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“Incidental” Versus “Direct” Third Party Beneficiaries Under Insurance Policies

Updated: Dec 1, 2023



As they say, when it rains, it pours. Indemnity and insurance are the “Big Two” when it comes to risk avoidance on construction projects. The next case, LaBarbera v. Security National Security Company, 86 Cal.App.5th 1329 (2022), involves both. It’s an interesting case, which I think could have gone either way, involving claims by a higher-tiered party that they were a third party beneficiary under an insurance policy in which they were not named as an additional insured.


The LaBarbera Case


The Indemnity Provision and Insurance Policy


In June 1016, Chris LaBarbera hired Richard Knight doing business as Knight Construction to remodel his house in Carmichael, California. The construction contract included an indemnity provision which provided that Knight would defend and indemnify LaBarbera from all claims arising out the remodeling work except for claims arising from LaBarbera’s sole negligence and willful misconduct.

Because words have meaning, particularly those in a contract, the indemnity read as follows:


Contractor [Knight] shall indemnify Client [LaBarbera] against, hold it harmless from and defend Client from all claims, loss, liability, and expense, including actual attorney’s fees, arising out of or in connection with Contractor’s services performed under this Contract. This indemnity shall be provided even if Client is partly responsible for the claim, damage, injury or loss, but Contractor shall not provide indemnity against claims or losses deemed to be caused by the sole negligence or willful misconduct of Client or Client’s agents or employees.

Knight also had a commercial general liability (“CGL”) insurance policy issued by Security National Insurance Company in place while he performed work on LaBarbera’s remodel. The CGL policy provided coverage limits of $1 million per occurrence and the policy provided that “We [Security National] will pay those sums that the insured [Knight] becomes legally obligated to pay as damages because of bodily injury . . . . We will have the right and duty to defend the insured against any suit seeking those damages.” The policy did not include a “burning limits” provision, meaning that legal defense costs incurred by Security National to defend Knight would not reduce the coverage limits. So, for example, if a $1 million judgment was entered against Knight, and Security National incurred $500,000 defending him, Security National would pay both the $1 million judgment as well as the $500,000 in defense costs.


As with all insurance policies, there were a number of exclusion. Among them was an exclusion for “[b]odily injury . . . for which the insured is obligated to pay damages by reason of the assumption of liability in a contractor or agreement.” However, the policy also provided that:


This exclusion does not apply to liability for damages . . . [a]ssumed in a contract or agreement that is an insured contract . . . . Solely for purposes of liability assumed in an insured contract, reasonable attorney fees and necessarily litigation expenses incurred by or for a party other than an insured are deemed to be damages because of bodily injury . . . . (emphasis added)

The term “insured contract” was in turn defined as “[t]hat part of any . . . contract or agreement pertaining to your business . . . under which you assume the tort liability of another party to pay for bodily injury . . . to a third person . . .” In short, the policy covered Knight’s liability under the indemnity provision contained in the construction contract between Knight and LaBarbera, however, any defense costs incurred by LaBarbera would be deemed “damages because of bodily injury” and would reduce the policy limit of $1 million.


Finally, the policy included a clause in the “Supplementary Payments” section that provided:


If we defend an insured against a suit and an indemnity of the insured is also named as a party to the suit, we will defend the indemnities if all of the following conditions are met: a. The suit against the indemnity seeks damages for which the insured has assumed the liability of the indemnitee in a contract or agreement that is an insured contract; . . . d. The allegations in the suit and the information. we know about the occurrence are such that no conflict appears to exist between the interests of the insured and the interests of the indemnity; e. The indemnity and the insured ask us to conduct and control the defense of that indemnity against such suit and agree that we can assign the same counsel to defend the insured and the indemnitee[.] . . . So long as the above conditions are met, attorney’s fees incurred by us in the defense of that indemnitee, necessary litigation expenses incurred by us and necessary litigation expenses incurred by the indemnitee at our request will be paid as Supplementary Payments. [And, such payments will not be deemed to be damages for bodily injury . . . and will not reduce the limits of insurance.

In short, if both Knight and LaBarbera agree to have National Security appoint the same counsel to represent both of them, then LaBarbera’s defense costs would not reduce or erode the $1 million in coverage. LaBarbera was not named as an additional insured under the CGL policy. Following all of this?


The Accident


In September 2016, while performing stucco work on the project, Nicholas Paz-Ramirez, and employee a stucco subcontractor hired by Kinight was electrocuted by a live wire. Paz-Ramirez sued both Knight and LaBarbera on negligence and premises liability theories.

Security National defended Knight in the litigation. In its answer on behalf of Knight, Security National generally denied Paz-Ramirez’ claims and also asserted several affirmative defenses, including: (1) “that other Defendants in this lawsuit . . . were themselves responsible for the Plaintiff’s damages” and that any liability should “be assessed in proportion to the liability of other co-Defendants”; and (2) that if Knight were found liable to Paz-Ramirez then “such liability in whole or in part will the direct or imputed fault and responsibility of other parties to this litigation.”


LaBarbera had his own premises liability insurance policy issued by Certain Underwriters at Lloyd’s London and Underwriters defended LaBarbera in the litigation. Underwriters defended LaBarbera without a reservation of rights.


In November 2017, concerned that his premises liability policy might not cover his potential liability, LaBarbera’s personal counsel sent a letter to Knight’s counsel tendering the claim to Knight based on the indemnity provision in the construction contract. Although the letter did not mention Security National or Knight’s CGL policy, Knight counsel forwarded the letter to Security National which denied the tender on the basis that LaBarbera was not an additional insured under the Knight’s CGL policy.


In February 2018, LaBarbera’s insurance defense counsel appointed by Underwriters wrote to Security National asserting that the “insured contract” exception to the CGL policy clearly provided that Security National was obligated to defend and indemnify LaBarbera.


In May 2018, Underwriters settled the Paz-Ramirez litigation for $465,000 not including over $100,000 in attorneys’ fees and costs. In December 2018, Security National settled the Paz-Ramirez litigation for $900,000.


The Insurance Lawsuit


In January 2019, LaBarbera and Underwriters sued Knight and Security National over their failure to defend and indemnity LaBarbera in the Paz-Ramirez litigation. The complaint included four causes of action against Security National for: (1) breach of contract; (2) tortious breach of the covenant of good faith and fair dealing; (3) a request for a judicial declaration that Security National had a duty to defend and indemnify LaBarbera; and (4) subrogation. LaBarbera and Underwriters sought $565,000 in damages, the $465,000 paid to settle the Paz-Ramirez litigation, and $100,000 incurred in attorneys’ fees and costs.


The complaint also included two causes of action against Knight for: (1) breach of construction contract; and (2) subrogation. LaBarbera and Underwriters later dismissed their claims against Knight.


Security National later filed a motion for summary judgment or, in the alternative, summary adjudication arguing that: (1) LaBarbera was not an insured or third-party beneficiary under the CGL policy thus had no standing to sue; (2) Even assuming LaBarbera had standing to sue, Security National had no obligation to defend LaBarbera because there was a conflict between Knight and LaBarbera.


The trial court disagreed with Security National as to its first argument, finding that LaBarbera was a third party beneficiary under the CGL policy, which provided that “we [Security National] will defend [the] indemnitee [LaBarbera]” if certain conditions were met. This language, held the court, “clearly expresses an intent that, under certain circumstances, the policy may operate for the benefit of indemnitee (here, LaBarbera).” However, the trial court agreed with Security National as to its second argument, concluding that there was an apparent conflict in Knight’s and LaBarbera’s litigation strategies, and that Security National had satisfied its burden that at least one of the conditions of the CGL policy had not been met.


Underwriters appealed.


The Appeal


On appeal, the 3rd District Court of Appeal explained that on appeal from a motion for summary judgment “we take the facts from the record that was before the trial court when it ruled on that motion . . . [but] we review the trial court’s decision de novo, considering all the evidence set forth in the moving and opposing papers except to which objections were made and sustained . . . [and] [w]e liberally construe the evidence in support of the party opposing summary judgment and resolve doubts considering the evidence in favor of that party.”


The Court of Appeal affirmed the judgment in favor of Security National, but not because there was a conflict between the litigation strategies of Knight and LaBarbera, but on the basis that LaBarbera was not a third party beneficiary under the CGL policy.


Noting that neither party had cited any California cases directly on point, the Court of Appeals instead found the reasoning of an out-of-state case cited by Security National to be persuasive. That case, a case out of Wisconsin, Berg v. Gulf Underwriters Ins. Co. 2008 WI App. 121, discussed the difference between “incidental” versus “direct” third party beneficiaries. In Berg, a Wisconsin appellate court, analyzing an insurance policy which provided that the insurer had no obligation to defend an indemnitee unless both the insured and indemnitee agreed to their joint defense by the insurer, held that the indemnitee was not a “direct” third party beneficiary but merely an “incidental” beneficiary who was only entitled to be defended by the insurer if both the insured and the indemnitee agree to their joint defense by the insurer.


Finding the Berg reasoning persuasive, although not binding as an out-of-state decision, the Court of Appeal found that LaBarbera was merely an ‘incidental” third party beneficiary under the CGL policy. The CGL policy, explained the Court, was intended to benefit Security National and Knight rather than LaBarbera, since it only obligated Security National to defend and indemnify LaBarbera if both Knight and LaBarbera utilized the same defense counsel appointed by Security National:


As in Berg,here the indemnitee defense clause benefits both Security National and Knight. Where Knight is obligated to pay LaBarbera’s liability and costs of defense pursuant to the insured contract, it is in Knight’s interest to have his insurer, Security National, pay for LaBarbera’s defense without having the costs of that defense reduce the policy limits. It is also in Security National’s interest to minimize its obligation with the efficiency of a combined defense where feasible and where agreeable to the insured.
As the trial court recognized, and as LaBarbera argues on appeal, LaBarbera would also benefit from the indemnitee defense clause were Security National to pay the costs of his defense and liability. However, the issue before us is not whether LaBarbera would benefit from the indemnitee defense clause, but rather whether the indemnitee defense clause was intended to benefit him. We conclude it was not.
As we have discussed, the parties agreed to the indemnitee defense clause to benefit one another. Indeed, were Knight to determine that a joint defense did not benefit him, he would not be obliged to agree to a joint defense, and Security National would not have to provide one. Thus, the terms of the contract do not necessarily require Security National to confer a benefit onto LaBarbera—Knight must consent. Thus, the intended benefit of the provision is not to LaBarbera—who would potentially benefit only if Knight were to agree to a joint defense—but rather to Knight and to Security National.

Thus, held the Court of Appeal, “the parties’ intent in crafting the indemnitee defense clause here was to benefit Security National and Knight, with LaBarbera as incidental beneficiary.”


Conclusion


To me, this is a tough decision, particularly without California precedent helping to shape the decision. On one hand, I agree with the Court of Appeal’s rationale that the intent of the indemnitee defense clause was to make it less expensive for Security National by encouraging both Knight and LaBarbera to agree to use the same defense counsel. On the other hand, it seems to me to be a case of hindsight being 20:20, as it appears that neither Knight or LaBarbera thought about working cooperatively together at the initiation of the case, although in hindsight it likely would have behooved them to do so. The other clearer take-away if you are an owner, or a higher-tiered party, is to be sure to get yourself named as an additional insured under the lower-tiered party’s insurance policy.





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