Allocation 2: Electric Boogaloo

September 17th, 2018 By Jeffrey C. Glass

The Fifth Circuit affirms an insured cannot arbitrarily allocate settlement proceeds to non-covered damages in order to preserve coverage claims against a non-contributing excess insurer.

In Satterfield & Pontikes Constr., Inc. v. United States Fire Ins. Co., — F.3d –, 2018 WL 3671370, at *1 (5th Cir. Aug. 2, 2018), the Court held proceeds of subcontractor settlement payments in a construction defect suit against a general contractor counted as “other insurance” under an excess policy which provided coverage only in excess of such “other insurance”.  This decision affirmed a decision from Texas’ U.S. Southern District, which prohibited an insured from unilaterally allocating general settlement amounts from its subcontractors to uncovered damages, in order to preserve claims against an excess insurer “that would cover the damages if the loss was properly allocated to that policy.”  Am. Guarantee & Liab. Ins. Co. v. United States Fire Ins. Co., 255 F. Supp. 3d 677, 686 (S.D. Tex. 2017).  We discussed the District Court decision in a recent post here, but the Fifth Circuit’s reasoning did depart slightly from the lower court’s rationale.

S&P was sued by Zapata County as general contractor of a courthouse construction project due to widespread defects that resulted in termination of S&P’s contract. S&P had two layers of coverage: 1) consecutive CGL policies from AGLIC (2006–2007) and Amerisure (2007–2011); and 2) excess coverage from U.S. Fire applicable upon exhaustion of the first layer of insurance.  S&P’s subcontractors also provided insurance and indemnity agreements to cover damage they caused to the project.

An arbitration panel awarded Zapata County over $8 million in damages, including for mold remediation, dome reconstruction, roof replacement, fireproofing replacement, terrazzo/window repairs, and cleaning; plus prejudgment interest and attorney’s fees/arbitration costs. Under the indemnification clauses in the subcontracts, S&P also settled with fifteen subcontractors and two third parties for an aggregate of $4,492,500. (These settlements did not allocate the proceeds of the settlements to the damages they covered.) S&P then sought insurance coverage for the $3,571,141 shortfall. AGLIC paid $1,985,604 of the award (which it claimed exceeded policy limits), but U.S. Fire, the excess carrier, refused to pay the remainder, arguing the first layer was not exhausted.  Amerisure stepped in to pay $1,146,405 under protest, and S&P paid $439,131 to satisfy the balance.  S&P, AGLIC, and Amerisure brought claims against U.S. Fire, claiming it breached its policy obligations. S&P argued US Fire should have paid the roughly $2 million shortfall above the approximately $4.5 million paid by the subcontractors and about $1.5 million owed by AGLIC. US Fire deducted from the $8 million award non-covered damages for mold remediation ($2.8 million), attorney’s fees ($1.5 million), prejudgment interest ($202,000), and arbitration fees ($29,000), plus AGLIC’s $1 million in first layer insurance leaving only $2.5 million potentially recoverable from U.S. Fire.  That amount was more than covered by the $2.7 million of the subcontractor settlements allocable to covered claims ($4.4 million less $1.7 million for non-covered damage).

The Fifth Circuit affirmed summary judgment for US Fire. Its policy covered damages in excess of the “Retained Limit,” defined to include, for covered claims, the total of the applicable limits of “Underlying Insurance” (the primary layer) or “Other Insurance”.  The latter was defined as “any type of Self-Insurance or other mechanism by which an Insured arranges for funding of legal liability for which this policy also provides coverage.” For non-covered occurrences, the “Retained Limit” was defined to include “the amount of the Self-Insured Retention”.  Satterfield & Pontikes, 2018 WL 3671370 at 3-4.  S&P’s fundamental argument was that because the subcontractor settlements were not proceeds of insurance coverage, U.S. Fire was not entitled to use them as “other insurance” to calculate whether the damages exceeded the retained limit and triggered excess coverage.  The court relied on its decision in RSR Corp. v. International Insurance Co., 612 F.3d 851, 858-59 (5th Cir. 2010), which held that settlements with first layer insurance providers technically counted as “other insurance” under the excess insurer’s policy.  Satterfield & Pontikes, 2018 WL 3671370 at 5.

In the present case, however, the settlements did not come from insurance providers, but subcontractors, raising the distinct question of whether U.S. Fire’s policy allows it to count the subcontractor indemnity settlements as “other insurance”.  The Court held the subcontractor indemnity agreements fell within the “very broad” definition of other insurance “because it is a ‘mechanism by which an Insured arranges for funding of legal liabilities for which [U.S. Fire’s] policy also provides coverage’.”  Id. (citing RSR’s reasoning that “settlement proceeds resulting from an indemnity agreement also count as ‘Other Insurance’.”).

Secondarily, the Court rejected S&P’s argument that it had the right to allocate the settlement proceeds to the damages not covered by U.S. Fire’s policy (the mold damages and attorneys fees).  The Court held “S&P bears the burden to show that the subcontractor settlement proceeds were properly allocated to either covered or non-covered damages” and if it could not meet that burden, the court “must assume that all of the settlement proceeds went first to satisfy the covered damages under U.S. Fire’s policy.”  Id. at *7 (citing Mobil Oil Corp. v. Ellender, 968 S.W.2d 917, 927 (Tex. 1998)). Because S&P essentially admitted it did not provide a detailed allocation, the Court held the summary judgment for U.S. Fire was correct.  Id. at 8.