American Fam. Mut. Ins. v. Auto-Owners Ins.

• Decision Date: 05 November 2008
• Docket Number: No. 24723.,24723.
• Citation: 2008 SD 106,757 N.W.2d 584
• Parties: AMERICAN FAMILY MUTUAL INSURANCE COMPANY, Plaintiff and Appellant, v. AUTO-OWNERS INSURANCE COMPANY, Sandra Pike, Christopher Pike and Ashley Deiss, Defendants and Appellees.
• Court: South Dakota Supreme Court

757 N.W.2d 584

2008 SD 106

AMERICAN FAMILY MUTUAL INSURANCE COMPANY, Plaintiff and Appellant, v. AUTO-OWNERS INSURANCE COMPANY, Sandra Pike, Christopher Pike and Ashley Deiss, Defendants and Appellees.

No. 24723.

Supreme Court of South Dakota.

Argued May 20, 2008.

Decided November 5, 2008.

Ronald A. Parsons, Jr. and A. Russell Janklow of Johnson, Heidepriem, Janklow, Abdallah & Johnson, LLP, Sioux Falls, SD, for plaintiff and appellant.

William P. Fuller and Hilary L. Williamson of Fuller & Sabers, LLP, Sioux Falls, SD, for defendants and appellees.

O'BRIEN, Circuit Judge.

[¶ 1.] American Family Insurance (American Family) filed a complaint for a declaratory judgment against Auto-Owners Insurance Company (Auto-Owners). American Family sought a declaration that it had a subrogated interest against an Auto-Owners' homeowners' policy issued to Sandra Pike, Christopher Pike and Ashley Deiss (tenants). The circuit court granted summary judgment to Auto-Owners and tenants (the defendants). American Family appeals. We reverse and remand.

FACTS

[¶ 2.] The circuit court was presented with a joint stipulation of facts.¹ Donald Babinski owned a rental duplex located at 1026 North Menlo Avenue in Sioux Falls, South Dakota. Babinski purchased a business owners' policy of insurance from American Family to provide coverage for property damage to the rental dwelling on Menlo Avenue. Under the insurance policy, American Family was granted the right of subrogation in order to recover any amounts paid under the policy from those responsible for causing the loss.

[¶ 3.] On January 28, 2005, tenants signed a lease agreement to rent one unit of the duplex owned by Babinski. The lease agreement contained the following provisions:

2. MAINTENANCE, REPAIRS, AND ALTERATIONS—Resident agrees: ... (b) to be responsible for, at Resident's own cost, any and all breakage or damage done to any part of the premises, including damages or theft by Resident's guests to the apartment and common areas of the building ...

* * *

H. LIABILITY OF RESIDENT AND MANAGEMENT

1. NON-LIABILITY OF LESSOR— ... Resident is required to maintain liability and personal property insurance during the term of the lease or any subsequent leases. Proof of insurance is required at the time the lease is signed.

* * *

[3.] RESIDENT SHALL REIMBURSE MANAGEMENT FOR—a) any loss, property damage, or cost of repair or service (including plumbing problems and freezer punctures) cause[d] by negligence or improper use by Resident, his/her agents, family or guests ...

The lease did not contain any provision reserving a right of subrogation in favor of the landlord's insurer, American Family, nor did it specifically address damage to the dwelling caused by fire.

[¶ 4.] In accordance with the lease, the tenants purchased a homeowners' insurance policy from Auto-Owners for the rental duplex. The term of the policy provided coverage from February 28, 2005 to February 28, 2006. All three tenants were covered under the policy.

[¶ 5.] On March 1, 2005, an accidental fire occurred when one of the tenants, Ashley Deiss, took ashes from the fireplace and moved them to a cardboard box inside a closet in the residence.² As a result of the fire, American Family paid insurance proceeds to Babinski in the amount of $96,959.42 for the damage caused by the fire. American Family then sought subrogation in this amount against Auto-Owners on the tenants' homeowners' insurance policy. Auto-Owners denied American Family's subrogation claim.

[¶ 6.] American Family subsequently filed a declaratory judgment action seeking a determination of whether it had a subrogated interest against the Auto-Owners policy held by tenants. The parties entered into a joint stipulation of facts and filed cross-motions for summary judgment.

[¶ 7.] The circuit court granted Auto-Owners' motion for summary judgment and issued a memorandum decision. The circuit court concluded that the South Dakota Supreme Court would adopt the rule first pronounced in Sutton v. Jondahl 532 P.2d 478 (Okl.Civ.App.1975). The Sutton rule precludes a landlord's insurer from asserting a subrogation claim against a tenant absent an express agreement to the contrary. The circuit court found that public policy reasons supported the Sutton approach including the legal certainty provided by the rule and the fact that it avoids gamesmanship over the manner in which landlords craft lease provisions. Additionally, the circuit court held that even if it adopted the alternative case-by-case approach, discussed infra at ¶ 26, American Family did not have a subrogation right. This was because the tenants could not reasonably anticipate that the landlord's insurer could assert a subrogation claim against them if the rental property was destroyed by a fire caused by their negligence.

[¶ 8.] American Family appeals raising the following issues:

Whether the circuit court erred in granting summary judgment for the defendants.

Whether the circuit court erred in finding that the lease did not contemplate that the tenant would be liable to a subrogation claim by the landlord's insurer.

STANDARD OF REVIEW

[¶ 9.] The standard of review is well settled in actions where the parties agree that the material facts are not contested but the dispute is centered on the application of substantive law. "`With the material facts undisputed, our review is limited to determining whether the [circuit] court correctly applied the law.'" Johns v. Black Hills Power, Inc., 2006 SD 85, ¶ 4, 722 N.W.2d 554, 556 (citation omitted). The standard of review for questions of law is de novo. Daktronics Inc. v. LBW Tech. Co., 2007 SD 80, ¶ 2, 737 N.W.2d 413, 416 (citations omitted).

[¶ 10.] "`On appeal, this Court can read a contract itself without any presumption in favor of the trial court's determination.'" A-G-E Corp. v. State, 2006 SD 66, ¶ 15, 719 N.W.2d 780, 786 (citations omitted). "Thus, the interpretation of a contract is a question of law, which is reviewed de novo." Id. (citation omitted.)

ANALYSIS

ISSUE ONE

[¶ 11.] Whether the circuit court erred in granting summary judgment for the defendants.

[¶ 12.] This is a case of first impression for this Court. This Court has been asked to decide whether, for subrogation purposes, a tenant is co-insured under his or her landlord's insurance policy absent an express provision in the parties' lease to the contrary. If the Court decides that the tenant is co-insured under the landlord's policy, an insurer could not bring a subrogation action against a tenant who caused damage to the landlords' insured premises because the right of subrogation cannot arise in favor of an insurer against its own insured.

[¶ 13.] "The right to subrogation is not new in South Dakota. A half century ago, this Court stated: `It is a well settled rule of law that an insurer is entitled to subrogation, either by contract or in equity for the amount of the indemnity paid.'" Met Life Auto and Home Ins. Co. v. Lester, 2006 SD 62, ¶ 13, 719 N.W.2d 385, 387 (citation omitted). Under South Dakota law, subrogation can arise out of two sources. Id. "First, the parties can agree to create a contractual right of subrogation. This is commonly done in insurance policies. Second, equity can require the creation of subrogation based upon the circumstances, even without a contractual obligation." Id.

[¶ 14.] American Family contends that it has both a contractual and an equitable right of subrogation against Auto-Owners and the negligent tenants under South Dakota law.

Sutton Rule

[¶ 15.] The Sutton rule had its genesis in the case of Sutton v. Jondahl, 532 P.2d at 482.³ Under the Sutton rule, an insurance company providing fire insurance for a dwelling is not allowed to shift a fire loss to an occupying tenant even if the latter negligently caused the fire. Id. (citing New Hampshire Ins. Co. v. Ballard Wade, Inc., 17 Utah 2d 86, 404 P.2d 674 (1965)). Subrogation is not available to a landlord's insurer as against a tenant unless the lease explicitly provides otherwise because the tenant and the landlord are implied co-insureds under the landlord's fire insurance policy.

[¶ 16.] Sutton, 532 P.2d at 478-79, involved a fire caused by a ten-year-old boy playing with his chemistry set in his family's rental home. The landlord's insurer paid the loss and, as subrogee, brought suit against the father and son. Id. The Oklahoma Court of Appeals held that the insurance company had no subrogation rights against the tenant of its policy-holder. Id. at 481. The court found that "subrogation should not be available to the insurance carrier because the law considers the tenant as a co-insured of the landlord absent an express agreement between them to the contrary, comparable to the permissive-user feature of automobile insurance." Id. at 482. The Sutton rule is "derived from a recognition of a relational reality, namely, that both landlord and tenant have an insurable interest in the rented premises-the former owns the fee and the latter has a possessory interest." Id.

[¶ 17.] The Oklahoma Court of Appeals found that when fire insurance is provided for a dwelling, it protects the insurable interests of all joint owners including the possessory interests of a tenant, absent an express agreement by the latter to the contrary. Id. The court noted that the cost of the insurance premium is considered in establishing the "rent rate" and, in effect, the tenant is actually paying the premium as part of the monthly rent. Id. Moreover, absent an express agreement, "[p]rospective tenants ordinarily rely upon the owner of the dwelling to provide fire protection for the realty (as distinguished from personal property)[.]" Id.

Certainly it would not likely occur to a reasonably prudent tenant that the premises were without fire insurance protection or if there was such protection it did not inure to his benefit and that he would need to take out another fire policy to protect...