Sauce for the Goose: Transfer of a Policyholder's Insurance Coverage Rights By Subrogation

Policyholders structuring a transaction that may attempt to transfer rights to insurance proceeds likely would not wish to rely solely on equitable subrogation to accomplish this. Application of the doctrine may, however, serve to bolster other, more contract-based, efforts to accomplish the result sought. Just as the corporate parent in AT&T successfully used both an express assignment and equitable subrogation to accomplish the transfer of insurance rights, policyholders structuring transactions with their eyes open may similarly provide themselves with an additional layer of support. On the other hand, policyholders who do not wish to have their coverage rights transfer by subrogation should indicate in the relevant transaction documents that no subrogation is intended.

Michael T. Sharkey, a member of this newsletter's Board of Editors, is a partner with the law firm of Dickstein Shapiro LLP, in Washington, DC. The firm (which also has offices in New York and California) represents policyholders in insurance coverage cases nationwide. The opinions expressed in this article are those of the author and not necessarily those of any of his clients.

Insurance companies frequently assert, and benefit from, the right to subrogation. That is, upon payment of the policyholder's loss, insurance companies argue that they stand in the policyholder's shoes to assert any rights the policyholder may have against third parties in connection with the loss. Recent case law on subrogation supports the notion that sauce for the goose is sauce for the gander: In the appropriate circumstances, third parties that pay a policyholder's loss are themselves subrogated to the policyholder's rights against the insurance company for coverage.

Subrogation and Insurance

Imagine a policyholder faced with a loss, for which its insurance company has denied coverage, and for which the policyholder will have difficulty paying on its own. Imagine further that another entity, perhaps an affiliated corporation with its own business reasons for doing so, pays the loss for the policyholder, and then joins the policyholder in an action against the insurance company for breach of the insurance policy. Even if the action is otherwise successful in establishing coverage, the insurance company likely will argue that the coverage claims ultimately should fail. The policyholder, it will argue, never suffered a loss to be covered, on the grounds that the affiliated corporation, not the policyholder, paid the loss. The insurance company then will argue that the affiliated corporation, which is actually out the money, is not an “insured” under the policy, and, therefore, has no standing to make a claim. If such arguments were accepted, an insurance company could escape its coverage obligations simply by breaching its insurance policies, if its policyholder is able to find some other source of funds to pay the amounts the breaching insurance company should have paid.

One way to avoid this absurd result is application of a doctrine insurance companies frequently invoke on their own behalf: subrogation. “Equitable subrogation” is “'the substitution of one null in the place of another with reference to a lawful claim, demand, or right, so that he who is substituted succeeds to the rights of the other in relation to the debt or claim, and its rights, remedies or securities,'” and is “based on considerations of equity and good conscience where the goal is to place the burden of the debt upon the party who should bear it.” E.P. Bender Coal Co. v. Chubb Group of Ins. Cos., No. 05-216J, 2006 WL 2547045, at *2 (W.D. Pa. Sept. 1, 2006) (“Bender“) (citation omitted). A related doctrine is “conventional subrogation,” which arises out of a contractual agreement that a party paying the debt of another is entitled to the rights of the entity whose debt was paid. Id. at 1 n.4. Insurance companies, who are in the business of paying the losses of others, and whose policies typically contain clauses expressly granting them subrogation rights upon payment to the policyholder, frequently invoke and benefit from subrogation. For example, an insurance company paying a fire loss generally would be subrogated to any claim its policyholder may have against third parties responsible for causing the fire.

In some situations, the law limits an insurance company's subrogation rights in order to protect policyholders from overzealous application of subrogation. For example, an insurance company generally is not permitted to bring claims against one of its own policyholders through subrogation: “It is well established that 'an insurer cannot recover by means of subrogation against its own insured.'” Peterson v. Silva , 704 N.E.2d 1163, 1164 (Mass. 1999) (quoting Safeco Ins. Co. v. Capri , 705 P.2d 659, 660 (1985)). In many jurisdictions, the insurance company is not entitled to subrogate until the policyholder has been made whole for its loss. See, e.g., Sapiano v. Williamsburg Nat'l Ins. Co. , 33 Cal. Rptr. 2d 659, 660-61 (Ct. App. 1994).

Subrogation of Rights Against Insurance Companies

Subrogation, however, is not a doctrine that benefits only insurance companies. In two recent cases, courts have permitted claims for coverage to proceed against insurance companies, over the insurance companies' objections, under the theory that the entities claiming the insurance rights had been subrogated to the policyholder's rights to coverage. That is, rather than addressing subrogation to an insurance company of the policyholder's rights against third parties, these courts upheld subrogation to third-party indemnitors of the policyholders' rights to insurance coverage.

In AT&T Corp. v. Clarendon American Insurance Co. , 931 A.2d 409 (Del. 2007) (“AT&T”), the Supreme Court of Delaware held that a majority shareholder in a corporation was subrogated to the insurance coverage rights of certain of the corporation's directors, whose litigation defense the shareholder had funded. The shareholder, AT&T Corp., had designated 10 of its employees to serve as directors of the corporation, At Home. 931 A.2d at 411. At Home later went bankrupt, and its directors faced lawsuits seeking billions of dollars in liability. Id. The bankrupt At Home was unable to indemnify the directors for their defense or potential liability in these actions, and At Home's directors and officers (“D&O”) insurance companies denied coverage to the directors. Id. As a result, AT&T agreed to pay the defense costs, settlements, and judgments incurred by the directors who had served at AT&T's request, and received from those directors an assignment of their breach of contract claims against At Home's D&O insurance companies. Id.

The trial court granted the insurance company's motion to dismiss for failure to state a claim, holding that the directors had suffered no “loss” under the policy, because AT&T had paid their defense and any judgment or settlement, and that in doing so AT&T was a “volunteer” not entitled to equitable subrogation. Id. at 414.

On appeal, the Delaware Supreme Court first addressed whether the directors had suffered a covered “loss” under the D&O policies. Id. at 415-22. The court held that under the language of the policies, and California law rendering the directors liable for legal expenses and settlements in the event AT&T defaulted on its agreement to indemnify them, the directors had suffered a “loss.” Id. at 422. “Accordingly, those Directors had a cognizable legal claim against the D&O insurers, which AT&T, as their assignee, became entitled to enforce.” Id.

As an alternative basis for its reversal, the court also held that AT&T had standing to sue as the equitable subrogee to the insurance coverage rights of the directors it indemnified. Id. at 422-23. The court set forth the prerequisites for equitable subrogation under California law:

(1) Payment must have been made by the subrogee to protect its own interest. (2) The subrogee must not have acted as a volunteer. (3) The debt paid must be one for which the subrogee was not primarily liable. (4) Subrogation must not work any injustice to the rights of others.

Id. at 422.

The trial court had held that AT&T should be treated as a volunteer, unable to assert subrogation, unless it was legally obligated to indemnify the directors. Id. at 423. The Delaware Supreme Court reversed, holding that under the applicable law, “a subrogee need not have a legal obligation to indemnify a subrogor in order to have an interest worthy of protection.” Id. The court held that AT&T's incentive to indemnify these directors, in order not to discourage other employees from serving at AT&T's request as directors of other AT&T subsidiaries, constituted an interest sufficient that AT&T was not a volunteer, and so had standing to sue as a subrogee. Id.

In Bender, the court similarly upheld a corporation's standing as a subrogee to assert the insurance rights of an affiliated corporation. 2006 WL 2547045, at *3. E.P. Bender Coal Co., Inc. (“E.P. Bender Inc.”) had been ordered by the government to remedy damage from an acid mine drainage leak caused by E.P. Bender Coal Co. (“E.P. Bender Co.”), a corporation with which it shared a common ownership. 2006 WL 2547045, at *1, *2. Federal Insurance Company had denied coverage to E.P. Bender Co. for the liability, and E.P. Bender Inc. sought to sue Federal as subrogee to E.P. Bender Co.'s insurance rights. Id. at *1.

The court set forth the same four criteria for equitable subrogation that were listed by the AT&T court, and rejected Federal's argument that only insurance companies are entitled to avail themselves of equitable subrogation. Id. at *2. Accepting the allegations in the complaint as true for purposes of Federal's motion to dismiss, the court held that the “complaint alleges that E.P. Bender Inc. was ordered by the DEP to remediate the acid mine drainage seep as a condition of obtaining its bituminous surface coal permit,” and that these facts satisfy all four prongs of the equitable subrogation test. Id. at *3. The court also held that Federal's prior denial of coverage, and E.P. Bender Co.'s consent to the subrogation, supported the equity of subrogation: “If E.P. Bender Inc. paid for costs rightfully attributable to Federal, this circumstance would appear to be a clear example of the unjust enrichment that equitable doctrines aim to prevent.” Id.

Despite the insurance companies' objections to the use of one of their favorite doctrines against them in these cases, the decisions upholding subrogation of the coverage rights were not surprising. Insurance companies themselves frequently assert that they subrogate to the policyholder's insurance coverage rights against other insurance companies upon payment of a claim, thus conceding that rights to insurance coverage can transfer by subrogation. See, e.g., Home Ins. Co. v. Cincinnati Ins. Co., 821 N.E.2d 269, 280-82 (Ill. 2004) (insurance company that paid most of policyholder's loss asserted claim against another insurance company it argued should be primarily liable, using equitable subrogation theory).

Other Subrogation Possibilities

While both AT&T and Bender involved subrogation in the context of payments made by a present corporate affiliate or parent, nothing in these decisions limits the application of the subrogation to that specific context. Disputes over the purported transfer of rights to insurance coverage proceeds arise in many other contexts. For example, when companies are sued for long-tail latent injury torts arising out of the activities of predecessor corporations, insurance companies frequently dispute whether the same transactions that made the same company a successor for tort liability purposes also transferred the insurance coverage rights of the predecessor. Subrogation may provide an additional basis, in the proper situation, for the present company that pays the loss to argue it is entitled to access the rights to insurance proceeds.

In these disputes over successorship to rights to insurance proceeds, insurance companies frequently rely on the anti-assignment clause, which purports to prohibit assignment of insurance rights without the insurance company's consent. Most courts hold that the clause bars only pre-loss assignments of coverage, not post-loss claims for insurance proceeds. See, e.g., Elat, Inc. v. Aetna Ins. & Sur. Co. , 654 A.2d 503, 505-06 (N.J. Super. Ct. App. Div. 1995). Courts, however, disagree in some situations as to what constitutes a permissible “post-loss” assignment. Compare B.S.B. Diversified Co. v. Am. Motorists Ins. Co. , 947 F. Supp. 1476, 1479-81 (W.D. Wash. 1996) (transfer of insurance rights after property damage took place, but before environmental liability for property damage was asserted, was a post-loss transfer not barred by the anti-assignment clause) with Henkel Corp. v. Hartford Accident & Indem. Co. , 62 P.3d 69, 75 (Cal. 2003) (transfer of coverage for latent injury claims considered post-loss only when claims have “been reduced to a sum of money due or ' become due under the policy”). In neither AT&T nor Bender, however, did the insurance companies appear to argue that an anti-assignment clause barred transfer of the policyholder's rights through subrogation.

In fact, in Envoy Corp. v. Quintiles Transnational Corp., No. 3:03cv0539, 2006 WL 1288590, at *10-*12 (M.D. Tenn. May 10, 2006) (“Envoy“), the insurance company successfully argued that an anti-assignment clause does not prevent subrogation of insurance coverage rights. The insurance company, Federal, had defended and settled an action against its policyholder, and sought to be subrogated pursuant to the indemnification rights a former corporate parent had granted the policyholder in a sale agreement. Id. at *6. The agreement containing the indemnification provision, however, was subject to an anti-assignment provision barring unconsented assignments of rights under the agreement by “operation of law or otherwise.” Id. at *10. Despite this broad clause, and case law in the relevant jurisdiction declaring subrogation a form of “equitable assignment,” Investors Title Co. v. Herzig , 413 S.E.2d 268, 272 (N.C. 1992), the court nevertheless held that “although the provision of the Merger Agreement bars Envoy from assigning its rights under the agreement without consent, it does not bar a party from enforcing its subrogated rights.” Id. at *11. The court's analysis was based on contractual subrogation, but it stated the result likely would be the same for equitable subrogation. Id. at *12 n.3.

Policyholders structuring a transaction that may attempt to transfer rights to insurance proceeds likely would not wish to rely solely on equitable subrogation to accomplish this. Application of the doctrine may, however, serve to bolster other, more contract-based, efforts to accomplish the result sought. Just as the corporate parent in AT&T successfully used both an express assignment and equitable subrogation to accomplish the transfer of insurance rights, policyholders structuring transactions with their eyes open may similarly provide themselves with an additional layer of support. On the other hand, policyholders who do not wish to have their coverage rights transfer by subrogation should indicate in the relevant transaction documents that no subrogation is intended.

Michael T. Sharkey, a member of this newsletter's Board of Editors, is a partner with the law firm of Dickstein Shapiro LLP, in Washington, DC. The firm (which also has offices in New York and California) represents policyholders in insurance coverage cases nationwide. The opinions expressed in this article are those of the author and not necessarily those of any of his clients.