Excess Insurer May Recover Defense Costs from Primary Insurers

Valero Refining Company contracted with Encompass Power Services to design, engineer, and construct a co-generation facility. After a fire caused significant damage, Valero sought over $40 million in damages from Encompass.

A federal district court held that Encompass’ three primary insurers had to split the costs initially spent by one of them defending Encompass against Valero’s claims. The district court also held, however, that Encompass’ excess insurer could not recover from the three primary insurers any of the defense costs it had paid for Encompass’ defense even though it paid for the defense when the primary insurers should have done so, and even though the excess policy contained a subrogation clause. In the district’s court’s view, the excess insurer was barred from recovering its costs under an “empty shoes” theory because Encompass had assigned its rights against its primary insurers to Valero and the excess insurer therefore could not assert Encompass’ right to recover defense costs.

The excess insurer appealed to the U.S. Court of Appeals for the Fifth Circuit, arguing that the district court had erroneously denied recovery of its defense costs from the primary insurers. The circuit court decided that the excess insurer should have been able to recover its defense costs based on contractual subrogation.

As the circuit court explained, the three primary carriers refused to defend Encompass. The excess insurer “stepped in” to take over the defense and incurred significant defense costs. The excess insurer, the circuit court declared, thus bore the costs of a defense to which Encompass was entitled from the primary carriers. Under the terms of the subrogation clause in its policy, the excess insurer was entitled to reimbursement from the insurers who should have borne the costs that it paid, the Fifth Circuit ruled.

The circuit court concluded by rejecting the “empty shoes” argument, observing that an original creditor’s shoes will be “empty” any time a third party makes a payment on its behalf and then seeks to recover under the fiction that the debt still exists to that creditor; this is “not determinative” of the payor’s ability to recover under subrogation. [Continental Cas. Co. v. North American Capacity Ins. Co., No. 10-20262 (5th Cir. May 30, 2012).]

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Diocese’s 21 Month Delay in Notifying Insurer Dooms Coverage for Molestation Case 

The Catholic Diocese of Savannah was sued in April 2006 by a plaintiff who claimed he had been sexually molested by a Diocese employee on numerous occasions between 1978 and 1982. The Diocese notified its insurer 21 months later, which, a federal district court found, exceeded the delays Georgia courts had found to be unreasonable as a matter of law. The district court also rejected the Diocese’s contention that the delay was justified because it provided notice as soon as it discovered the policies. The Eleventh Circuit Court of Appeals affirmed, indicating that it was not persuaded by the Diocese’s argument that the case was unique because it involved a lawsuit based on events alleged to have taken place a quarter of a century earlier, with coverage premised on policies written just as long ago. [OneBeacon America Ins. Co. v. Catholic Diocese of Savannah, No. 11-14557 (11th Cir. May 30, 2012).]

Deck’s Condition a Result of Excluded Perils, and Was Not a Separate Loss

Homeowners alleged that “fin walls” supporting their deck system had rotted due to improper construction. Their insurer denied their claim due to exclusions for rot and defective construction. The coverage dispute reached the Supreme Court of Washington, which held that the deck’s condition was the result of the excluded perils of defective workmanship and rot and did not constitute a separate loss apart from those perils. Simply put, the court concluded, rotting wood deteriorates to the point that it loses its structure – a natural process of decay that does not amount to a new or different condition. Because the homeowners’ policy excluded coverage for both rot and defective construction, the deterioration of the fin walls was not a covered condition. [Sprague v. Safeco Ins. Co. of Amer., No. 85794-6 (Wash. May 17, 2012).]