The Subrogation Strategist

In Western Heritage Ins. Co. v. Frances Todd, Inc. 2019 Cal. App. Lexis 299, the Court of Appeals of California, First Appellate District, addressed whether a commercial condominium association’s carrier could subrogate against the tenants (aka lessees) of one of its member unit owners. After examining the condominium association’s declarations, as well as the lease terms between the owner and the lessees, the court held that the association’s carrier could not subrogate against the lessees because they were implied co-insureds on the policy. To reach its decision, the court explained that an insurer steps into the shoes of its insured, not the party with whom it is in privity. Although the first-party property portion of the association’s insurance policy did not, as required by the association’s declarations, have the owner listed as an additional named insured, the court held that it would be inequitable to treat the association as the sole insured for purposes of determining Western Heritage’s right to bring a subrogation action.

In Western Heritage, William R. de Carion d/b/a Surfwood Properties (de Carion or Lessor), owned a commercial unit within a multi-unit commercial building. The building was managed by the East Shore Commercial Condominiums Owners’ Association (the Association). As a unit owner, de Carion was a member of the Association. The Association’s Declarations of Codes, Covenants and Restrictions (CC&Rs) required the Association to procure fire insurance for the commercial units by adding the unit owners as additional named insureds. The CC&Rs also prohibited owners and their “tenants” from procuring their own fire insurance policies for the premises. In 2013, de Carion leased his commercial space to Frances Todd, Inc. d/b/a The Wooden Duck, Eric Todd Gellerman and Amy Frances Feber (Lessees).

The lease agreement required Lessees to keep the premises in good repair. It also included a “yield up” clause, requiring Lessees to surrender the premises at the end of the tenancy in substantially the same condition as they received it, except in the event of a “casualty.” The lease also required that Lessees indemnify de Carion for any liability resulting from Lessees’ negligence, and required Lessees to maintain liability insurance. The lease made no mention of fire insurance.

In 2014, a fire erupted within Lessees’ space. The fire damaged de Caron’s unit and other nearby property. At the time of the fire, the Association had a fire insurance policy with Western Heritage, which paid to repair the damages. Despite the requirement in the CC&Rs that unit owners be added as additional named insureds on the Association’s policy, the policy did not have de Carion listed as an additional named insured with respect to first-party property coverage.

In 2015, Western Heritage filed a subrogation action against Lessees. In 2016, Lessees filed a motion for summary judgment, arguing that they were implied co-insureds under the policy. Western Heritage opposed the motion, arguing that the defendants were not implied co-insureds because the lease held Lessees responsible for property damage and the Association was not a party to the lease.

The Court of Appeals acknowledged California precedent holding that a lessee is not responsible for negligently caused fire damages where the lessor and lessee intended the lessor’s fire policy to be for their mutual benefit. The court cited prior decisions holding that if the lease states that fire insurance will be used to repair fire damages, then all parties to the lease are considered co-insureds to the policy, thereby barring subrogation. The court further cited cases holding that if a lease holds the lessor responsible for repairing damages caused by fire, then it is implied that the lessor will procure insurance on the premises for the benefit of the tenant as well.

Focusing on the facts of this case, the court found that the lease required Lessees to maintain liability insurance, but not fire insurance, implying that de Carion would carry fire insurance. Further, the court found that the CC&Rs governing the property required the Association to name de Carion as an additional named insured on the Association’s insurance policy. In addition, the court found that owners such as de Carion, and tenants such as Lessors, were prohibited by the CC&Rs from purchasing individual fire policies. Further, the court noted that the “yield-up” clause in the lease provided that Lessees would surrender the premises in substantially the same condition as it was on the first day of the lease, except that Lessees would not be responsible for repairs caused by casualties. Thus, the yield up clause implied that Lessor would procure fire insurance for the benefit of Lessees. Considering these findings together, the court held that Lessees were implied co-insureds on the Western Heritage policy.

In reaching this holding, the court rejected Western Heritage’s arguments that: 1) it stood in the Association’s shoes, not de Carion’s shoes, for purposes of subrogation; and 2) de Carion was only listed as an additional insured under the commercial liability section of the policy, not the first-party fire coverage. As argued by Western Heritage, pursuant to the anti-subrogation rule, because the Association did not add de Carion as an additional insured for the loss at issue, it could proceed against Lessees. The court noted, however, that although the Association did not add de Carion as an additional named, it was contractually obligated to do so by the CC&Rs. In addition, the CC&Rs provided that the insurer who issued the Association’s and de Carion’s first-party coverage would include a waiver of subrogation clause waiving subrogation against both owners and tenants in the Association’s condominiums. In light of the Association’s contractual requirements, as set forth in the CC&Rs, the court held that it would be inequitable to treat the Association as the sole insured for purposes of Western Heritage’s right to bring a subrogation action to recover the amounts it paid under its fire policy.

The Western Heritage case reminds subrogation professionals that courts may invoke equitable principles when determining subrogation-related issues. Although courts often consider the insured with whom the insurer is in privity to be the party in whose shoes the insurer steps, courts may invoke equitable principles to determine that the insurer steps into the shoes of all named insureds under the policy, even insureds with whom the insurer is not in privity. In addition, Western Heritage reminds us that, when determining whether a commercial lessee in California is an implied co-insured on its lessor’s insurance policy, it is important to look at all of the terms of the lease to determine whether the lessee will be held responsible for damages caused by casualties. Even if the lease does not, explicitly, hold a lessee responsible for damages caused by casualties and require the lessee to have fire insurance, the lessee may be deemed an implied co-insured. If the court finds that the lessee is an implied co-insured, subrogation against the lessee will be barred.