United States: Subrogation Rights In R&W Insurance Policies

The volume and size of insurer payments under R&W insurance policies are increasing. According to a May 2023 Aon study, the average R&W insurance claim payment to Aon clients in 2022 was $9 million, "significantly higher than the average claim payment in each of the previous two years." Aon, 2023 Transaction Solutions Global Claims Study, at 22. In addition, according to Aon, the frequency of claims on deals worth more than $100 million increased from prior years. Id. at 8, 29. As claim payments continue to rise, insurers may be looking for tools to mitigate losses. Subrogation can be one such tool, particularly when an identifiable third party is clearly responsible for the insured's loss. This article explores some of the factors that insurers should consider when deciding whether to pursue subrogation.

What Is Subrogation?

At its core, "[s]ubrogation entitles an insurer to stand in the shoes of its insured for the purpose of seeking indemnification from one or more third parties whose wrongdoing caused the loss for which the insurer was obligated to pay." Fed. Ins. Co. v. Spectrum Ins. Brokerage Servs., Inc., 758 N.Y.S.2d 21, 22 (App. Div. 2003). An insurer's subrogation rights arise from a combination of policy terms and the doctrine of equitable subrogation. Millennium Holdings LLC v. Glidden Co., 27 N.Y.3d 406, 414–15 (2016). Although subrogation is an equitable doctrine, R&W insurance policies often define or limit an insurer's subrogation rights. Courts may rely on equitable subrogation principles, however, when interpreting the policy terms or to fill in gaps. Thus, an R&W insurer contemplating pursuing a subrogation claim must understand both the policy terms and the equitable subrogation principles in the applicable jurisdiction.

By enabling an insurer to pursue recovery directly from the wrongdoer after paying the insured for its losses, subrogation can be a win-win for the insurer and the insured, aligning their incentives and mitigating the losses they each suffer. Examples of large recoveries through subrogation claims include insurers' $1.2 billion settlement recovery from airline defendants in litigation related to the September 11 attacks¹and Allstate's recovery of more than $600 million for payments made on claims related to California wildfires.²

Considerations for R&W Insurers

An R&W insurer contemplating a subrogation claim should consider at least these issues: (1) policy terms that may limit its subrogation rights, (2) the "make whole" doctrine and other legal precedents that may bear on its right to recover, (3) the extent to which the insured will be able and willing to cooperate, and (4) the potential impact of pursuing subrogation on the relationship with the insured.

Policy Terms Impact Subrogation Rights

R&W insurance policies typically define the insurer's subrogation rights and often waive the insurer's right to subrogate against the seller except in cases of fraud. Defendants in subrogation suits may try to claim the benefit of these provisions. The term "seller," however, is usually defined in the policy to refer to a very specific set of persons. An insurer thinking of pursuing subrogation against persons associated with the target company should understand the scope of that definition — it may not be as broad as the potential subrogation defendant believes.

One case, which recently settled in the federal court for the District of Massachusetts, shows how the policy's definition of "Seller" can be critical. See AIG Specialty Ins. Co. v. McColgan, 626 F. Supp. 3d 454 (D. Mass. 2022). AIG brought a subrogation claim against the former CEO and a former director of the acquired company, claiming that they fraudulently induced the insured's purchase of that company by failing to disclose that one of the company's key customers would not renew its contract. In his motion to dismiss, the former CEO relied on a provision in the policy that limited the kinds of subrogation claims that could be brought against the seller: "The Insurer shall be entitled to subrogate against any Seller only if such payment results from or arises out of a Breach resulting from or arising out of fraud on the part of such Seller." The CEO contended that he was a "Seller," but the court rejected this argument, observing that "Seller" had been defined in the policy to mean the firm's stockholders, that the CEO had not been a stockholder, and that AIG had broad subrogation rights against non-Sellers such as the CEO.

Another key question is whether the insurer's payment to its insured was "compelled" or "voluntary." In general, an insurer may recover in subrogation only those amounts that it was required to pay under the policy. An insurer may not voluntarily pay for losses not covered under the policy and then seek to recover those payments from third parties. Whenever there is doubt as to whether an insurer was required by the policy to cover a certain loss, this point can present a problem for the insurer. And with R&W insurance, there often is room for such doubt, as claims are frequently paid as part of a settlement between the insurer and insured. The question whether such payments were compelled can thus be a challenge to an insurer's subrogation rights.

Two subrogation cases outside of the R&W insurance context, read together, are illustrative. In Vigilant Ins. Co. v. Travelers Prop. Cas. Co. of Am., 243 F. Supp. 3d 405 (S.D.N.Y. 2017), several insurers disputed the priority of coverage among themselves for an employee's claim against the insured, but all of the insurers still contributed to the insured's settlement with the employee. One of those insurers (Vigilant) brought a subrogation suit against another (Travelers) that refused. Vigilant argued that it should not have had to contribute to the settlement but did so only because Travelers refused. After a lengthy analysis of the facts, the court rejected Travelers' argument that Vigilant's payment had been "voluntary," finding that Vigilant reasonably believed payment was necessary to protect its legal or economic interests.

In National Union Fire Insurance Co. v. Ranger Insurance Co., 599 N.Y.S.2d 347 (App. Div. 1993), however, the court came out the other way. There, an insurer defended its insured's interest at trial and ultimately authorized and paid a settlement on the insured's behalf, despite discovering on the eve of trial that its insurance policy contained a clear exclusion for the claimed loss. The insurer was not permitted to pursue a subrogation claim, because the court concluded that the settlement payment had been voluntary and not required under the policy.

Vigilant and National Union demonstrate the importance of both the policy terms and the specific circumstances surrounding resolution of the underlying claim. If an insurer reasonably believes it must make a payment to comply with its obligations under the policy, it is likely that a court would find that the payment was compelled rather than voluntary. If, on the other hand, the insurer knows (or has good reason to know) that the claimed loss is not covered or that it has made a payment not required by the policy terms, a subrogation claim may not prevail.

The 'Make Whole' Doctrine and the Insurer's Right To Recover

Another potential pitfall is the priority of recovery between the insurer and the insured, which can become complex when the insured was not (or believes it was not) fully compensated for its losses. The priority of recovery from a subrogation claim depends on both policy terms and the "make whole" doctrine, a common-law doctrine providing that when the "sources of recovery ultimately available are inadequate to fully compensate the insured . . . the insurer . . . has no right to share in the proceeds" recovered from the tortfeasor. Winkelmann v. Excelsior Ins. Co., 85 N.Y.2d 577, 581 (1995); see also 16 Couch on Insurance § 223:133 (3d ed. rev. 2023).

Priority of recovery may be an issue when the loss exceeds policy limits. In this circumstance, R&W insurance policies often contain provisions giving priority to the insured for any subrogation recovery for claimed losses in excess of the policy limits. For instance, a policy may say that "any amounts recovered by the Insurer in connection with the exercise of its subrogation or assignment rights shall be applied (i) first to reimburse the Insurer and the Insureds for any costs or expenses incurred in connection with such recovery, (ii) second to reimburse the Insured for Loss in excess of the Limit of Liability of this Policy, and (iii) third to the Insurer for amounts paid by the Insurer pursuant to this Policy."

Priority of recovery also may be an issue when the insurer accepts less than the claimed loss amount via settlement. For instance, if the insured claims to have suffered a loss of $10 million and recovers $5 million under the policy, along with another $2 million through a final judgment against the wrongdoer, then under the "make whole" doctrine the insurer presumably would not be able to retain anything from the wrongdoer through subrogation until the insured's loss was fully compensated. However, in In re September 11 Litigation, the court observed that the rule does not apply where the insured elected to settle its own claim against the alleged wrongdoer "without exhausting the sources of recovery available to them and without resolving the underlying issues in the [action against the tortfeasor]." 328 F. Supp. 3d at 185. Thus, in the example above, if the insured recovered the $2 million through a settlement with the wrongdoer where it conceivably could have recovered more, the insurer would have priority over the amounts recovered through subrogation.

Before proceeding with a subrogation claim, the insurer should understand its position for recovery with respect to the insured, including both the applicable policy terms and potential impact of the "make whole" doctrine, and consider whether its insured may have a claim for any proceeds recovered in subrogation.

Navigating the Insurer-Insured Relationship

A subrogation claim can significantly affect the insurer's relationship with its insured. Some R&W insurance policies require the consent of the insured before an insurer can subrogate against the insured's customers, clients or suppliers. These provisions aim to ensure that the insured's business is not disrupted by a suit against key stakeholders, but they can be frustrating for insurers. It may be wise to include language in the policy that prohibits the insured from unreasonably withholding such consent.

Moreover, even when the insurer is permitted to proceed without the insured's consent, as a practical matter the subrogation action can be difficult to maintain without the insured's cooperation. The insured suffered the underlying loss and has firsthand knowledge of the events that gave rise to the claim, so the insurer will likely need the insured to provide documents and witnesses. Thus, policies should include language requiring the insured to cooperate with the insurer and help it preserve its subrogation rights.

All that said, even if an insurer can pursue subrogation without the insured's consent and even if the insured is contractually obligated to cooperate in those subrogation efforts, insurers should remain mindful of how subrogation claims can distract the insured's key employees and otherwise affect the insured's business — and thus undermine the overall client relationship between insurer and insured.

* * *

If the trend of increasing R&W insurance claims continues, subrogation may become an important option for insurers to consider. Experienced counsel can help R&W insurers navigate the subrogation landscape.

Footnotes

1. See In re Sept. 11 Litig., 328 F. Supp. 3d 178, 182 (S.D.N.Y. 2018).

2. Steve Evans, Allstate's Wildfire Subrogation Recoveries Reach $605M, Artemis (Feb. 23, 2021), https://www.artemis.bm/news/allstates-wildfire-subrogation-recoveries-reach-605m/.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.