Subrogation for One Insured OK Even If Loss Paid to Second Party

By Don R. Sampen, published, Chicago Daily Law Bulletin, October 1, 2024

The Illinois Supreme Court recently held that an insurer, as subrogee of the owner of a building under construction, was entitled to seek reimbursement from a subcontractor whose allegedly negligent work gave rise to property damage, despite the insurer’s payment of the loss to an insured other than the owner.

The case is Zurich American Insurance Co. v. Infrastructure Engineering, Inc., 2024 IL 130242 (Sept. 19). The insurer, Zurich, was represented by Nielsen Zehe & Antas P.C. of Chicago. Karbal, Cohen Economou Silk & Dunne LLC of Chicago represented the subcontractor, Infrastructure Engineering (IEI).

In 2013, City Colleges of Chicago entered into a contract with CMO as general contractor for the construction of an academic building for Malcolm X College. City Colleges also entered into a contract with Moody Nolan Inc. to provide architectural services for the building.

The Moody Nolan contract incorporated the contract between City Colleges and CMO, and effectively made City Colleges a third-party beneficiary. Moody Nolan subcontracted the civil engineering work for the project to IEI.

The contract between CMO and City Colleges required CMO to purchase a builder’s risk policy applicable to the period of construction. CMO purchased the policy from Zurich, and City Colleges as owner was listed as an additional named insured. CMO was deemed as the “sole and irrevocable agent” for all insureds under the policy.

The policy provided, among other things, that upon a payment by Zurich under the policy, it “will be subrogated, to the extent of such payment, to all the Insured’s rights of recovery from other persons,” unless the right of subrogation had been waived.

In 2015, before construction was completed, a rainstorm flooded the basement of the building, damaging the building and various equipment. Zurich covered the loss and made payments totaling almost $3 million to CMO, which repaired the damage.

In 2016, Zurich, as subrogee of City Colleges, filed this action against IEI. It claimed that IEI breached its subcontract with Moody Nolan, of which City Colleges was a third-party beneficiary, by designing a defective storm water management system for the building. Zurich alleged that it stood in the shoes of City Colleges in seeking reimbursement from IEI.

IEI opposed the claim and, by way of summary judgment, argued that City Colleges sustained no loss and received no loss payments from Zurich. Zurich therefore had no right to subrogate, according to IEI, because Zurich could not meet the requirement for subrogation that Zurich made payment to the alleged subrogor, City Colleges.

The trial court agreed with IEI and entered judgment in its favor. The appellate court reversed in favor of Zurich, and the Supreme Court granted IEI’s petition for leave to appeal.

Analysis

In an opinion by Justice David K. Overstreet, the Supreme Court affirmed the appellate court’s decision. He initially addressed the purpose of a builder’s risk policy, which is to provide protection for projects under construction against accidental losses for owners, contractors and subcontractors covered by the policy.

He also observed that, while the right of subrogation originated in equity, it may also arise by contract where, as here, subrogation rights are expressly provided for in the insurance policy. When that is the case, courts will apply the policy terms as written.

In this case Overstreet noted that the policy expressly provided for Zurich’s right to be subrogated “to all the Insured’s rights of recovery from other persons” to the extent of its payment for a loss.

IEI argued, however, that City Colleges itself sustained no loss, rather CMO did because it had the responsibility for repairing the damage. Moreover, IEI claimed the language “to all the Insured’s rights of recovery” referred only to a single insured’s right of recovery — i.e., “the insured’s rights” — and that the single insured was CMO, which submitted the insurance claim, received payment from Zurich and repaired the damage.

Overstreet disagreed. He observed that City Colleges had an insurable interest in the property, it sustained a loss by the damage that occurred, it was an insured under the policy, and it was compensated for its loss by the payment to CMO. In addition, the Zurich policy deemed CMO as the agent for all insureds under the policy, and CMO was acting in such a role when receiving payment from Zurich.

IEI also raised the three subrogation requirements recognized in Illinois: (1) a third party is primarily liable to the insured for a loss, (2) the insurer is secondarily liable, and (3) the insurer pays the insured, thereby extinguishing the debt of the third party. IEI contended that the third requirement was not met with respect to City Colleges.

Overstreet responded initially by noting that, although these requirements have been recited in the context of equitable subrogation, they also have relevance for contractual subrogation. In any event he wrote that the elements are all met here. IEI allegedly damaged City Colleges’ property and became primarily liable to City Colleges. Zurich was secondarily liable and paid the loss, and it is now entitled to seek reimbursement from IEI.

The Supreme Court therefore affirmed the decision of the appellate court in favor of Zurich.

Key Points

• An insurer as subrogee of one insured may be entitled to subrogation against a tortfeasor even if the insurer pays the loss to a second insured under the same policy where the second insured acts as agent for the first insured.
• The elements recognized as necessary for equitable subrogation — (1) a third party is primarily liable to the insured for a loss, (2) the insurer is secondarily liable, and (3) the insurer pays the insured, thereby extinguishing the debt of the third party — may have relevance to contractual subrogation as well.