It is well established that a surety has contractual and common law rights to recover losses from its principal and indemnitors, as well as the right to equitable subrogation to recover against others with a relationship to the principal, such as the principal’s liability carrier.[i] However, whether a surety may recover from the principal’s commercial general liability (CGL) carrier may be an issue of jurisdictional interpretation; and a recent California federal court decision shows how impactful that interpretation can be, and not in a good way.
The case is Berkley Regional Insurance Co. v. Capitol Specialty Insurance Corp.,[ii] which involved a surety that issued subcontract performance and payment bonds on a California project related to construction for a school. The principal, JMS Air Conditioning & Appliance Service, Inc. (JMS), was a subcontractor required to install chiller pipes and related back filling. The obligee initiated a claim against both bonds, asserting that JMS performed the work “incorrectly, negligently, and below construction industry standards.” Specifically, the obligee claimed that JMS installed “leaking hydronic piping that caused damage to the project.”
After an investigation, the surety determined the claim was valid; and it paid the contractors and material suppliers who were hired to remedy the project damage. It then sought reimbursement from two different CGL insurers of JMS under the doctrine of equitable subrogation. The two insurance policies had identical contract language. Like many general liability policies, the provisions in these contracts provided that the insurer pay “those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies.”
The surety brought suit against the two insurers, arguing that, after it paid the costs to repair the project work, it had the right to pursue full recovery from the insurers, who were primarily responsible for the loss. The insurers claimed that, even if the surety stepped into the principal-insured’s shoes, the applicable policies were not triggered because neither JMS nor the surety was determined to be legally obligated to pay any damages. The court sided with the insurers, dismissing the surety’s action.
It was the meaning of the policy language “damages” that was the sticking point. The court held that under California law the principal never became legally obligated to pay damages because the term “damages” in the liability insurance indemnity provisions is interpreted under a “bright line rule” to mean only money ordered by a court to be paid. This interpretation was upheld by the California courts in numerous instances, noted the court, and the language was unambiguous. Thus, because litigation against JMS never ensued and there was no court order for JMS (or the surety on JMS’s behalf) to pay damages to the obligee related to the insured’s loss, the surety suffered no damages required to be indemnified under the policies.
A surety’s success under its principal’s CGL policy typically represents only partial recovery and only for certain types of claims, all tied to the language of the insurance contract. But this decision appears to put the surety in quite a pickle, at least in California, to ever recover under a principal’s CGL policy for indemnity based upon equitable subrogation. Bond obligations require a timely response from the surety to investigate the claim, pay, and/or perform, or else the surety risks allegations of bad faith and violations of fair claims practices laws. There is no waiting for a court order. And thus, if indemnity to the surety under a principal’s CGL requires a court order, the surety in this scenario will nearly always come up short.
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Marina De Rosa is an Associate at Ernstrom & Dreste, LLP, in Rochester, New York. Her primary areas of practice focus on construction and surety law as well as complex commercial litigation. Her Juris Doctor degree is from Syracuse University College of Law, where she was an associate editor of the Journal of Science and Technology. She is a member of the ABA TIPS FSLC. De Rosa can be reached at [email protected] or 585.242.4960.
[i] Matthew G. Davis & Daniel Pentecost, Drive for Show, Recover From CGL Carriers for Dough, National Bond Claim Association .
[ii] 2022 U.S. Dist. LEXIS 174456 [Cent. Dist. Cal., Sept. 26, 2022, No. CV 20-6622 FMO (Ex)].