Allied Mut. Ins. Co. v. Heiken, 2004 WL345579 (Iowa, February 25, 2004)

Allied Mutual’s insureds, the Heikens, contracted to construct a building on their farm. Approximately two years later, the building’s metal canopy collapsed and therefore Allied was required to indemnify the Heikens for more than $50,000. The insurance policy in question contained a standard subrogation clause that assigned Allied recovery rights after a covered loss; it also required cooperation by the Heikens if Allied pursued a subrogation action.

Unrelated to the collapse, the contractor that had built the building had filed a mechanics lien claim. After the collapse, the Heikens filed a counterclaim against the contractor, claiming the structure was improperly built. Allied sought to intervene in that action, but was denied. At time of trial, the Heikens and the contractor settled their claims in the presence of an attorney representing Allied, who had advised the contractor of its subrogation claim (both in direct communications, as well as through the failed intervention efforts). Allied’s attorney refused to consent to the settlement, and demanded that Allied be reimbursed by the Heikens for the amount it had paid on their behalf.

The Heikens refused to reimburse Allied, so the company filed a breach of contract action against them asserting lack of cooperation with, and impairment of, its subrogation efforts. However, the trial court dismissed the claim, and found that the Heikens had not impaired Allied’s subrogation rights when they released the contractor from liability for the loss.

On appeal, the Iowa Supreme Court acknowledged that it had yet to fully consider the remedies available to a subrogating insurer when its insured releases a responsible third party from liability for the underlying loss. The court reviewed the doctrine of subrogation, finding that an insurer’s subrogation claim is against the third party responsible for the loss and not against the insured. However, it also noted that the actions of an insured can affect the subrogation rights of an insurer.

The court discussed whether an insurer has a remedy against its insured when a release appears to bar the subrogation rights of the insurer. The court held that an insured releasing a third party from the liability, as the Heikens did in this case, will normally enable the insurer to deny the insured’s claim if it has not already been paid, or to get its money back from the insured if the claim has been paid.

Thus, the court concluded that Allied may have a claim against its insured under certain circumstances, although such a claim would not exist in every case. In fact, the court found that there was an exception under Iowa law that addressed this particular situation. Such exception occurs when a subrogation target obtains a release from an insured with knowledge or with information that, reasonably pursued, would lead to the knowledge of an insurer’s subrogation claim. The court held that because the contractor was aware of the subrogation lien when it obtained a release from the Heikens, Allied would not be barred from pursuing its subrogation claim against the contractor. Consequently, the court held that Allied’s claim against its insureds was properly dismissed because Allied was not adversely affected in its subrogation claim against the contractor.

Although this decision arose under Iowa law, the principle upon which it was decided (i.e., the release of a claim may not be effective as to an assigned portion of the claim if the settling party is aware of an outstanding lien on the claim) is applicable in other jurisdictions. By way of illustration, just this past week the Oregon Court of Appeals, in Clapp v. Orix Credit Alliance, Inc., 2004 WL346641 (Oreg. App., February 25, 2004), held that when one obtains a right against a third party by subrogation or assignment, the third party remains liable to the one who obtained the right even if it pays the subrogor or assignor if the third party is on notice the existence of the subrogation lien or assignment.

PRACTICE TIPS:

1. Subrogation targets and their insurance carriers should always be made aware of a subrogation claim, even when the matter is being fully and competently advocated by counsel for the insured. By doing so, recovery rights are more likely to remain viable in certain jurisdictions, even if an insured executes a release of the underlying claim. This is especially applicable in the workers compensation and health care subrogation context, where the underlying claim is typically being protected by the claimant’s own counsel.

2. If an insured executes a release in favor of a subrogation target, and the subrogation target has not been notified of the lien, a claim may exist against the releasing insured for breach of the policy (i.e. for hampering the carrier’s ability to recover).

3. The recovery professional’s best practice under such circumstances is to bring an action against both the settling third party and the insured, so that a court will find one of these defendants responsible for payment of the outstanding lien (though it is uncertain from the text of the court decision whether or not this dual-attack approach was taken in this case).