« Court of Appeals decision in Continental makes clear that a CGL policy covers damage occurring before or after policy period—implications for defective product claims. | Main | No Voluntary Payment Clauses: Why Communication with Your Insurer is More than Just Good Etiquette »

February 09.2009

New Additional Insured and Defense Obligations Under Assembly Bill 2738 Effective January 1, 2009

by Joe Whalen

In residential construction projects, the builder usually hires a number of specialty subcontractors and typically requires that the builder be named as an additional insured on their general liability policies.  While builders may not expect to obtain defense or indemnification from a subcontractor for claims that do not arise from a subcontractor's work, nevertheless California law has provided a broad obligation for subcontractor insurance carriers to provide such a defense.  In 2001, the California Court of Appeals in Presley Homes, Inc. v. American States Insurance Company, held that an insurer's defense obligation under an additional insured endorsement covered all claims in the litigation, including claims for which there was no possibility of indemnity coverage.   The court noted that this was not a contractual requirement but a public policy decision that the court had adopted in Buss v. Superior Court, 16 Cal.4th 35 (1997).  After the Presley decision, subcontractors complained that their insurers were often required to defend builders and developers against construction defect claims that had nothing do to with the work performed by the subcontractor.  Horror stories about landscaping contractors having to defend builders for roofing defect claims, although probably more fantasy than fact, proliferated.
 
As a result of successful lobbying by the California Professional Association of Specialty Contractors, the California legislature passed Assembly Bill 2738, which became effective on January 1, 2009.  The new law applies only to residential construction defect claims and builds on a 2006 law (AB 758) that forbade a builder from requiring "Type 1" indemnity in subcontracts for residential construction.  The new law goes further and provides that a builder may not contract to require subcontractors to indemnify or insure a builder for construction defect claims that do not arise out of the subcontractor's scope or work, or that arise out of the negligence of the builder of the builder's other subcontractors or suppliers.  Although the new statute makes clear that Presley is still viable law in California, it also limits the additional insured coverage that may be provided to builders to the subcontractor’s scope of work.

For claims that are within the subcontractor’s scope of work, AB 2738 preserves the insurer’s obligations under Presley for coverage under validly issued additional insured endorsements, and in those cases subcontractor insurers still have an immediate obligation to defend builders.  No defense obligation is owed, however, until the builder provides written tender to the subcontractor specifically including all information provided by the claimant regarding the nature of the claim, and the relationship to the subcontractor’s work.  Upon tender, the subcontractor must elect to either control the defense and defend the builder through qualified counsel, or pay a reasonable share of the builder’s defense costs.  The election must be made within 90 days.  If the subcontractor elects to pay a reasonable share of the builder’s ongoing defense costs, it must pay within 30 days of invoice defense costs while the claim is pending.  The builder is required to allocate a share of defense costs to itself and all subcontractors to the extent claims are alleged to be caused by their work, acts or omissions.  A reallocation must occur within 30 days of final resolution of the claim, whether by settlement or judgment, if requested in writing, and the subcontractor bears the burden of proof on reallocation.  Penalties for subcontractor failure to timely and adequately perform in providing a defense include resulting compensatory and consequential damages, reasonable attorneys fees as well as reasonable contractual provisions for damages (e.g. liquidated damages), which builders are now likely to include in their contracts with subcontractors. 

The new statute leaves many open questions.  First, how will subcontractor insurers react to the choice regarding defending the builder?  While subcontractors have for years advocated for the right to control the defense they are providing to builders, one wonders, given the option to pay a share of the builder’s defense costs instead, whether subcontractor insurers will agree.  Second, what happens if several subcontractors decide to provide separate defenses for the builder?  Does this mean that one set of lawyers will defend the roofing portion of the claim, while another defends the plumbing portion and so on, all on behalf of the builder?   It will be interesting to see how this plays out.  AB 2738 also provides new requirements on builders and subcontractors when a residential project is insured under a so-called “wrap” insurance program.  Those provisions will be the subject of a later blog.

Posted in Construction Insurance | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d83425306353ef01116855cc6b970c

Listed below are links to weblogs that reference New Additional Insured and Defense Obligations Under Assembly Bill 2738 Effective January 1, 2009:

Comments

Thanks, Joe for a very interesting post on this new statute. It will be interesting to see how insurers for the subs try to handle the counsel issue. Unfortunately, I suspect a number of carriers will hire their own panel counsel rather than contribute to the cost of existing defense counsel. This will present the risk of multiple counsel purportedly representing the builder, but in fact each acting at cross-purposes to protect the interests of the carrier that appointed them. This seems likely to raise serious conflict and Cumis counsel issues.

Posted by: John Green | Feb 12, 2009 9:15:15 AM

Interesting article and commentary. I first encountered additional insured language in South Carolina construction defects cases during 2000. Several large contractors include this language in subcontracts, although the actual additional insured status doesn't always come to fruition due to a failure to follow up with insurance agents for the subcontractor, etc. This is becoming a huge issue and one that should bear the attention of lawyers, contractors, as well as insurers. As for the panel counsel question posed, I would thnk that the subcdontractor's carrier must provide a defense within its panel. This shouldn't cause conflicts, as most of my cases contain 6-40 parties by the time all pleadings are asserted. This leads to common insurance carriers retaining attorneys from their panel w/i the state. At the end of the day, I suspect the carrier will decide how to apportion the claim between the insured general contractor and the insured subcontractor. Just like some companies write policies that mandate subcontractors to be named as additional insured parties, I would think insurers will draft clauses forbidding an insured sub to name a general as an additional insured. How does that conflict work?

Posted by: Clay Olson | Mar 2, 2009 9:42:17 PM

Post a comment





Comments to the Policyholder Perspective blog are welcome; however, such communications must be considered NON-CONFIDENTIAL and do not create any attorney-client relationship. Accordingly, please refrain from including confidential information in any comment or question. Feel free to read the full disclaimer and terms of use.