Rausch v. Allstate Insurance

WILNER, J. It is not uncommon for a fire insurance policy to contain a subrogation clause that permits the insurer to recover, from any person (other than the insured) who causes a covered loss under the policy, amounts paid by the insurer by reason of that loss. Under such a clause, the insurer stands in the shoes of the insured and can seek to recover those amounts to the same extent that the insured could have recovered them from the person causing the loss, had there been no insurance. The question before us in the two cases that we have consolidated for appellate purposes is under what circumstances, if any, the insurer may pursue its contractual right of subrogation against a tenant of the insured who negligently damaged the insured premises and thereby caused the loss. Although, as we shall see, most of the courts that have addressed the issue have ended up holding in the tenant’s favor, denying recovery, the theories used to support that result vary.

Part of the difficulty in agreeing on a single theory to support the result arises from the differing circumstances underlying the cases — the wide variety in lease provisions that define the landlord-tenant relationship, whether the leased property is commercial or residential, whether the lease is of a single-unit structure or part of a multi-unit structure. In large measure, the issue presents a clash between what a direct application of basic and well-established legal principles would produce and what the courts have come to regard as either impractical or inequitable to tenants, or at least certain classes of tenants. ⁶⁹⁵ THE CASES BEFORE US Rausch In January, 1999, John Dunlop purchased 5037 Netherstone Court, in Columbia, as a piece of rental property. The property was a single-family dwelling. In September, 1999, he appointed American Relo Realty, Inc. to manage the property.

The agreement between Dunlop and American Relo required Dunlop to maintain lire insurance for damage that might arise from the occupancy or management of the house. In March, 2000, American Relo leased the property to the Rausches, for a period of six months, at a rental of $1,500/ month. Included in the written lease were provisions that: (1) Prohibited the tenants from doing anything on the property in contravention of any hazard insurance policy in force or which would increase the premium on such a policy; (2) Required the tenants to indemnify the owner for any liability for injury, death, property damage, or other loss arising within those portions of the property within the exclusive control of the tenants or occasioned by any act or omission of the tenants; (3) Required the tenants to surrender the property at the end of the lease in the same condition as when received, ordinary wear and tear excepted; (4) Declared, with respect to the portions of the property within the exclusive control of the tenants, that the owner was not responsible for any loss or damage to goods or chattels placed in the property or for personal injury to the tenants and that it was the responsibility of the tenants to “obtain and pay the costs of any insurance to protect Tenant from loss or damage to Tenant’s personal property placed on, in or about the Property, mid to maintain adequate personal liability insurance.” (Emphasis added); (5) Declared that, if the property were rendered totally uninhabitable by fire or certain other causes, or if the property were partially damaged and the owner elected not to repair ⁶⁹⁶ the damage, the tenancy would immediately terminate and all rent would cease as of the date of the occurrence; and (6) Made the tenants responsible for “any and all damages to the Property caused by any act of negligence of Tenant” or other residents of the property as well as for the cost of all repairs, replacements, and related services if the need for the same resulted from the negligence or misuse by the tenants. Although Item (4) above clearly required the Rausches to maintain “adequate personal liability insurance” and insurance to protect their property, and Item (1) anticipated that the owner would likely have a fire insurance policy of his own in force, nothing in the lease itself required the owner to maintain such insurance, and there is no indication that the tenants were aware of that requirement in the management agreement.

The owner, in fact, purchased a fire insurance policy from Allstate Insurance Company that remained in force during the tenancy. On April 12, 2000, Ms. Rausch caused a fire in the property by leaving a flammable item on the rear burner of the electric range that had been turned to “high” and then leaving the house. The fire caused nearly $152,000 in damage. Allstate paid $138,000 to Dunlop. 1 The Allstate policy contained a subrogation clause, which provided that (1) if Allstate paid any loss, the “insured person’s rights to recover from anyone else become ours up to the amount we have paid,” (2) the insured person “must protect these rights and help us enforce them,” but (3) the insured could waive “your rights to recover against another person for loss involving the property covered by this policy” if the waiver was in writing and was given prior to the date of loss.

There is no indication that Dunlop directly made such a waiver. Exercising its rights as subrogee, Allstate sued the Rausches in U.S. District Court to recover the $138,000 it had paid to Dunlop. The complaint alleged both negligence and breach of ⁶⁹⁷ contract. The Rausches moved for summary judgment, arguing that the law prohibited subrogation actions by a landlord’s insurer against the landlord’s tenants on the ground that the tenants were regarded as implied co-insureds.

Both sides acknowledged that, although there were cases on the issue around the country, this Court had never addressed it. Because it was an unanswered question in Maryland, the court, invoking the Maryland Uniform Certification of Questions of Law Act (Maryland Code, § 12-601 through 12-618 of the Cts. & Jud. Proc. Article) (CJP) and Maryland Rule 8-305, certified the following two questions: “(1) Does Maryland law recognize the doctrine of ‘implied co-insureds’ so that a tenant is an implied co-insured of the landlord?

(2) If so, is Allstate barred from bringing the instant subrogation action against tenants of its insured?” We shall address those questions as framed by the court, but, because theories other than “implied co-insured” have been used by courts to preclude subrogation actions against tenants, we shall, in our response, take account of those theories as well. The statute does permit this Court to reformulate the certified questions so long as our answer properly disposes of the questions as certified. See CJP § 12-604; also Mardirossian v. Paul Revere Life, 376 Md. 640 , 647 n. 4, 831 A.2d 60 , 64 n. 4 (2003) (citing Piselli v. 75th Street Medical, 371 Md. 188 , 202 n. 4, 808 A.2d 508 , 516 n. 4 (2002)). Harkins In May, 1999, Janice Harkins entered into a one-year lease for Apartment 28 in the Oak Court Apartments, a multi-unit apartment development.

The lease, signed on behalf of the owner by its leasing agent, United Homes, Inc., ran from June 1, 1999 through May 31, 2000. Included in the written lease were provisions that: (1) Made available a storage space for Ms. Harkins but, in that provision, stated: ⁶⁹⁸ “Resident expressly agrees that landlord shall not be liable for any loss, damage or injury to property. Tenant shall have insurance coverage for this storage area as well as Renter’s Insurance for the apartment. Landlord is not responsible for such loss which may be incurred.” (Emphasis added); (2) Required the tenant to reimburse the landlord for “any loss, damage or actual cost of repairs or service caused in the apartment or apartment complex by improper use or negligence of tenant or tenant’s guests or occupants”; and (3) Required the tenant, when moving out, to “surrender the apartment in the same condition as when received, reasonable wear expected.

Reasonable wear means occurring without negligence, carelessness, accident, or abuse.” Other than the reference in Item (1) to renter’s insurance, which Ms. Harkins obtained, the lease was silent with respect to insurance. In fact, the owner obtained a fire insurance policy from Harford Mutual Insurance Company that was in effect during Ms. Harkins’s tenancy. The policy contained a subrogation clause, stating that, “[i]f any person or organization to or for whom we make payment under this policy has rights to recover damages from another, those rights are transferred to us to the extent of our payment” and that the payee “must do everything necessary to secure our rights and must do nothing after loss to impair them.” The clause permitted the insured to waive its rights against another party in writing (1) prior to a loss, or (2) after a loss if the party is a tenant. The owner never directly waived its rights against Ms. Harkins.

On March 29, 2000, Ms. Harkins lit one or more scented candles on a nightstand in her bedroom and then left the room to answer the telephone. While on the telephone, the smoke alarm went off, but Ms. Harkins thought it had malfunctioned. When she smelled smoke, Ms. Harkins investigated and discovered that her bedspread was on fire. After an unsuccessful attempt to extinguish the fire, she left the apartment.

The fire and smoke caused extensive damage to the second floor of ⁶⁹⁹ the apartment building. Harford paid over $83,000 to repair the damage and then, exercising its rights as subrogee, sued Ms. Harkins in the Circuit Court for Harford County to recover the amount it had paid. Harkins moved for summary judgment on the grounds that (1) as a matter of law, she was not negligent in causing the fire, and (2) the subrogation clause relied on by Harford was unenforceable because (i) she was an implied co-insured under the policy, (ii) the clause was against public policy, and (iii) it would be inequitable to enforce the clause against her. The Circuit Court was unable to conclude that there was an absence of negligence, as a matter of law, but, relying on the holding and pronouncements in Sutton v. Jondahl, 532 P.2d 478 (Okla.Ct.App.1975) and other cases adopting those pronouncements, found that Harkins was an implied co-insured under the Harford policy and that, as a result, the subrogation clause could not be enforced against her.

On that ground, it entered summary judgment for Ms. Harkins. Harford appealed, and we granted certiorari on our own initiative prior to proceedings in the Court of Special Appeals and consolidated the case with Rausch for argument and decision. DISCUSSION Introduction These cases involve the coalescence of at least five independent principles of law, each fairly well-established. The first is simply an application of general negligence principles to the landlord-tenant relationship.

It has long been recognized, although there are a dearth of cases in Maryland, that, in the absence of any valid contractual provision to the contrary, a tenant is liable in tort to the landlord if and to the extent that the tenant negligently damages the landlord’s property. See Pearson v. Wiltrout, 17 Md.App. 497 , 302 A.2d 678 (1973); Liability of Tenant for Damage to the Leased Property Due to His Acts or Neglect, 10 A.L.R.2d 1012 , 1014 ⁷⁰⁰ (1950); 2 1 Friedman on Leases § 9.9 (4th ed.1997). The Legislature has recognized and given effect to that principle. See, for example, Maryland Code, § 8-203 of the Real Property Article, permitting residential landlords to demand security deposits from tenants to protect, among other things, against damage to the leased premises and, upon termination of the lease, to retain amounts for damage to the leased premises in excess of ordinary wear and tear.

A second principle, which is a corollary to the first, is that, although State law prohibits clauses in a lease that' purport to exonerate a landlord from liability for injury or loss caused by the landlord’s negligence (see Maryland Code, § 8-105 of the Real Property Article), there is no flat prohibition against a clause exonerating a tenant from liability for loss caused by the tenant’s negligence or a provision waiving a landlord’s right to sue a tenant for damage negligently caused by the tenant. If a lease contains such a provision, expressly or impliedly, and is otherwise valid, that provision may effectively negate any common law tort liability on the part of the tenant. The third principle is an application of basic contract law to the landlord-tenant relationship. Just as a lease may negate a tenant’s common law tort liability, it may, independently of tort liability, contractually impose liability on the tenant for damage to the leased premises resulting from the tenant’s negligent act or omission, either by a specific lease provision to that effect or by a covenant on the part of the tenant to return the property, save for ordinary wear and tear, in the same condition as the tenant received it. 3 ⁷⁰¹ The fourth and fifth principles arise from the law of subrogation and its application to subrogation clauses found in insurance policies.

It has long been recognized, as a legal principle, that an insurer may not recover from its insured, or a co-insured, as subrogee. See Wager v. Providence Ins. Co., 150 U.S. 99, 110 , 14 S.Ct. 55, 58 , 37 L.Ed. 1013, 1018 (1893). In Aviation Ins.

Co. v. Barclay, 237 Md. 318, 327 , 206 A.2d 119, 123-24 (1965), we noted, albeit in dicta, that “[t]he authorities are in complete accord, and it is conceded in the instant case, that the insurer cannot recover, as subrogee, against its insured,” and that is clearly the case. See also R. Keeton and A. Widiss, Insurance Law, 341 (1988). Indeed, any other construction would be absurd — because, as subrogee, the insurer stands in the shoes of the insured, it would essentially involve the insured suing himself to recover damages he sustained by his own conduct. Those courts which find a tenant to be an implied co-insured of the landlord use that principle to deny recovery.

Apart from that legal limitation, equitable principles apply to subrogation. In Bachmann v. Glazer, 316 Md. 405, 412 , 559 A.2d 365, 368 (1989), citing a number of earlier cases, we observed that subrogation is founded on the equitable powers of the court and is intended “to provide relief against loss and damage to a meritorious creditor who has paid the debt of another.” It is, we said, “a legal fiction whereby an obligation extinguished by a payment made by a third person is treated as still subsisting for the benefit of this third person” who “succeeds to the rights of the creditor in relation to the debt.” Id. The rationale for the doctrine is “to prevent the party primarily liable on the debt from being unjustly enriched when someone pays his debt.” 4 Id. ⁷⁰² We noted in Bachmann that there were three categories of subrogation — legal, which arises by operation of law when a third party, who pays another’s debt to protect his/her own interests, is deemed entitled to reimbursement; conventional, which is provided for by contract; and statutory, which, of course, arises from an act of the Legislature. The basis of conventional subrogation — the kind we have here — is “an agreement, express or implied, between a debtor and a third party or between a creditor and a third party that, upon payment of the debt, the third party will be entitled to all the rights and securities of that debtor or that creditor.” Id. at 413-14 , 559 A.2d at 369 .

We confirmed in Bachmann, however, that, though founded on contract, recovery on a theory of conventional subrogation is nonetheless subject to principles of equity and that “[a] conventional subrogee is not necessarily entitled to subrogation as a matter of legal right; the relative equities of the parties are still to be balanced.” Id. at 416 , 559 A.2d at 370 . The theory espoused by the insurance companies in these cases is that the tenants, through their own negligent acts or omissions, caused substantial damage to their landlord’s property and that, as a result, were liable to the landlords, in both tort and contract, for the damage they caused. Had there ⁷⁰³ been no insurance, the landlords would have been entitled to sue the tenants to recover for the loss. Pursuant to their own contractual obligation under the fire insurance policies, the insurers paid at least part of the debt owed by the tenants and, under the conventional subrogation clauses in those policies, they succeeded to the rights of the landlords — their insureds — and were therefore entitled to be reimbursed by the tenants, who were the principal debtors.

Holding aside the lingering question of Harkins’s negligence, which was never resolved, the defense in these cases invokes predominantly the assertion that the tenants are, in effect, co-insureds with their landlords under the landlords’ policies and, as such, may not be sued under the subrogation clauses. Harkins adds the equitable defense — that it would be inequitable to permit the insurers to proceed against the tenants under their subrogation clauses. Thus, although the tenants’ ultimate responsibility arises from principles of tort and contract liability, the decisive issue before us is one of subrogation law. Are the tenants to be regarded, either as a matter of law or a matter of fact, as co-insureds under the landlords’ insurance policies and, if not, is there some other basis, including any paramount equity, favorable to them that precludes the enforcement of an otherwise valid subrogation clause?

The Legal Landscape Although the prospect of subrogation claims against tenants of the insured has long existed, the actual emergence of such actions has been traced by at least one commentator, Milton Friedman, to a 1950 case that inferentially involved but did not turn on a subrogation claim — General Mills v. Goldman, 184 F.2d 359 (8th Cir.1950), cert. denied, 340 U.S. 947 , 71 S.Ct. 532 , 95 L.Ed. 683 (1951). See Friedman, Friedman on Leases § 9.9 (4th ed.1997). In that case, Goldman purchased investment property for $110,000 and promptly leased it to General Mills for a ten-year period at an annual rental of $15,000. 5 ⁷⁰⁴ Two years into the lease, the processing plant situated on the land was destroyed by a fire that Goldman contended was caused by the tenant’s negligence. Goldman had obtained a fire insurance policy that provided $100,000 of coverage for loss to the building and $15,000 for loss of rental, and the company, in furtherance of that obligation, paid Goldman nearly $111,000.

Notwithstanding that payment, which exceeded the cost of the property, Goldman sued to recover $342,000 from General Mills, for additional costs and loss of rental. 6 The insurer intervened, as subrogee, to recover the amount it had paid Goldman. The case, governed by Minnesota law, turned on a general provision in the lease that exonerated the tenant from liability for “loss by fire.” Goldman, supra, 184 F.2d at 366. Goldman’s position, and apparently that of the insurer, was that the exoneration did not apply to a fire caused by the tenant’s negligence. General Mills argued that the exoneration did so apply because it was contemplated by the parties that any reimbursement for fire loss, however caused, would come from the landlord’s fire insurance.

Reversing a judgment for Goldman and the insurer, a majority of the appellate panel concluded that there was no public policy in Minnesota that would preclude the parties from resorting solely to fire insurance in the event of a fire, whether or not occasioned by the tenant’s negligence, and it construed the lease as being to that effect. In the court’s view, the exoneration for “loss by fire” anticipated that the loss would be covered by insurance regardless of any negligence and, if the landlord wished to limit that exoneration, it could have done so in the lease. In light of all of the other detailed provisions regarding tenant liability and the court’s supposition that, because the property was purchased as an investment the premiums for insurance coverage would come from the rent paid by General Mills, the panel majority simply ⁷⁰⁵ refused to read into the general exoneration the unwritten exception sought by Goldman. The importance of the case, according to Friedman, Friedman on Leases § 9.9, supra, lies in the fact that the court, in ultimately ruling for the tenant, was forced to rely on the exoneration clause in the lease, thereby acknowledging “that in its absence the tenant would have been liable to the landlord’s insurer under the doctrine of subrogation.” Id. at 572-73.

Whether that nuance in fact encouraged insurers to seek to enforce subrogation clauses against tenants is unclear. Goldman has been frequently cited, but mostly for the proposition that the parties, through express or implied exoneration clauses in the lease, can effectively shift the burden of liability from the tenant to the landlord’s insurance company. 7 Indeed, it is that concept — the second principle noted above— that has taken root. The generally accepted progenitor of the “no-subrogation” rule is Sutton, supra, 532 P.2d 478 . 8 In Sutton , the 10-year- ⁷⁰⁶ old son of the tenant caused a fire in the leased premises while playing with his chemistry set. The landlord’s insurer, which paid the loss, sued the father and the son, alleging negligence on both their parts, and, after a full trial, won a verdict against the father, but not the son.

The appellate court reversed, predominantly upon finding error in jury instructions that plainly cast the burden on the defendants to prove that they were not negligent. That alone required a new trial. The court then turned to the insurer’s role, which is the relevant part of the opinion for our purposes. Because the insurer paid the entire amount of the loss, the trial court found that the landlords were no longer parties in interest, and it required that the insurer be substituted for the landlords as the plaintiff.

That ruling does not appear to have been disturbed on appeal, thus leaving the case as one between the insurer and the tenant. The court treated the insurer as a subrogee, although it is not clear whether there was a subrogation clause in the policy, and, with a rhetorical flourish reminiscent more of lyrical poetry than stodgy equity jurisprudence, characterized subrogation as “begotten of a union between equity and her beloved — the natural justice of placing the burden of bearing a loss where it ought to be.” Id. at 481-82. In that regard, and without citing any authority whatever, the court concluded: ⁷⁰⁷ “Under the facts and circumstances in this record the 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 . That principle, the court added, was 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. at 482 .

Here, the court said, the landlords purchased fire insurance “to protect such interests in the property against loss from fire” and that “the premium paid had to be considered in establishing the rent rate on the rental unit.” Id. From that, the court concluded that “the tenant actually paid the premium as part of the monthly rental.” Id. Based on its own ex cathedra assumption of the “realities of urban apartment and single-family dwelling renting,” the court determined that tenants “rely upon the owner of the dwelling to provide fire protection for the realty (as distinguished from personal property) absent an express agreement otherwise” and that “[bjasic equity and fundamental justice upon which the equitable doctrine of subrogation is established requires 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 agreement to the contrary.” Id. at 482 . Upon that determination, the court held that “[tjhe company affording such coverage should not be allowed to shift a fire loss to an occupying tenant even if the latter negligently caused it.” Id.

(citing New Hampshire Ins. Co., supra, 404 P.2d at 674). As a final comment, the court observed that the failure of the pleadings and the evidence to show that the insurer even had, a right of subrogation against the tenant furnished another reason why it was error to instruct the jury to return a verdict for the insurer unless the tenant proved that he was ⁷⁰⁸ not negligent. With that, the court remanded the case for a new trial. 9 Though the ultimate conclusion in Sutton was based, to some extent, on the court’s perception of the tenant’s expectations under the lease, the case has been treated as establishing at least a presumption, if not a per se rule, that, absent an express agreement in the lease to the contrary, landlord and tenant are co-insureds under a landlord’s fire insurance policy, and, as a result, the insurer has no right of subrogation against the tenant to recover amounts paid on the policy by reason of a fire loss, even if caused by the negligence of the tenant.

Several courts have followed the rigid approach taken by the Oklahoma intermediate appellate court, although not necessarily the rationale for that approach. See DiLullo v. Joseph, 259 Conn. 847 , 792 A.2d 819 (2002); Lexington Ins. Co. v. Raboin, 712 A.2d 1011 (Del.Super.1998); North River Ins. Co. v. Snyder, 804 A.2d 399 (Me.2002); Peterson v. Silva, 428 Mass. 751 , 704 N.E.2d 1163 (1999); United Fire & Cas.

Co. v. Bruggeman, 505 N.W.2d 87 (Minn.App.1993); Tri-Par Investments, L.L.C. v. Sousa, 268 Neb. 119 , 680 N.W.2d 190 (2004); Safeco Ins. Co. v. Capri, 101 Nev. 429 , 705 P.2d 659 (1985); Community Credit Union of New Rockford, N.D. v. Homelvig, 487 N.W.2d 602 (N.D.1992); GNS Partnership v. Fullmer, 873 P.2d 1157 (Utah App.1994); Cascade Trailer Court v. Beeson, 50 WashApp. 678, 749 P.2d 761 (1988). The Oklahoma Supreme Court has acknowledged Sutton but has not yet blessed it. See Travelers Insurance Companies v. Dickey, 799 P.2d 625 (Okla.1990) (distinguishing Sutton and holding that a roofing contractor was not a co-insured under the owner’s policy, notwithstanding a provision in the roofing contract requiring the owner to maintain property insurance). ⁷⁰⁹ Not all of