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Insurance Law

SUBROGATION - New Appleman on Insurance Law Library Edition, Chapter 49

By Joseph D. Jean, Rachel M. Wrightson, and Danielle C. Carmona

This chapter discusses the contractual, equitable, and statutory subrogation rights that are available to insurers after they have paid a policyholder's claim for damages that were caused by a third-party tortfeasor.  When an insurer pays a policyholder's claim, the insurer becomes subrogated to the rights of the policyholder.  The insurer is thereby able to pursue recovery from any third party that caused the policyholder's loss. 

As discussed in Section 49.01, subrogation is a creature of equity designed to achieve the substantial ends of justice and public policy.  Subrogation is a central loss-shifting component of insurance that aims to make an adjustment between the parties so that a loss is ultimately paid by the party that ought to pay it.  Subrogation can cause significant strains on business relationships because an insurer may pursue subrogation claims against third parties with which the policyholder has contracted or created a joint venture or partnership.  And because the subrogated insurer is said to "step into the shoes" of the policyholder, subrogation has the potential to invade the attorney-client privilege and joint defense relationships.

Section 49.02 identifies and discusses the three most common forms of subrogation - conventional, legal or equitable, and statutory.  Subrogation rights that arise from express contract provisions are known as "conventional" or contractual subrogation because the insurer's rights derive from a "convention" or agreement between the parties.  Where there is a convention or contract establishing the subrogation rights of the parties, most courts will seek to enforce them as written.  But courts will generally ensure that the provisions serve the ultimate loss shifting goals of subrogation and of the particular jurisdiction. 

In some states the maxims of equity apply regardless of whether there is an agreement or not.  In other words, legal subrogation can supersede conventional subrogation. As discussed throughout this chapter, subrogation actions can be fact intensive and the outcomes differ from case to case. 

Statutory subrogation rights frequently arise in connection with government-mandated benefits and insurance such as workers compensation, uninsured/underinsured motorist coverage, Medicare/Medicaid, and the federal Employee Retirement Security Act of 1974 (ERISA).  Where a statute provides the right to subrogation, the statute's terms and conditions govern those rights.

Sections 49.03 and 49.05 discuss various limitations that have developed with respect to a subrogated insurer's rights.  An insurer's subrogation rights are not without limit.  Indeed, an insurer's subrogation rights are limited to amounts that the insurer actually paid to satisfy the policyholder's claim.  Where, for example, the insurer paid only part of the policyholder's claims, many jurisdictions hold that the insurer's subrogation rights are subordinate to the policyholder's rights to be made whole.  This issue arises when the policyholder pays a deductible, the policy excludes part of the policyholder's claim, or the policyholder did not purchase policy limits sufficient to cover its claim.

Until the insurer has paid the claim, it technically is not a real party in interest.  Thus, certain situations can be problematic for insurers, such as where an insurer has not paid the claim but must seek to enforce its subrogation rights due to the running of a statute of limitations.  In these situations, insurers may try to bring suit and attempt to join their policyholder in the suit to preserve their subrogation rights.  But, depending upon the language in the insurance policy, insurers can sometimes require their policyholder to bring suit and then intervene in that action to preserve their rights.  Once the insurer has paid the claim, however, it becomes a real party in interest and can either take over the case or jointly proceed with the policyholder if the policyholder also has uncovered losses.

Because a subrogated insurer "steps into the shoes" of its policyholder, the insurer's rights are no greater than those of the policyholder.  As a result, insurers are subject to all of the same legal and equitable defenses that the third party might have against the policyholder in addition to those that the third party might have specifically against the insurer.  If a policyholder fails to assert a compulsory cause of action or fails to abide by a statute of limitations, the policyholder can extinguish its insurer's subrogation rights against the tortfeasor.  And if a policyholder lacks standing or is otherwise unable to sue, so too the insurer's claims must fail.

Of particular significance are situations where a policyholder has restricted its insurer's subrogation rights by, for example, contractually waiving them or releasing the tortfeasor as part of a settlement.  Most jurisdictions will allow a policyholder to waive its insurer's subrogation rights before a loss has occurred.  And if an insurer wishes to restrict a policyholder's ability to do so, the insurer can seek to include such a restriction in its insurance policy. 

But the story is often different after a loss has occurred.  Indeed, most insurance policies specifically limit the policyholder's ability to impair the insurer's subrogation rights after the loss has occurred.  Moreover, most jurisdictions will not enforce a post-loss release against an insurer where a policyholder and a tortfeasor collude to prejudice the insurer's subrogation rights.  In that case, the insurer can proceed against the tortfeasor, leaving the tortfeasor to seek an offset against what it must pay to the insurer or reimbursement from the policyholder.  And depending upon the situation and the equities involved, the insurer might even be able to proceed against the policyholder, especially where the policyholder is seen as recovering a windfall.  Absent collusion, such as where the tortfeasor did not know of the insurer's subrogation rights, courts enforce the release but permit the insurer to deny the claim or to seek reimbursement from the policyholder if it already paid the claim.  Though constrained by the post-loss release in such cases, courts are able to achieve equity by enforcing a policy's limitation on coverage in favor of the insurer.  In all of these situations courts generally hold that the insurer is in the superior position of equity.

In some situations, however, the policyholder can argue that the insurer was not prejudiced by the settlement because the insurer's subrogation rights had no value.  Courts are split on this issue with some evaluating the assets of the tortfeasor against the damages suffered by the insurer and others looking to other issues such as whether the underlying claims had any merit to begin with.  In still others, the courts assume that the insurer suffered prejudice and put the burden on the policyholder to rebut that presumption.

If an insurer has improperly denied the policyholder's claim, most courts will allow the policyholder to settle the case as it sees fit - even if it results in an impairment of the insurer's subrogation rights.  This is because courts will generally not allow an insurer that has breached its contract with the policyholder to hide behind the very same contract to the detriment of the policyholder.  Moreover, equity is served here because "one who comes into equity must come with clean hands" and "one who seeks equity must do equity."

When it comes to an insurer's subrogation rights against another insurer, waiver does not necessarily foreclose all of the insurer's rights.  Thus, an insurer whose subrogation rights have been released by the policyholder may nonetheless still have a right of contribution against another insurer.  In this case, courts have recognized that a waiver does not override the basic principle that insurers remain equally liable for discharging common obligations.

Section 49.04 addresses defenses to subrogation claims.  Specifically, this section explores the anti-subrogation rule, which bars an insurer from subrogating against its own policyholder for a claim arising from the very risk for which the policyholder purchased coverage.  This rule prevents an insurer from subrogating against its own policyholder with respect to a loss or liability for which the policyholder is covered under the policy in question because, as between the insurer and the policyholder, the insurer assumes responsibility for the loss or liability.  The law acknowledges that for the insurer to recover from its policyholder for a covered loss or liability would undermine coverage and would be inequitable.  This section also examines the factors that are considered when courts determine whether the anti-subrogation rule applies, and the question of who qualifies for its protection, including implied co-insurers, contractors and sub-contractors. 

Additionally, Section 49.04 discusses the "made-whole" doctrine, which is an equitable defense to subrogation requiring that the policyholder must be fully compensated for all of its damages before subrogation will be allowed,.  Thus, to the extent that an insurer is able to recover from a third-party tortfeasor, the made-whole doctrine would require the policyholder to be compensated out of the proceeds first and then the insurer can take the remainder.  The made-whole doctrine is often used as a gap-filler in insurance contracts, unless the parties expressly exclude it.  A minority of courts do not allow parties to contract their way out of the doctrine.  As discussed in this section, to disclaim the presumption that a policyholder must be made whole before subrogation rights arise, parties must use clear, specific language in the insurance policy.

Further, Section 49.04 discusses the volunteer rule, which provides that subrogation is not available to one who voluntarily pays the debt of another.  This rule follows from the well-established maxim of equity that "equity will not aid a volunteer."  In most cases, however, the "volunteer" rule does not apply to contribution claims by one insurer against another insurer based on conventional subrogation or contribution. 

Section 49.04 also examines the compensated surety doctrine, which rests on the theory that a surety who has paid a loss has no standing to subrogate unless equitable considerations dictate otherwise.  Courts differ as to how the compensated surety doctrine applies, particularly as regards whether a claim for subrogation is equitable or conventional, and a number of courts have concluded that where the subrogation is based on contract, it is not subject to equitable restraints such as the compensated surety doctrine. 

Additionally, Section 49.04 addresses waivers of subrogation, including policy language that might operate as a waiver, and implied waivers, which generally require that a party manifest an unequivocal intent to waive subrogation. 

Finally, Section 49.04 examines equitable defenses such as estoppel and unclean hands, and legal defenses such as statutes of limitations.  With respect to statutes of limitations, courts have generally held that the statute of limitations for a conventional subrogation claim begins to run when the policyholder's underlying cause of action accrues.  But others have held that the statute of limitations begins to run when the insurer pays the claim.  As a general matter, because an insurer's subrogation rights are no greater than the policyholder's rights, any defenses that a tortfeasor might have against the policyholder apply against the insurer. 

Section 49.05, in addition to discussing the consequences of impairing an insurer's subrogation rights, discusses the policyholder's duty to preserve them.  Because, as previously explained, an insurer's rights are no greater than its policyholder's, a policyholder's actions can have dire consequences for an insurer's subrogation rights.  Thus, most insurance policies, and indeed many courts, require the policyholder to preserve the insurer's subrogation rights once a loss has occurred.  Policies often also require the policyholder to cooperate with the insurer in general and, more specifically, in pursuing subrogation claims against third parties.  Similarly, a policyholder must typically provide an insurer with notice of claims and notice of settlements that impact the insurer.  Where a policyholder has failed to comply with its contractual obligations, courts have allowed an insurer to deny coverage all together or, if it has already paid the claim, to seek reimbursement from its policyholder.  But if the insurer has improperly denied the policyholder's claim, it may not be entitled to enforce certain contractual provisions or even seek subrogation.

As previously mentioned, some courts require an insurer to show prejudice before the insurer can deny a claim following a policyholder's settlement.  Others will presume that the insurer as been prejudiced by the breach and require the policyholder to overcome that presumption.  In most jurisdictions, prejudice requires a showing that the insurer had a realistic prospect of recovery from the tortfeasor and that the policyholder's actions prevented that recovery.  A mere showing that the policyholder violated the terms of the policy is generally not enough.  This analysis can be complicated and may take into account the assets held by the tortfeasor, the strength of the underlying claim, the extent of the damages suffered by the insurer, and the risk and expense of litigation.

If a policyholder wishes to settle a litigation but is concerned that it might impair its insurer's subrogation rights, the policyholder can often proceed with the settlement but specify in the settlement that the insurer's subrogation rights are not released.  Similarly, a settling policyholder can settle uncovered claims without impairing its insurer's subrogation rights.  And tortfeasors can attempt to protect themselves by making any settlement proceeds payable to both the policyholder and its insurer.

Subrogation arises in a variety of circumstances, and section 49.06 identifies the most common situations to bring a better understanding of subrogation that can be applied to the context of property situations.  For example, in the product liability context, insurers can subrogate against any party in the chain of distribution of the product under any theory of liability that is available to the policyholder.  Such theories would include, among others, strict liability in tort, breach of warranty, misrepresentation, negligence, or indemnity.  As with any other subrogation claim, the tortfeasor can assert whatever defenses it would have had if the policyholder brought the claim.  Thus, in jurisdictions where contributory negligence is available, courts have allowed tortfeasors to defeat the insurer's subrogation right by proving the policyholder's contributory negligence. 

Subrogation actions frequently arise in connection with claims involving directors and officers.  Where directors and officers are closely aligned with the policyholder, even if they are not named in the insurance policy, they may be considered co-insureds and able to take advantage of the anti-subrogation rule.  But where a director or officer is not insured under the policy or engaged in intentional misconduct, the anti-subrogation rule may not apply.    Subrogation claims against directors and officers present unique problems and potentially conflict with the maxims of equity because they can require a director or officer to be adverse to himself or herself, causing the kind of conflict between insurers and policyholders that the anti-subrogation rule and equity are designed to prevent.

When a tenant negligently damages a leased property, the landlord's insurer is likely to look for ways to recoup payments it made to cover its policyholder's losses.  Tenants typically seek to benefit from the anti-subrogation rule by arguing that they are co-insureds or de facto co-insureds under the landlord's policy.  Many states agree, finding that such an outcome promotes public policy by shifting responsibility for the loss to insurers that are in a better position to handle it.  But depending on the jurisdiction, a landlord's insurer may have a right of subrogation against the tortfeasor tenant.  Courts generally apply one of three approaches to determine whether an insurer's subrogation rights are barred by the anti-subrogation rule: (1) The Sutton approach, (2) the case-by-case approach, and (3) the Anti-Sutton approach.  In some jurisdictions, however, statutory law controls when an insurer can bring a subrogation claim against a tenant.

The Sutton approach represents a modern trend of authority.  Courts following the Sutton approach presume the tenant is a co-insured, unless, for example, the lease expressly provides that the tenant is responsible for its own negligence.  Courts applying the Sutton rule find that the approach reflects the modern realities of apartment dwelling.  However, courts generally only imply the tenant's co-insured status for the limited purpose of barring subrogation.  Some courts also apply the Sutton rule in the commercial context.

Courts adopting the case-by-case approach have criticized the assumptions underlying the Sutton approach and instead analyze the lease terms to determine the parties' intent regarding the provision of insurance.  Thus, a court may find that there was no reasonable expectation of insurance where the lease did not provide for insurance, the parties did not discuss insurance, and the lease made the tenants liable for damage caused by them, their guests or invitees.  Some courts expand their review beyond the lease terms to include admissible evidence of surrounding circumstances.

A small minority of courts endorse the Anti-Sutton approach, under which a tenant is presumed not to be a co-insured, absent an express lease provision to the contrary.  An even smaller minority of jurisdictions do not follow any of the three approaches, instead opting for statutory controls over subrogation rights.

Section 49.07 discusses how parties can minimize the risk that a subrogation claim might arise, and explores the steps that parties can take during contract drafting and business negotiations, as well as the contractual and risk-transfer elements that can be implemented to prevent subrogation litigation.  Specifically, this section examines subrogation waivers that can be included in a contract pursuant to which contracting parties agree that the risk of loss lies with the insurance company, and prevents the insurer from pursuing recovery against specific parties.  This section also discusses how contractual obligations to identify parties as insureds or additional insureds under a policy can avoid subrogation. And this section examines specific contractual and policy language that can be utilized to effect subrogation waivers and implement insured or additional insured status.

Section 49.08 discusses how to enforce subrogation rights and explores the issues that can arise, and how the proceeds of a judgment or settlement should be distributed between the insurer and policyholder.  This section acknowledges the complications that can arise when a policyholder's loss is not fully covered by an insurer, and examines an insurer's role in subrogation litigation.  Additionally, this section addresses the "real party in interest" rule, which requires that a civil action be brought in the name of the party who has the legal right to bring suit and its impact on subrogation litigation.  This section also explores the problems unique to subrogation litigation with respect to confidential information and privileged communications, and examines whether an insurer that "steps into the shoes" of a policyholder is entitled to discover communication or information that would otherwise be privileged as between a policyholder and their counsel.

Joseph D. Jean, Member of the Firm, practices in Lowenstein Sandler PC's insurance coverage group.  Based in the firm's New York office, he represents policyholders in litigations and alternative dispute resolutions involving insurance coverage and complex commercial matters.

Rachel M. Wrightson, Counsel, practices in the insurance coverage group.  Also based in New York, she focuses her practice on representing policyholders in all aspects of insurance coverage matters. 

Danielle C. Carmona, Associate, based in the firm's New Jersey office, practices in the insurance coverage group, where she represents policyholders in various insurance coverage matters. Sean Collier, Esq., Megan E. Hiorth, Esq., Mitchell J. Decter, Esq., Priya R. Masilamani, Esq., and Syrion Jack, Esq., all of whom are attorneys at the firm, contributed to this chapter.

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