Vernic v. Lincoln Gen. Ins. Co. (In re Lincoln Gen. Ins. Co.)

244 A.3d 520

Franjo VERNIC dba SF Rehabitat, Objector

v.LINCOLN GENERAL INSURANCE COMPANY, In Liquidation, Respondent

(Ancillary matter to In Re: Lincoln General Insurance Company In Liquidation No. 1 LIN 2015)

No. 4 LIN 2017

Commonwealth Court of Pennsylvania.

Argued September 17, 2020

Decided December 3, 2020

Pamela A. Bower, Campbell, CA and Kevin J. McKeon, Harrisburg, for Objector.

Karl S. Myers, Philadelphia, for Respondent.

BEFORE: HONORABLE RENÉE COHN JUBELIRER, Judge, HONORABLE MICHAEL H. WOJCIK, Judge, HONORABLE CHRISTINE FIZZANO CANNON, Judge

OPINION BY JUDGE COHN JUBELIRER

Presently before the Court is the question of what priority level should be assigned to the claim of Franjo Vernic, d/b/a SF Rehabitat or San Francisco Rehabitat (Vernic), arising out of proceedings surrounding the Notice of Determination (NOD) issued by the Insurance Commissioner in her capacity as Liquidator of Lincoln General Insurance Company (Lincoln). The Court granted reargument at the Liquidator's request on this specific issue following a single-judge opinion sustaining Vernic's exceptions to the Referee's Report and Recommendation (Report) on Vernic's objections to the NOD.¹ Vernic v. Lincoln Gen. Ins. Co. , 244 A.3d 520 (Pa. Cmwlth., 2019) ( Vernic I ). Therein, the Court sustained Vernic's exceptions on the basis that he did not irrevocably assign his claim against Lincoln and his claim should be valued at the total amount of the judgment against Vernic and the attorney's fees he incurred as a result of Lincoln's breach of its duty to defend in California. The Court had also affirmed the Referee's decision assigning the claim to class (b) under the order of distribution provision found in Section 544 of The Insurance Department Act of 1921² (Act), as the Liquidator had initially found. The Liquidator subsequently asked to assign Vernic's claim to class (e) as a general creditor claim. Under California law, the Liquidator asserts that recovery of a judgment resulting from a wrongful failure to defend is the equivalent to recovery resulting from a bad faith tort claim, and bad faith tort claims are entitled to no more than class (e) priority. Vernic first argues the Liquidator waived the ability to challenge the priority level by failing to file exceptions like he did to the Report. Assuming the issue was preserved, Vernic argues that the claim should be assigned to class (b) as a "claim[ ] under policies for losses wherever incurred," 40 P.S. § 221.44(b), as the Liquidator originally found, and the Referee held.

I. FACTUAL BACKGROUND

A. The Policy and Underlying California Litigation

The relevant facts were previously set forth by this Court in Vernic I , as follows:

Lincoln issued a commercial general liability policy to Vernic, a general contractor in California, effective from February 15, 2008[,] to February 15, 2009 (Policy). The Policy stated in pertinent part:

We will pay those sums that the insured becomes legally obligated to pay as damages because of "bodily injury" or "property damage" to which this insurance applies. We will have the right and duty to defend the insured against any "suit" seeking those damages.

(Policy at 1.) The Policy also contained a subcontractor exclusion, which permitted Lincoln to disclaim coverage for damages caused by a subcontractor [that] failed to satisfy four specific conditions as set forth in the Policy.

During the Policy's coverage period, Vernic entered into a contract with Edwin A. Hardy (Hardy) to complete remodeling work, including architectural services, at Hardy's single-family residence (Property). Vernic then entered into a contract with Gerald J. Veverka, d/b/a Veverka Architects^{[ ]} (Veverka), wherein Veverka agreed to provide architectural services at the Property. The contract between Vernic and Veverka included an indemnification provision requiring Vernic to indemnify Veverka for any and all claims arising out of Veverka's architectural services. While Vernic was performing work at the Property and while the Policy was in effect, the Property sustained significant damage due to water infiltration. On November 2, 2011, Hardy filed a civil complaint against Vernic in the San Francisco County Superior Court (trial court), docketed at Edwin A. Hardy v. Franjo Vernic dba San Francisco Rehabitat , No. CGC-11-515611, asserting several causes of action arising from Vernic's allegedly defective work and the resulting damages to Hardy's residence.

It is undisputed that both before and after the complaint was filed, Vernic and Hardy each notified Lincoln of the claims of damage allegedly caused by Vernic. On June 14, 2011, Lincoln commenced an investigation into the claims through an independent adjusting company, Sams & Associates (Sams). While Sams authored three reports, the last of which was dated September 29, 2011, its adjuster admitted to being unable to reach a conclusion regarding whether Drummond Masonry, a subcontractor whose defective stone work was believed to be the cause of all or some of the damage to the Property, was hired by Vernic or Hardy. The last report indicated that Sams was unable to complete its claim analysis at that time and would follow up with Vernic to review requested documents from his sub-contractors.

Despite these facts and the questionable applicability of the Policy's subcontractor exclusion, Lincoln formally denied coverage in letters to Vernic dated October 21, 2011[,] and December 14, 2011. ... Because Lincoln denied Vernic representation and Vernic could not afford to hire a private attorney at that time, Vernic filed a pro se response to Hardy's complaint.

On or about February 28, 2013, Hardy filed an amended complaint adding Veverka as a defendant.^{[ ]} Veverka tendered the defense of the amended complaint to Vernic and Lincoln, and Lincoln denied the tender and refused to defend Veverka. Thereafter, Veverka served a cross-complaint on Vernic for express indemnity. Vernic claims he was financially unable to file a response to either Hardy's amended complaint or Veverka's cross-complaint. While Vernic did have private counsel for a period of time during the parties’ subsequent mediation, he was unable to afford trial counsel, and the case proceeded to an uncontested bench trial. The trial court subsequently entered judgment in favor of Hardy and against Vernic in the amount of $846,779.09 ..., and entered judgment in favor of Veverka and against Vernic in the amount of $180,178 ..., for a total judgment of $1,026,957.09[,] (California judgment).

Vernic I , 244 A.3d at 523–24 (footnotes omitted).

While the litigation was pending, the parties also entered into various "agreements." The first was a "Stipulation re Consent to Judgment and Uncontested Trial" (Stipulation), which was not signed by any of the parties, but indicated that Vernic could not afford counsel to defend against the claims and, therefore, he agreed not to contest the claims and assigned Hardy and Veverka all rights, claims, interest, and title in relevant insurance policies. Id. 244 A.3d at 523–24. The parties also entered into a Settlement Agreement and Mutual Release (Agreement) signed by the relevant parties, which provided in relevant part that Vernic would stipulate to a judgment and covenant not to execute against him or Lincoln and Vernic would "seek recovery from his liability insurer ... [with] any recovery from Lincoln ... apportioned as between [Hardy], [ ] Veverka, and Mr. Vernic." Id. 244 A.3d at 524 (alterations in original) (emphasis omitted).

B. Liquidation Proceedings

In 2015, "upon the petition for review in the nature of a complaint for order of liquidation of Lincoln filed by the Insurance Commissioner, ... this Court ordered that Lincoln be liquidated pursuant to Article V of the [Act]," the Liquidator was appointed, and claims against Lincoln were ordered to be filed. Id. 244 A.3d at 524–25. "Vernic filed a timely proof of claim on June 13, 2016, demanding $1,092,250.09 under the Policy ...." Id. The Liquidator issued the NOD, assigning a priority level (b) classification and valuing Vernic's proof of claim at zero dollars, explaining that Vernic assigned any and all claims he had against Lincoln to Hardy and Veverka. (NOD at 1.)

Following issuance of the NOD,

Vernic filed timely objections to the NOD arguing that (1) he did not effectively assign his claims against Lincoln to other parties, (2) payment of the judgment against him is not a prerequisite to the allowance of a claim under the law, and (3) Lincoln improperly denied him indemnification and a legal defense. The Liquidator filed a response denying the material allegations in Vernic's objections, and asserting that (1) its denial of coverage was justified by the terms of the Policy, (2) Vernic assigned his rights against Lincoln to Hardy and Veverka, neither of whom filed a proof of claim, and (3) the California judgment is unenforceable against Lincoln's estate because it was obtained through collusion.

Vernic I , 244 A.3d at 524–25. At the parties’ request, this Court appointed a Referee, and the parties agreed to use a summary judgment procedure before the Referee. Before the Referee, the Liquidator asserted in response to Vernic's claims that, even if Vernic had not assigned his claim, his claim should be assigned class (e) priority. Based upon the parties’ submissions, the Referee then issued his Report.

Specifically, the Referee recommended that the NOD be affirmed with respect to the priority level (b) classification of Vernic's claim, but reversed as to the value of the claim. The Referee concluded that Lincoln had a duty to defend Vernic in the California litigation because Hardy's complaint and amended complaint contained allegations of property damage "actually or potentially within the coverage of the [P]olicy." (Report at 9 (emphasis in original).) However, relying on the Stipulation rather than the Agreement, the Referee concluded that "Vernic assigned any and all rights to recover

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