IL Court: Insurer Can Subrogate Additional Insured Without Equitable Principles

Illinois Appellate Court Holds that Insurer May Subrogate to the Rights of an Additional Insured Based on a Contractual Right to Subrogation and that Equitable Subrogation Principles Do Not Apply

In a recently decided opinion, the Illinois Appellate Court, First District held that an insurer may subrogate to the rights of an additional insured under an insurance policy based on a contractual right to subrogation without consideration of equitable subrogation principles. The Court explained that the general prerequisites for equitable subrogation do not control the express terms of a subrogation clause in a contract.

In Zurich American Insurance Company v. Infrastructure Engineering, Inc., — N.E.3d —, 2023 WL 6982150 (Ct. App. Ill. Oct. 24, 2023), the issue presented to the Court was whether the general prerequisites for equitable subrogation should be applied when an insurer bases its right to subrogate on an express contractual subrogation provision. The Court held that equitable principles do not apply to contract-based subrogation.

The factual context of the case is important to understanding the issues before the Court. CMO was the general contractor for the construction of a new academic building for Malcolm X College, which was owned by The City Colleges of Chicago. CMO purchased a builder’s risk policy from Zurich. The “named insured” in the policy was CMO. The City Colleges of Chicago was named as an “additional insured” by way of its status as the owner of the building being constructed. CMO was deemed under the policy to be the agent for all entities insured under the policy. As a condition of the policy, Zurich was subrogated to all the insured’s unwaived rights of recovery, if any, against any third party for any loss or damage arising out of the performance of professional services.

The defendant, Infrastructure Engineering, was a subcontractor on the construction project hired to design and install a rainwater collection system. Although the Court did not identify the role of the company—Moody Nolan—with which Infrastructure Engineering contracted for work, the Court determined that The City Colleges of Chicago was a third-party beneficiary of that contract.

The incident giving rise to the case was a rainstorm that occurred while the building was still under construction and the rainwater system was incomplete. The water intrusion from the rainstorm flooded the basement and caused significant damage.

CMO made a claim under Zurich’s policy for the rainwater damage, which Zurich paid. Zurich, as a subrogee of CMO and The City Colleges of Chicago, sued Infrastructure Engineering, alleging that Infrastructure Engineering caused the damages to the building and its electrical and mechanical equipment.

Infrastructure Engineering filed a motion for summary judgment, arguing that Zurich was not entitled to subrogate for The City Colleges of Chicago. The trial court agreed and granted summary judgment as to Zurich’s subrogation rights arising from The City Colleges of Chicago. The trial court concluded that Zurich had no right to subrogation because The City Colleges of Chicago sustained no loss and received no payments from the insurer, which are requirements for subrogation. Zurich appealed.

On appeal, Zurich argued that its insurance policy entitled it to a right of subrogation and that the trial court incorrectly applied the requirements of equitable subrogation rather than making a determination based on contractual subrogation. Infrastructure Engineering argued that Zurich had no right of subrogation because there was no contractual relationship between CMO and Infrastructure Engineering and because The City Colleges of Chicago suffered no loss and received no loss payments under the Zurich insurance policy. Infrastructure Engineering argued that Zurich must establish three prerequisites for a right to subrogation: (1) a third party must be primarily liable to the insured for the loss; (2) the insurer must be secondarily liable to the insured for the loss under an insurance policy; and (3) the insurer must have paid the insured under that policy, thereby extinguishing the debt of the third party. Zurich argued that Infrastructure Engineering’s position improperly focused on whether The City Colleges of Chicago received any claim payments under the policy instead of analyzing the subrogation provision in the policy itself.

The Court concluded that the requirements set forth in the insurance policy controlled Zurich’s right to subrogation. The Court recognized both contractual subrogation rights and equitable subrogation rights. Contractual subrogation rights are those expressly provided for in an insurance policy or other instrument. Equitable subrogation is implied to have been intended where necessary to avoid an inequitable and unfair result. The Court observed that the existence of an unambiguous subrogation provision bars the application of equitable subrogation principles. The Court explained that where the right of an insurer to subrogation is expressly provided for in an insurance policy, the insurer’s rights must be measured by and depend solely on, the contract terms.

The Court agreed with Zurich’s position that the proper focus was on whether Zurich was entitled to subrogate based on the express terms of the builder’s risk policy that it issued. The Court rejected the proposition that equitable subrogation principles strictly control a party’s right to subrogation when the party meets all of the contractual requirements for subrogation in the controlling contract. Significantly, the Court rejected the holdings of the following cases to the extent that they hold that the three general prerequisites for equitable subrogation control over the express terms of a subrogation clause in a contract: State Farm Mutual Automobile Insurance Co. v. Easterling, 2014 IL App (1st) 133225; SwedishAmerican Hospital Association of Rockford v. Illinois State Medical Inter-Insurance Exchange, 395 Ill. App. 3d 80 (2009); Economy Premier Assurance Co. v. Country Mutual Insurance Co., 2021 IL App (1st) 192364-U.

The Court held that Zurich’s policy contained express subrogation provisions:

Infrastructure Engineering further argued that The City Colleges of Chicago was not “the Insured” for purposes of the subrogation provision. Infrastructure Engineering contended that the subrogation provision does not provide Zurich with the right to subrogate on behalf of one insured (The City Colleges of Chicago) based on a loss sustained by, claimed by, and paid to another insured (CMO). The Court, however, found that the policy identified The City Colleges of Chicago as an “Additional Named Insured” and CMO as its agent for purposes of paying policy premiums, communicating with Zurich, and receiving claim payments. Also, the Court observed that, under the policy, “Insured” collectively refers to the “Named Insured” and all “Additional Named Insured(s).” Accordingly, the Court concluded that the term “Insured” was broad enough to include The City Colleges of Chicago.

The Court rejected Infrastructure Engineering’s contention that The City Colleges of Chicago suffered no losses from which Zurich’s right to subrogation could arise. The Court found that both CMO and The City Colleges of Chicago had insurable interests protected by Zurich’s builder’s risk policy. As the owner of the property under construction, The City Colleges of Chicago had a tangible, insurable interest in the insured property and suffered a loss due to the rainwater intrusion flooding the basement. The Court found that The City Colleges of Chicago also suffered a loss as a result of the delays caused by the flooding. According to the Court, CMO purchased the builder’s risk insurance policy for the benefit of The City Colleges of Chicago, which also reimbursed CMO for its portion of the policy premiums.

The Court concluded that The City Colleges of Chicago was a third-party beneficiary under Infrastructure Engineering’s contract and that The City Colleges of Chicago suffered a loss that served as the basis for Zurich’s subrogation claim under the terms of the insurance policy. The Court, therefore, reversed and remanded to the trial court.