In Potomac Insurance Company of Illinois v. Pennsylvania Manufacturers’ Association Insurance Company, ___ A.3d ____, 2013 WL 5018577 (N.J. Sept. 16, 2013), the New Jersey Supreme Court, applying New Jersey law, affirmed, as a matter of first impression, the Appellate Division’s judgment holding that one insurer with an obligation to indemnify and defend the policyholder under a commercial general liability policy has a direct claim for contribution against its co-insurer for defense costs arising from continuous property damage, even where the co-insurer settled with the policyholder. Id. at *1, 11.
In 2001, the policyholder, a general contractor, was sued for negligent construction of a middle school. Id. at 2. The policyholder tendered the claim to its five insurance carriers and demanded that those carriers defend and indemnify it. Id. at *2. Four of the insurers had overlapping coverage periods. Id. Two of these insurers paid the policyholder’s legal fees and defense expenses, while the other two co-insurers initially disclaimed coverage and did not pay any of the policyholder’s defense costs. Id. at *3. The policyholder’s declaratory judgment action against the two non-paying insurers for defense costs was settled and the policyholder released the co-insurer from all claims arising from the construction litigation, and the underlying action settled. Id. at *2-3. In 2007, one of the insurers who had paid defense costs brought a contribution action against the two non-paying co-insurers seeking reimbursement of the non-paying co-insurers’ shares of the defense expenses and other relief. Id. at *4. The trial court recognized that issue of whether an insurer could maintain a direct contribution action for defense costs against a co-insurer was a matter of first impression in New Jersey. Id. at *5. The trial court held that such a cause of action could be maintained and ruled in the insurer’s favor. The Appellate Division affirmed. Id.
Reviewing the legal question de novo, the New Jersey Supreme Court affirmed. Id. at *8. The court found that the recognition of a direct cause of action for contribution among co-insurers was a logical extension of its adoption of the continuous-trigger theory and a pro rata formula articulated by the court in its 1994 decision in Owens-Illinois, Inc. v. United Insurance Company, 138 N.J. 437, 650 A.2d. 974 (N.J. 1994). The court reaffirmed that under the continuous trigger theory, applicable to personal injury and property damage claims, “when progressive indivisible injury or damage results from exposure to injurious conditions for which civil liability may be imposed, courts may reasonably treat the progressive injury or damage as an occurrence within each of the years of a [commercial general liability] policy.” Id. at *6. The court also reaffirmed its holding that, under the pro rata methodology, losses are “allocated to ‘the carriers on the basis of the extent of the risk assumed, i.e., proration on the basis of policy limits, multiplied by years of coverage.’” Id. Based on Owens-Illinois, the court held that “when multiple insurance policies are implicated by the continuous-trigger analysis, all affected insurers ‘must respond to any claims presented to them and if they deny full coverage, must initiate proceedings to determine the portion allocable for defense and indemnity costs.’” Id. at *7. The court thus determined that, although Owens-Illinois did not consider co-insurers’ obligations to indemnify their common insured, the court nevertheless “envisioned the litigation of direct claims between co-insurers to ensure that the policyholders’ losses would be equitably allocated among its carriers.” Id. at 7, 8. Accordingly, the court held that an “inequitable allocation of the cost of defense, like an unfair allocation of the obligation to indemnify, may justify a judicial remedy,” and, therefore, found that a defending insurer can maintain a direct contribution action against a non-defending co-insurer. Id. at *8. The court found that its holding was further supported by several public-policy considerations. Specifically, the court provided that allowing claims for allocation of defense costs would promote the efficient use of resources of insurers, litigants, and the court; promote early settlement; incentivize individuals and businesses to purchase sufficient coverage every year; and serve the principles of fairness. Id. at 9.
The Potomac Insurance decision is important for several reasons. First, it creates an incentive for litigants to achieve early settlements. Second, it provides comfort for a defending insurer to provide a vigorous defense for its insured by paying more than its share of defense costs knowing that it will have a remedy against other, non-defending co-insurers. Third, the opinion may affect not just property damage disputes, but also litigation arising from long-tail personal injury claims, such as injuries caused by asbestos. Finally, the decision could be utilized as persuasive authority in other states that, like New Jersey, apply the pro rata formula to loss allocation, rather than joint and several allocation.