.2d 1039 (Ill.1994).

"721 F. Supp. 740 (E.D. Pa. 1989). 1d. at 742.

13 Jd.

'4660 A.2d 672 (Pa. Commw. Ct. 1995).

'51d. at 676 (citing McCabe v. Old Republic Ins. Co., 228 A.2d 901 (Pa. 1967). '6No. CIV. A. 94-5039, 1995 WL 465197 (E.D. Pa. Aug. 7, 1995).

1d. at *3. 18Id.. 19Id... 20pennsylvania Turnpike Comm'nv. Transcontinental Ins. Co., No. CIV.A. 94-5039.1995 WL 465197 at *3 (EI). Pa Aug. 7, 1995). 21Id. at *4.. 22Id. 23Id..

z"This is not always the way the contracts work, however. See Patent Scaffolding Co. v. William Simpson Constr. Co., 64 Cal. Rptr. 187 (Ct. App. 1967) (general contractor was to procure insurance for subcontractor); Waterway Terminals Co. v. P.S. Lord Mech. Contr., 406 P.2d 556 (Ore. 1965) (owner was to provide subcontractor insurance as part of agreement submitted by subcontractor to contractor).

2"See Transport Indem. Co. v. Home Indem. Co., 535 F.2d 232 (3d Cir. 1976). 26495 N.W.2d 450 (Minn. Ct. App. 1993). 271d. at 453.

28Id. Nevertheless, in Township of Springfield v. Ersek, 660 A.2d 672 (Pa. Commw. Ct. 1995), the court adhered to the general rule that the terms of the policy control. There, an employee of a golf shop was injured on the stairs leading to the premises. The court held that:

The fact that the lease between the Township and Ersek has been held to be not specific enough to constitute a waiver of Ersek's immunity under the Workmen's Compensation Act bears no relevance to the duties of Phoenix (the insurer) to the Township under the policy issued naming the Township as an additional insured.

Id. at 675-76.

29568 A.2d 1325 (Pa. Super. Ct. 1990).

3'There is a degree of speculation, and thus an evidentiary consideration, as to what an unprocured endorsement might say. 3'726 F. Supp. 204 (N.D. Il. 1989).

32The court held that the contractual liability coverage did not provide coverage for the general contractor's third count. (The insurer nonetheless did have a duty to defend all counts because the first two counts were covered.) Had the subcontractor settled the case before Aetna had an opportunity to file a declaratory relief action, the result regarding indemnity may well have been different, the settlement commingling funds for both covered and uncovered counts. 330ffice Structures, Inc. v. Home Ins. Co., 503 A.2d 193 (Del. 1985).

34Id. at 197.

35517 P.2d 1117 (Ariz. Ct. App. 1974).

36It should be noted in this case that there were several evidentiary concerns raised by the appellate court. Specifically, at least one insurance policy was not submitted into evidence and the appellate court could not determine if the general contractor would have been an "insured" or a "named insured" had it been included on an endorsement because the parties never provided the trial court with a policy which defined insured. Id. at 1121-22

37Id.at 1122 at 1122.

38See Travelers Ins. Co. v. General Casualty Co. of Am., 187 F. Supp. 234 (D. Idaho 1960). 39731 P.2d 167 (Haw. 1987).

40Id.at 169 "603 P.2d 108 (Ariz. Ct App. 1979). 42/d. at 113.

43This article will not address the interesting, though lengthy, issues arising out of policies which the parties do not agree cover the same loss. 4532 P.2d 97 (Cal. 1975). 4'ld. at 98.

"bld. at 104.

4752 Cal. Rptr.2d 580 (Ct. App. 1996).

^sld. at 582. 491d. at 584. 5Id. at 582.

51Id.at 584. 52Id.at 585. 53716 S.W.2d 348 (Mo. Ct. App. 1986).

5^In this regard, the Crown Center court cited Hardware Dealers Mut. Fire Ins. Co. v. Farmers Ins. Exch., 444 S.W.2d 583 (Tex. 1969): "In Hardware Dealers .. [t]he court discussed the various approaches which have been taken to try to resolve the problem created by insurance companies engaging in the battle of draftsmanship to create more terms to avoid coverage. The other insurance clause problem has been created by the insurance company and despite years of litigation the problem persists." 716 S.W.2d at 355. 551d. at 355-56.

"In this case, the $200 million limits of the Occidental line and the $100 million limits in the Commercial line yielded a ratio of 2:1 or one-third to the Occidental and two-thirds to the Commercial.

57It is the authors' experience that there are some additional insured endorsements which have separate policy limits.

58See Commercial Union Ins. Co. v. Pittsburgh Corning Corp., 789 F.2d 214, 218 (3d Cir. 1986); ACandS, Inc. v. Aetna Casualty & Sur. Co. 764 F.2d 968, 975 (3d Cir. 1985).

59See Voccio v. Reliance Ins. Cos., 703 F.2d 1 (lst Cir. 1983); Brown v. United States Fidelity & Guar. Co., 314 F.2d 675 (2d Cir. 1963); Texas Farmers Ins. Co. v. Sorino 881 S.W.2d 312 (Tex.1994); Smoral v. Hanover Ins. Co., 322 N.Y.S.2d 12 (App. Div. 1971). 60322 N.Y.S.2d 12 (App. Div. 1971); see ALLAN D. WINDT, INSURANCE CLAIMS & DISPUTES 5.09 (3d ed. 1996 & Supp.).

6'Smoral, 322 N.Y.S.2d at 14 (citations omitted).

62But see, Country Mut. Ins. Co. v. Anderson, 628 N.E.2d 499 (III. App. Ct. 1993). The Country court found no bad faith where insurer exhausted limits settling on behalf of two of three insureds. The plaintiff insisted that the non-settling insureds other insurance contribute and the other insurer refused. The court complemented County for quick action in recognizing that liability was in excess of policy limits and for seizing the opportunity to settle the case. Id. at 504.

6352 Cal. Rptr.2d 80 (Ct. App. 1996), see notes 47-52 supra, and accompanying text.

641d. at 588. 65ld.

66Smoral v. Hanover Ins. Co., 322 N.Y.S.2d 12, 14 (App. Div. 1971).

6Windt, supra note 60, 5.09. 6s578 So. 2d 34 (Fla. Dist. Ct. App. 1991). 69 Id. at 35.

701d. at 35-36. See also, Lynton v. Metcalf, 327 N.Y.S.2d 823 (Civ. Ct. 1971) [There, a passenger in a negligently parked taxicab negligently opened the door into oncoming traffic causing an accident. The passenger was an additional insured on the taxicab's policy. The taxi company settled the claimant's action against it in exchange for a release which reserved claims against the passenger. Citing Smoral, the court held that the insurer owed the passenger a duty of good faith which meant adequate protection for both the taxi company and the passenger and ordered the insurer to pay the claim.

7151 F.3d 530 (5th Cir. 1995). See also, Bohn v. Sentry Ins. Co., 681 F. Supp. 357 (E.D. La. 1988), aff d, 868 F.2d 1269 (Sth Cir. 1989). In Bohn, the court held that a primary insurer had no further duty to defend when it reached a settlement in good faith even though the additional insured was not released. This case is possibly distinguishable from the Smoral case on the grounds that the Smoral court specifically found that the insurer breached its duty of good faith and fair dealing to the additional insured. 7Vitek, 51 F.3d at 536.

'31d.

'"Id. at 536-37.

Michael T. Lucey is the newly elected managing partner of the San Francisco firm of Gordon & Rees, LLP. He specializes in employment discrimination and insurance coverage litigation. A 1977 graduate of Stanford University, Mr. Lucey received his J.D. from the Hastings College of Law in San Francisco in 1981. He is a member of the Federation of Insurance & Corporate Counsel.

Michael D. Bruno is an associate at Gordon & Rees, where he specializes in employment discrimination and insurance coverage litigation. He graduated from UCLA with a Bachelor's degree in Political Science in 1990 and received his J.D. from Santa Clara University in 1993.

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