September  22, 2000

Bulletin # 40: Insurance Requirements and Subrogation Rights

ZZZ Sheet Metal prided itself on the quality of its organization. Among other things, it had built an experienced front office staff to support the construction operation. Under the direction of an administrator with twenty-five years of experience, the office almost seemed to run itself. Therefore, ZZZ management was not particularly distressed when the office administrator indicated that she was retiring. After a brief search, the firm hired a new administrator who had worked as an office manager for a cell phone marketing company in her five years since college. It looked like a perfect fit.

The new employee proved energetic and eager, although her lack of knowledge of the construction industry was somewhat troubling. However, the contracts kept moving, paperwork was signed, and the jobs continued to roll in. ZZZ seemed to have survived the transition in good order.

Unfortunately, there was a problem. In one of the first contracts the new administrator had reviewed and approved, there was language tucked away under the “Insurance” section that stated: “All property insurance policies obtained by the Contractor shall specifically provide for a waiver of subrogation in favor of the Owner and any other contractors, subcontractors, sub-subcontractors, agents or employees, as well as the Architect, for damages caused by fire or other perils to the extent coverage would be available under property insurance meeting the requirements of this provision.”

Almost immediately after taking the job, the new administrator had transitioned the firm’s insurance business from the long-time agent for ZZZ to a friend who sold personal and business insurance at another firm. As to the particular job, the administrator simply requested “standard construction insurance.” The administrator did not provide the agent with the section of the contract applicable to insurance, and did not carefully review the certificate of insurance when it was issued.

Among other things, the administrator did not realize that the property insurance she had purchased did not provide for a waiver of subrogation as required by the construction contract. The policy coverage was also defective in several other respects.

As an example, the coverage specifically excluded the cost of debris removal or demolition upon the occurrence of a casualty. To the administrator, the certificate of insurance and the underlying policy were just more pieces of paper that had to be circulated and put in the file in order for the crew to start work.

Several months into the project, a fire struck the site. ZZZ’s work was damaged, along with the work of numerous other contractors and subcontractors. One whole wing of the project required demolition and reconstruction. Major repair work would be required for the rest of the project. While the origin of the fire was not absolutely clear, the likely source was a generator placed on the site by another contractor that apparently ignited a pile of construction debris left by the contractor. The owner and all of the contractors and subcontractors notified their insurance companies and prepared for the reconstruction process.

Ten days after the insurance carriers were notified, the first signs of a problem began to emerge. ZZZ’s carrier denied coverage for the cost of demolition and removal of the contractor’s work in place, pointing to the policy exclusion. In addition, the carrier insisted that it be subrogated to the rights of ZZZ to pursue an action for any amounts it paid under the ZZZ policy against the contractor that had supplied the generator, the owner, and the construction manager. When the ZZZ insurance carrier notified the other parties of its intent to exercise subrogation rights against them, the construction manager contacted ZZZ, and notified the firm that defects in its insurance coverage had placed ZZZ in breach of its contract. To the extent that other contractors, the construction manager, or the owner were required to pay any amount to ZZZ’s insurance carrier, the construction manager would be seeking reimbursement from ZZZ for that amount, as well as for all of the costs incurred in contesting the claim. A construction site catastrophe had become a legal debacle for the firm. The failure to pay careful attention to the insurance requirements under the contract would ultimately cost the firm (in a settlement several years later) more than the profit ZZZ could ever have earned on the job.

There are a number of aspects as to insurance coverage that can trip up a contractor. In addition, defects in insurance coverage tend to become apparent only when a casualty has occurred. There are few surprises less welcome for a contractor than learning it is uninsured when a claim arises. The existence of a subrogation issue comes in a close second. Subrogation is a legal concept under which a party (usually the insurance carrier) obtains rights against a third party by virtue of its payment of a claim to its insured. For example, if a third party crashes a truck into the insured’s building, the insurer may pay to fix the building and be subrogated to the rights of the building owner against the trucking firm for reimbursement of the repair costs. At the end of the day, the insured gets its repairs paid, the insurance company is made whole, and the responsible party (the trucking firm) ends up paying for the damage. That certainly seems a sensible outcome under most circumstances. Unfortunately, the impact of subrogation rights in a construction context is very different. With multiple parties, multiple insurance carriers and potentially vast damages, the existence of subrogation rights can very easily destroy the entire risk allocation structure that is a crucial part of a successful project. Carriers may pay their claims to their insured, but their exercise of subrogation rights would inevitably trigger lengthy and expensive litigation among the insurance carriers and the insured as they sought reimbursement from each other. Carriers forced to reimburse other carriers or other parties might then seek to be made whole by their insured, asserting that the insured had some responsibility for the casualty. As insurers and insured are pitted against one another, an entire project can be placed at risk.

On the other hand, with waivers of subrogation in place, each insurer acknowledges that it will pay claims to its insured without recourse to any subrogation rights that might otherwise exist. This permits each party with property insurance coverage to be paid for the damage to its property without triggering a free-for-all among the insurance carriers. Waivers of subrogation permit the property insurance coverages to work as the parties intend. Almost all construction contracts contain waiver of subrogation language, since such waivers generally serve the interests of both parties to the contract. In some jurisdictions, the presence of the waiver of subrogation language in the contract will be binding upon the insurers providing the coverage. Some insurance carriers also routinely incorporate waiver of subrogation provisions into property insurance policies for construction. However, the prudent contractor should never assume that a waiver of subrogation applies unless it has written confirmation (which may include a specific endorsement to its insurance policy) that the waiver of subrogation provision is provided for in the policy.

Lengthy books exist on liability and property insurance in a construction context, and it is well beyond the scope of this Contract Bulletin to review all of the intricacies of such insurance coverage. However, there are two steps that any contractor can take to significantly reduce its insurance-related risks:

1. Know your agent and make certain that your agent is knowledgeable and experienced in working with the construction industry.

2. Always send your agent all sections of the contract dealing with insurance and indemnification at the time you request insurance coverage for the project, and obtain written confirmation that the coverage provided meets the contract requirements.


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