Appeals Court Weighs Equitable Versus Contractual Subrogation

By Don R. Sampen, published, Chicago Daily Law Bulletin, November 21, 2023

The 1st District Appellate Court recently held that an insurer was entitled to subrogate to the rights of an insured despite the fact a different insured received the insurer’s payment for loss.

The case is Zurich American Insurance Co. v. Infrastructure Engineering, Inc., 2023 IL App (1st) 230147 (Oct. 24). The insurer, Zurich, was represented by Nielsen, Zehe & Antas P.C. of Chicago. Karbal, Cohen, Economou, Silk & Dunne LLC of Chicago represented the entity against whom the subrogation action was filed, Infrastructure.

Zurich issued a builder’s risk insurance policy to a general contractor, CMO, in connection with the construction of a new academic building for Malcolm X College in Chicago. City Colleges of Chicago owned and operated the college. A different contractor for City Colleges, Moody Nelson, subcontracted with Infrastructure to design the stormwater management system for the building.

While the building was still under construction, a rainstorm caused the basement to flood, resulting in substantial damage. CMO submitted a claim to Zurich for the damage, and Zurich paid nearly $3 million for the loss.

The Zurich policy contained a subrogation provision permitting Zurich to be subrogated “to all the insured’s rights of recovery from other persons,” for any loss paid by Zurich. The policy also identified CMO as the “named insured,” and identified City Colleges and others as “additional named insureds.”

The policy further designated CMO as the agent for all insureds for purposes of paying premiums and receiving claim payments. Infrastructure was not an insured.

Following its payment, Zurich assumed the right as subrogee of both City Colleges and CMO to file suit against Infrastructure. Zurich alleged that Infrastructure’s defective stormwater management system caused the loss. Infrastructure subsequently sought summary judgment, arguing that Zurich was not entitled to subrogation. The trial court agreed and granted Infrastructure’s motion. Zurich brought this appeal.

Contractual vs. Equitable Subrogation

In an opinion by Justice Nathaniel Howse Jr., the 1st District reversed. He initially addressed the applicable standards for subrogation. In the trial court, Infrastructure had argued that the prerequisites are (a) a tortfeasor who is primarily liable to the insured for the loss, (b) an insurer that is secondarily liable to the insured, and (c) the insurer having paid the loss and extinguishing the debt of the tortfeasor.

Based on these requirements, Infrastructure contended, and the trial court agreed, that Zurich had no right to subrogation because Infrastructure had no contractual relationship with CMO, and City Colleges suffered no loss and received no loss payment.

On appeal, however, Zurich argued that the prerequisites identified by Infrastructure applied only to equitable subrogation, whereas the trial court should have determined instead that contractual subrogation applied based on the terms of the policy.

Infrastructure’s immediate response was that Zurich had waived the contractual subrogation argument because Zurich had not initially raised it in response to Infrastructure’s summary judgment motion. Howse observed, however, that Zurich did raise the point in the hearing before the trial court on Infrastructure’s motion, and also raised it in supplemental briefing ordered by the court prior to the trial court’s ruling. Hence, the argument was not waived.

Taking up the merits of the argument, and relying on Trogub v. Robinson, 366 Ill. App. 3d 838 (1st Dist. 2006), Howse agreed with Zurich that when an insurer bases its right to subrogate on an express contractual provision, equitable subrogation standards do not apply. He made clear, moreover, that the court disagreed with case law expressing a different view.

Application of Contractual Subrogation Terms

Switching gears and focusing on the Zurich policy subrogation provisions, Infrastructure then argued the language allowing Zurich to subrogate “to all the Insured’s rights of recovery from other persons” did not give Zurich the right to subrogate to the rights of one insured — City Colleges — based on a loss sustained by another insured, CMO.

Howse disagreed. He emphasized that CMO was a “named insured,” City Colleges was an “additional named insured,” and CMO had been designated the agent for all insureds for any and all purposes. The term “insured,” moreover, referred to all entities insured under the policy.

As for the contention that City Colleges had not sustained a loss or received a payment, Howse wrote that both the owner and general contractor in a construction project have an insurable interest in the property until construction is complete. City Colleges therefore had a tangible interest in the property that was damaged.

In addition, City Colleges paid a portion of the Zurich policy premium, and CMO as the agent for all the insureds was required to communicate with Zurich on City Colleges’ behalf and be the party to receive the claim payments.

Accordingly, in Howse’s view, the unambiguous policy language gave Zurich the right to subrogate to City Colleges’ rights under the circumstances.

Finally, Infrastructure argued that, notwithstanding the policy language, Zurich could not pursue its subrogation claim because neither City Colleges nor CMO was a third-party beneficiary of the subcontract between Infrastructure and the contractor that hired it, Moody Nelson. Infrastructure relied in part on language in its subcontract stating that it did not create a cause of action in favor of any third party against Infrastructure.

Howse rejected the argument because Moody Nelson’s contract with City Colleges expressly required City Colleges to be a third-party beneficiary of any subcontracts Moody Nelson entered into with subcontractors. The Infrastructure subcontract, moreover, contained a provision stating that any inconsistencies between it and the contract between Moody Nelson and City Colleges, would be governed by the latter. City Colleges therefore had a potential contract claim against Infrastructure.

Accordingly, the 1st District reversed in favor of Zurich.

Key Points

• An insurer’s express contractual subrogation rights take priority over equitable subrogation principles.
  
• Depending on policy language and the interest of the insureds in property damage that occurs, an insurer may contractually be entitled to subrogate to the rights of an insured to bring suit against an entity causing damage even if that insured received no payment from the insurer.