Commercial construction is on the rise in top U.S. markets, and more construction brings more construction-defect claims, along with the coverage issues that often arise with those claims. Insurers faced with defending an insured against uncovered claims must preserve their policy defenses through a reservation of rights letter or risk waiver of those defenses.
An insurer reserving its rights, however, may find itself limited in how it can defend its insured due to a judgment in Colorado courts.
Colorado—Bellwether of Change?
In August 2019, the Colorado Court of Appeals issued an important opinion in Bolt Factory Lofts Owners Association, Inc. v. Auto-Owners Insurance Company. This opinion affects the options available to insurers involved in Colorado construction-defect litigation, and, if adopted by other jurisdictions, could change how insurers defend against extracontractual litigation arising from the handling of third-party claims.
Bolt Factory Lofts began as a typical construction-defect lawsuit. A condominium-owners association sued six contractors for alleged construction defects at a Denver condominium development. Two of those contractors then brought third-party claims against several subcontractors, including Sierra Glass, which supplied and installed windows and doors at the development. Auto-Owners had issued a series of insurance policies to Sierra Glass and defended it in the lawsuit under a reservation of rights.
The lawsuit was originally set for a 15-day jury trial. Throughout the course of the lawsuit, the owners association reached a series of settlement agreements, and the two contractors that had sued Sierra Glass assigned their third-party claims to the owners association. The only remaining claims to be tried were the assigned third-party claims against Sierra Glass.
Last-Minute Change
Two days before the trial was set to start, the owners association made a $1.9 million demand to Sierra Glass, which Auto-Owners declined to accept. To protect itself from the prospect of uncovered claims, Sierra Glass then entered into an agreement with the owners association under which the association agreed to not pursue recovery against Sierra Glass and, in exchange, Sierra Glass agreed to assign any bad-faith claims it had against Auto-Owners. This type of agreement, known as a Bashor agreement, is permitted in Colorado.
According to Auto-Owners, under this agreement, Sierra Glass agreed not to present a defense at trial. At a pretrial conference, Sierra Glass’ personal counsel informed the trial court that Sierra Glass “will probably not be posing a defense” in the case and noted that the retained defense counsel would be “here and sitting on their hands and not questioning or doing those sorts of things.”
Sierra Glass implicitly withdrew its jury demand and the original 15-day jury trial was reduced to a two-day bench trial as Sierra Glass would no longer put on any defense against the owners association’s claims.
Auto-Owners moved to intervene the day the bench trial began and asked the trial court to add it as a party. Auto-Owners also sought a continuance and restoration of a jury trial. In support of its motion, Auto-Owners argued, among other things, that it was seeking to protect its rights under its insurance contract with Sierra Glass, and a fair opportunity to defend, before a jury, the claims asserted by the owners association against Sierra Glass.
Rule 24—Intervention
Auto-Owners premised its motion on Colorado Rule of Civil Procedure 24, which provides a right of intervention “when the applicant claims an interest relating to the property or transaction which is the subject of the action and he is so situated that the disposition of the action may as a practical matter impair or impede his ability to protect that interest, unless the applicant’s interest is adequately represented by existing parties.” (Colorado’s rule on intervention tracks with the federal equivalent.)
Before the trial began, the trial court held a hearing on the motion to intervene, and heard arguments from the owners association’s counsel and Auto-Owners’ counsel. At the hearing, the trial-court judge noted his concern over the fact that it would be harder for Auto-Owners to later contest the findings of the bench trial “because it has all of the trappings…and all the procedural protections of an actual trial, and yet there is this allegation that Sierra Glass is not going to defend itself.”
Motion Denied
Despite this concern, the trial-court judge denied the motion to intervene, finding that Auto-Owners’ interest was contingent on, and it was sufficiently protected by, its right “to bring a declaratory action later to defend themselves in what I perceive to be the imminent bad-faith action.”
The bench trial went forward and Sierra Glass did not present a defense. While its retained defense counsel was present at trial, he did not present an opening statement, introduce evidence, call or cross examine any witnesses, or deliver a closing argument.
The trial court found in favor of the owners association and entered a $2,489,021.91 judgment against Sierra Glass.
The Appeal
Auto-Owners appealed the trial court’s order denying its motion to intervene, contending that it was entitled to intervention as a matter of right.
Under Rule 24, the following elements must be met for intervention as a matter of right:
- The applicant claims an interest in the subject matter of the litigation;
- Disposition of the action may impair or impede the applicant’s ability to protect that interest; and
- The applicant’s interest is not adequately represented by existing parties.
The Court of Appeals focused its analysis on the first element, noting that a contingent interest may be insufficient to warrant intervention. It ultimately concluded that because Auto-Owners reserved the right to deny coverage, “its interest in the litigation was contingent on the liability phase of the proceedings, and so it failed to satisfy” the first element and, accordingly, affirmed the trial court’s denial of the motion to intervene.
What These Results Could Mean
Auto-Owners has petitioned the Colorado Supreme Court for a review of the Court of Appeals opinion, and its petition is currently pending.
If the Colorado Supreme Court denies the petition or accepts it and affirms the Court of Appeals, insurers handling construction-defect claims will effectively be deprived of an important procedural remedy and have one less tool available to defend against claims alleging third-party bad faith.
While an insurer can still challenge the legitimacy of an underlying judgment in a subsequent third-party bad-faith action, insureds (or assignees) will inevitably argue any such challenges are attacks on the integrity of the judge who entered the judgment.
For carriers facing the Bolt Factory Lofts scenario, it is important to keep an eye on this petition; how this issue is resolved could impact construction-defect claims and related coverage issues in 2020 and beyond.