Valley Crest Landscape Development, Inc. v. Mission Pools of Escondido, Inc.: An Insurer May Be Entitled to Subrogation in the Absence of the Contractual Indemnitor’s Fault

By: Steven E. McDonald and Jamie M. Cheng

Factual and Procedural Background

Jeffrey Epps suffered severe injuries after diving into the shallow end of a swimming pool at St. Regis Resort in Dana Point, CA. He and his wife Michelle Epps brought suit against the owner of the hotel, the general contractor who built all the exterior improvements at the hotel, and the subcontractor who built the pool. They claimed in part that the vertical tile depth markers were illegible because they were partially submerged and that the color of the pool plaster made the pool seem deeper than it really was.

The general contractor had an express indemnity agreement with the owner to defend and indemnify the owner for all claims arising out of the general contractor’s work. The subcontractor in turn had an express indemnity agreement with the general contractor for the subcontractor to indemnify the general contractor.

The general contractor’s insurer, National Union, took up the defense of the general contractor. National Union also defended the owner as an additional insured. The general contractor tendered its defense to the subcontractor, but the subcontractor never responded to the tender. Additionally, the subcontractor did not have adequate insurance as required by its subcontract and thus did not have insurance coverage for the claims.

The general contractor cross-complained against the subcontractor for express indemnity and contribution. National Union also intervened and cross-complained against the subcontractor, alleging that it was subrogated to the general contractor for its payment of defense fees and costs.

On summary judgment, the subcontractor was determined to have little to no liability for plaintiff’s injuries. The general contractor and subcontractor settled with the plaintiffs and the owners, leaving only the general contractor and National Union’s cross-complaints against the subcontractor for trial. The court tried National Union’s claim for equitable subrogation and the general contractor’s claim for express indemnity separately. It determined that based on the indemnity agreement in the subcontract, National Union was entitled to the full amount it paid in defense of the general contractor, the amount it paid in defense of the owner, and all amounts paid in settlement. The court also awarded the general contractor the $250,000 it expended under its self-insured retention.

Issue 1: Was the general contractor’s cross-complaint time-barred by Code of Civil Procedure section 337.1, subdivision (a)?

No. Code of Civil Procedure section 337.1, subdivision (a), sets forth a four-year statute of limitations for patent construction defect actions, commencing from the date of substantial completion of the project. This limitation does not apply to cross-complaints for express indemnity. The court declined to follow a case that applied section 337.1 to limit an equitable indemnity cause of action.[1] Express indemnity claims differ from equitable indemnity claims because the former would follow the statute of limitation for breach of contract, accruing from the date of the breach. The court also reiterated the principle that “a tort defendant retains the right to seek equitable indemnity from another tortfeasor even if the plaintiff’s action against the cross-defendant is barred by the statute of limitations.” Since the statute of limitations had not began to run until the subcontractor allegedly breached the express indemnity agreement when it failed to defend and indemnify the general contractor, the general contractor’s express indemnity claim was timely.

Issue 2: Did the trial court abuse its discretion by finding that the doctrine of superior equities does not preclude National Union from bringing an equitable subrogation claim?

No. The trial court made no specific findings on the balance of equities, but it found that National Union could bring its subrogation claim. The appellate court applied the doctrine of implied findings and decided that the trial court found the equities weighed in favor of National Union. It otherwise reviewed the trial court’s ruling under an abuse of discretion standard.

The doctrine of superior equities is one of the elements required to maintain an action for equitable subrogation. It can act to bar a subrogor (usually an insurer) from recovering against a party (the alleged wrongdoer) whose equities are equal or superior to those of the insurer.[2] There are two bases for equitable subrogation that affects how courts consider the doctrine of superior equities: equitable indemnification (as in tort) and contractual indemnification (such as by an indemnity agreement).[3] This case dealt with the latter. The court synthesized the patchwork of prior superior equity tests in contractual indemnification into a four-factor balancing test: (1) the cause of the loss, (2) nature of the indemnity agreements, (3) receipt of premiums, and (4) compliance with contractual obligations.

The court found that the first factor weighed in favor of the subcontractor because it did not cause the loss, as determined on summary judgment. The second factor weighed in favor of the insurer because the subcontractor’s indemnity agreement with the general contractor creates “liability of greater primacy” than that of the insurer who insured against the loss. The third factor was “neutral” because the insurer accepted premiums for undertaking the risk, but the subcontractor also received consideration for its performance of the indemnity agreement. And finally, the forth factor weighed in favor of the insurer because National Union fulfilled all of its contractual obligations, but the subcontractor failed to comply with its contractual obligation to maintain adequate insurance and to indemnify and defend the general contractor. On balance, the court decided that the trial court did not abuse its discretion when it impliedly found that the equities weighed in favor of National Union.

Issue 3: Did the trial court abuse its discretion in denying the subcontractor a jury trial on the general contractor’s claim for express indemnity?

Yes. The trial court had determined that the general contractor was seeking specific performance of the contract in its express indemnity claim and held a bench trial on that issue. The appellate court reversed, holding that denying a jury trial to the subcontractor was improper for two reasons. First, the relief the general contractor sought was damages from breach of contract, not specific performance on the contract. Second, the cross-complaint did not allege inadequacy of legal remedy, which is a prerequisite for specific performance. Therefore, because the relief sought was in the form of damages, the trial court should have conducted a jury trial on this issue.

The court also held that the subcontractor did not waive or forfeit its right to a jury trial because on the record, it never consented to such waiver. And since denial of a right to jury trial is reversible error per se, the appellate court reversed and remanded this issue for resolution by jury trial.

Final Observations

By establishing the four-factor test, the court clarified the test for weighing the equities in contractual indemnity cases. In doing so, Valley Crest in effect abrogates the principle in Patent Scaffolding that an insurer cannot bring a subrogation claim based on breach of contract where the breach did not cause the loss. The test now allows an insurer to bring a subrogation claim solely based on a breach of an agreement to indemnify.

The decision also represents the culmination in a public policy shift from insurers bearing the loss in legal claims to indemnitors bearing the loss. In the past, Patent Scaffolding stated that since insurers accept premiums to cover losses, it would be unfair for them to receive a windfall if they recovered what they contractually agreed to pay from parties who did not cause the loss.[4] Now, Interstate Fire and Valley Crest state that allowing those who breach their contract to escape liability would reward them for refusing to fulfill their indemnification obligations: “it would be better for the windfall to go to the one that undisputedly fulfilled its contractual obligations, rather than to the one that allegedly breached them.”[5]

There is technically still a split in authority as to whether an insurer is entitled to subrogation in contractual indemnity cases in the absence of the contractual indemnitor’s fault.[6] Valley Crest does not create an absolute rule that the doctrine of superior equities will never bar insurers from bringing such subrogation claims. The deference to the trial court and the fact that the general contractor paid $250,000 in self-insured retention likely influenced the court to decide in favor of the insurer. Trial courts citing Valley Crest will still have broad discretion in weighing the equities. For example, the four-factor test leaves open the possibility for the doctrine of superior equities to bar subrogation where an indemnitee’s fault in causing the loss outweighs an indemnitor’s breach.

The Supreme Court has not opined on the doctrine of superior equities since it first adopted and established the doctrine in 1938.[7] Notably though, the Court initially issued Valley Crest as an unpublished decision, and then ordered the opinion published on July 2, 2015. But until the Supreme Court weighs in again, courts and lawyers will likely continue to struggle to keep this archaic doctrine relevant in light of modern principles of comparative fault in the post-Li v. Yellow Cab era.[8]

[1] See Wagner v. State of California (1978) 86 Cal.App.3d 922.

[2] State Farm General Ins. Co. v. Wells Fargo Bank, N.A. (2006) 143 Cal.App.4th 1098, 1107.

[3] See Interstate Fire and Cas. Ins. Co. v. Cleveland Wrecking Co. (2010) 182 Cal.App.4th 23, 32.

[4] Patent Scaffolding Co. v. William Simpson Const. Co. (1967) 256 Cal.App.2d 506, 516.

[5] Interstate Fire and Cas. Ins. Co., supra, 182 Cal.App.4th at p. 47.

[6] See State Farm General Ins. Co., supra, 143 Cal.App.4th at p. 1118, fn. 12; Reliance Nat. Indemnity Co. v. General Star Indemnity Co. (1999) 72 Cal.App.4th 1063, 1081.

[7] See Meyers v. Bank of America National Trust & Savings Association (1938) 11 Cal.2d 92.

[8] See Li v. Yellow Cab Co. (1975) 13 Cal.3d 804; see generally State Farm General Ins. Co., supra, 143 Cal.App.4th at pp. 1120-1128 (conc. opn. of Ruvolo, P.J.).