In Colorado, Primary Insurers are Necessary Parties in Declaratory Judgment Actions.

The United States District Court for the District of Colorado recently ruled that primary insurers are necessary parties, under Fed. R. Civ. P. 19, in a declaratory judgment action being pursued by an excess carrier. See Insurance Co. of State of Pennsylvania v. LNC Communities II, LLC, 2011 WL 5548955 (D. Colo. 2011). Federal Rule of Civil Procedure 19 is almost identical to Colorado Rule of Civil Procedure 19 and pertains to the joinder of persons needed for “just adjudication.” The Insurance Co. of the State of Pennsylvania (“ICSOP”) sought a declaratory judgment that it did not have a duty to defend or indemnify the defendants (collectively referred to as “Lennar Companies”) with regard to the underlying lawsuit brought by The Falls at Legend Trail Owners Association, Inc. (the “HOA”). Id. at *2. In its lawsuit, the HOA alleged Lennar Companies were liable for construction defects at The Falls at Legend Trail residential development.

Lennar Companies held two primary insurance policies, one issued by OneBeacon Insurance Company f/k/a General Accident Insurance Company (“General Accident”) and the other issued by American Safety Risk Retention Group, Inc. (“American Safety”). Lennar Companies also carried excess policies issued by ICSOP and Ohio Casualty Insurance Company (“Ohio Casualty”). In its analysis, the U.S. District Court for the District of Colorado pointed out that excess policies, such as the policy issued by ICSOP, typically provide coverage only for that portion of the damages that are in excess of the total applicable limits of the underlying or primary policies. Id. at *1.

Although Lennar Companies notified their insurers of the HOA’s lawsuit, none of the insurers meaningfully participated in their defense or agreed to provide reasonable settlement authority. Faced with the threat of multi-million dollar liability at trial, Lennar Companies settled the HOA’s lawsuit without ICSOP’s approval. Apparently, American Safety and Ohio Casualty promised to fund a small part of the settlement, but ICSOP did not. In its complaint, ICSOP alleged it had no duty to defend or indemnify for a number of reasons, and included policy exclusions, not being the named insured, and the failure to exhaust the limits of all underlying insurance. Id. at *2.

About a month after ICSOP filed its declaratory judgment action, Lennar Companies filed suit against all of their insurers in Denver County District Court for breach of contract, bad faith breach of contract, and a declaratory judgment that the insurers were and are obligated to defend and indemnify for liability and defenses costs arising out of the HOA’s lawsuit. The same day, Lennar Companies filed a motion to dismiss ICSOP’s declaratory judgment action for, primarily, a failure to join required and indispensable parties under Fed. R. Civ. P. 19. Under Rule 19(a)(1), a person is required to be joined if:

(A) In that person’s absence, the court cannot accord complete relief among existing parties; or

(B) That person claims an interest relating to the subject of the action and is so situated that disposing of the action in the person’s absence may:

(i) As a practical matter impair or impede the person’s ability to protect the interest; or

(ii) Leave an existing party subject to a substantial risk of incurring double, multiple, or otherwise inconsistent obligations because of the interest.

If feasible, a required person must be joined.

See Insurance Co. of State of Pennsylvania, 2011 WL 5548955 at *3. If the required person cannot be joined as such action would destroy the court’s jurisdiction, the U.S. District Court for the District of Colorado indicated that the court must turn to Rule 19(b). “Under Rule 19(b), if a required person ‘cannot be joined, the court must determine whether, in equity and good conscience, the action should proceed among the existing parties or should be dismissed.’” Id.

Rule 19(b) provides the factors a court should consider when deciding whether to proceed without the required person, including the extent of prejudice to that person or existing parties from judgment, extent to which any prejudice could be lessened or avoided by protective measures in the judgment or shaping of the relief. Additionally, Rule 19(b) proscribes consideration of whether judgment rendered in the person’s absence would be adequate, and whether the plaintiff would have an adequate remedy if the case was dismissed for non-joinder.

In their motion to dismiss, Lennar Companies argued that, under Rule 19(a), the court could not provide complete relief among the existing two parties as determination of Lennar Companies’ primary insurers’ obligations was a necessary prerequisite to determining ICSOP’s obligations under its policy. Id. at *4; see also City of Littleton v. Commercial Union Assurance Companies, 133 F.R.D. 159 (D. Colo. 1990). The court agreed, acknowledging that the ICSOP policy explicitly indicated that it was in excess of the primary policies, and therefore dependent upon a determination of whether the primary policies provide coverage. The court further acknowledged that, although it could construe General Accident’s policy, it would not be binding on the parties. As such, the court recognized the shortfall with regard to finality of judgment, which would be contingent upon a necessary lawsuit involving the parties and Lennar Companies’ primary insurers. Pursuant to the City of Littleton case, supra, the court found General Accident to be a required party under Fed. R. Civ. P. 19(a)(1)(A). See Insurance Co. of State of Pennsylvania, 2011 WL 5548955 at *5.

Lennar Companies argued that General Accident was a required party as it has an interest relating to the subject matter of ICSOP’s lawsuit “in that the primary layer of insurance it issued to [The Lennar Companies] is beneath the umbrella policy issued by ICSOP” and its ability to protect its interest will be impaired or impeded under Rule 19(a)(1)(B)(i). Id. at *6. Even though absent insurers would not be bound by the court’s judgment, the U.S. District Court of the District of Colorado noted that their absence could deny them the opportunity to present their individual defenses at a meaningful time. In order to adjudicate ICSOP’s claim that it has no duty to defend or indemnify, the court will necessarily have to determine Lennar Companies’ primary insurers’ liability. Accordingly, the court found General Accident a required party under Fed. R. Civ. P. 19(a)(1)(B)(i).

Lennar Companies also argued that proceeding in the absence of their primary insurers could subject ICSOP to multiple or inconsistent obligations. Id. at *8. The court agreed, acknowledging that its conclusions concerning the happening of an occurrence, property damage, and exhaustion of the primary policies could conceivably conflict with another court’s conclusions on these matters. As such, the court concluded that General Accident is a required party under Rule 19(a)(1)(B)(ii).

The court then turned to Rule 19(b) to determine whether it should dismiss ICSOP’s lawsuit rather than proceed. Id. at *10. In its analysis under Rule 19(b)(1), the court reiterated its findings of potential prejudice to General Accident, and ICSOP. Additionally, the court found that Lennar Companies could be prejudiced if the case went forward in the absence of General Accident. The court explained that the possibility of inconsistent outcomes in ICSOP’s declaratory action and Lennar Companies’ lawsuit could be “highly prejudicial” to Lennar Companies given the possibility of a gap in coverage.

The court then unsuccessfully explored the possibility of lessening or avoiding the potential prejudice by the inclusion of protective measures in the judgment, shaping the relief, or any other measures pursuant to Rule 19(b)(2). Withholding judgment until the primary insurers’ coverage and defense liability are determined in the other action filed would not promote judicial efficiency, economy, or the courts’ or parties’ convenience “and would invite complexity, delay, and a needless increase of litigation costs.” Id. at *11 (quoting City of Littleton, 133 F.R.D. at 165). The court also acknowledged that the possibility of shaping the relief by expressly holding that its determination of the primary insurers’ obligations not binding would effectively render judgment in this case meaningless. As such, the court found no reasonable alternative to lessen or avoid the inherent prejudice the case presented.

In consideration of whether judgment rendered in General Accident’s absence would be adequate under Rule 19(b)(3), the court reiterated its conclusion that complete relief was not available unless General Accident was joined. The court found that this conclusion “weighs in favor of dismissing the case.” Id. at *11. Finally, the court addressed whether ICSOP would have an adequate remedy if its action were dismissed for nonjoinder. The court acknowledged that not only was an alternative forum available, the other lawsuit was pending in the same forum ICSOP chose to file its declaratory action. Accordingly, the court found that equity and good conscience, as well as all of the Rule 19(b) factors dictated dismissal rather than proceeding in General Accident’s absence and found the case properly dismissed under Fed. R. Civ. P. 12(b)(7).

For additional information regarding Colorado construction litigation, please contact David M. McLain at (303) 987-9813 or by e-mail at mclain@hhmrlaw.com.