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How Waivers of Subrogation Can Have Unexpected Consequences for Project Owners
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September 6, 2010
By Stephen Palley
“Subrogation” usually refers to an insurance company’s right to step into the shoes of its insured and sue in the insured’s name to recover money that the insurance company has paid to the insured after a loss. Standard form construction contracts have long included subrogation waivers.
The benefit of these waivers is that they help avoid conflict on construction projects: When parties agree to obtain insurance against losses, usually property-related, the insurers are not permitted to sue project participants for reimbursement. In short, “waivers of subrogation serve in avoiding disruption of construction projects and reducing litigation among parties to complicated construction contracts. “ Lexington Insurance Co. v. Entrex Communication Services, Inc., 275 Neb. 702, 749 N.W.2d 124 (2008).
But, as another court recognized: “The argument against permitting such waivers is that it makes the contractor less vigilant in preventing property damage. Despite this argument, the American Institute of Architects, which drafted the form of waiver in this case, has made ‘strenuous efforts’ to convince courts to enforce such waivers, and Pennsylvania courts have agreed.” St. Paul Fire and Marine Insurance Co. v. Turner Construction Co., 317 Fed.Appx. 219, 2009 WL 738768 (3rd. Cir. 2009), citing 2 Sweet, Sweet on Construction Industry Contracts: Major AIA Documents, §22.04[m] (4th ed. 1999).
Subrogation waivers can have other direct impacts on the parties to the construction contract. On the one hand, parties may be held to have given up their own rights of recovery against their contractual counterparties in circumstances where insurance is not available. On the other hand, without an effective waiver, a party to the construction contract may be subject to suit by the insurer or the counterparty to the contract. Although the concepts may seem dry, the financial stakes can be significant.
The scope of subrogation waivers is frequently litigated. One commonly disputed issued is whether waivers extend to claims for damage other than to “the Work” – i.e., work performed under the construction contract, including damage to adjacent property during or after project completion. How this plays out depends very much on contract language and jurisdiction. Two recent state Supreme Court cases address the issue and reach opposite conclusions, highlighting the importance of carefully reviewing subrogation waivers and insurance policies at the outset of a construction project.
In one case, the Colorado Supreme Court held that a waiver of subrogation did not bar a suit for damage to non-Work property. Copper Mountain v. Industrial Systems, 208 P.3d 692 (Colo. 2009). There, Copper Mountain, a resort owner, contracted for renovations and an addition. Copper Mountain covered the project by obtaining an endorsement to its insurance policy for existing property rather than buying builder’s risk insurance through a stand-alone policy. During construction, a steel subcontractor’s welding operations caused a fire that resulted in significant damage to existing property. Copper Mountain was responsible for a $1 million self-insured retention and sued the general contractor and its subcontractor to recover the $1 million.
The defendants argued that Copper Mountain’s claims were barred by a waiver of subrogation in ¶11.4.5, which waived subrogation rights with respect to adjacent property during construction and with respect to property insurance secured on the completed Project after final payment “for damages caused by fire or other causes of loss covered by this separate property insurance.
The defendants also argued that ¶11.4.7 waived claims with language mutually waiving rights “against each other and any of their subcontractors… for damages caused by fire or other causes of loss to the extent covered by property insurance pursuant to this Paragraph 11.4, or other property insurance applicable to the Work.”
The trial court agreed with the defendants and was affirmed by the Court of Appeals. The Colorado Supreme Court reversed, holding that “the contract [did] not bar Copper’s claims… for damages to property that was not part of the contractual Work, despite the fact that Copper insured the damaged property under an existing policy covering the Work.” 1/
The Supreme Court took note of several contract provisions: ¶1.1.3, defining the Work as “the construction and services required by the Contract Documents, whether completed or partially completed, and… all other labor, materials, equipment, and services provided to or to be provided by the Contractor to fulfill the Contractor’s obligations”; ¶3.3.2, providing that the general contractor would be responsible to the owner “for acts and omissions of [its] employees,” subcontractors and “agents and employees”; ¶10.2.5, requiring the general contractor “to promptly remedy damage and loss (other than damage or loss insured under property insurance required by the Contract Documents)” caused by the contractor or its subcontractors “to the Work, or to other property at or adjacent to the site, such as structures not designated for removal, relocation or replacement during the construction”; ¶11.5, obligating the general contractor to secure insurance to protect it from claims “which may arise out of or result from [contractor’]s operations under the Contract and for which [contractor] may be legally liable… including [c]laims for damages, other than to the Work itself, because of injury to or destruction of tangible property”; ¶11.4.1, requiring Copper to secure all risk builder’s insurance for “the amount of the Initial Contract Sum, plus value of subsequent Contract modifications.”
The court framed the issue as “whether Copper waived its right to sue… for damages to its non-Work property even though Copper insured that property under an existing policy covering Work property.” The court held that neither ¶11.4.5 nor ¶11.4.7 barred non-Work damage claims. The court reasoned that ¶11.4.7 refers to insurance secured for the Work, and, therefore, the waiver did not apply to damages to non-Work.
The court looked to the clauses set out above and reasoned that they provided contextual support for this conclusion. If Copper had waived claims for non-Work, there would be no reason to require the contractor to secure insurance for damage to “other than to the Work itself” as provided in ¶11.5. Similarly, ¶10.2.5’s requirement that the contractor remedy damage to property other than that insured by property insurance also would be meaningless if claims for non-work property were waived. The court observed that it was choosing “a construction of the contract that harmonizes provisions instead of rendering them superfluous. If the intent of the contract were to waive all claims to the non-Work to the extent covered by Copper’s insurance, the contract could have stated this explicitly.”
In the other case, the Nebraska Supreme Court reached the opposite conclusion. Lexington Insurance Co. v. Entrex Communications Services, Inc., supra.
The case arose out of property damage caused by a collapsing television tower. The construction contract contained the same AIA ¶¶11.4.5 and 11.4.7 as in the Copper Mountain case. By the time the case reached the Nebraska Supreme Court, the insured had assigned its claims to its property insurer, Lexington. The trial court had previously ruled: 1) a waiver of subrogation that applied to gross negligence claims was not contrary to public policy; and 2) the owner “had waived all claims covered by its all-risk insurance policies, including damages to the Work and non-Work property.” The Nebraska Supreme Court affirmed.
The court observed a split of authority between what it characterized as a majority and minority approach, citing the following Texas Court of Appeals description:
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One approach makes a distinction between Work (as that word is defined in the contract) and non-Work property and limits the scope of the waiver to damages to the Work; and the second approach draws no distinction between Work and non-Work, but instead, limits the scope of the waiver to the proceeds of the insurance provided under the contract between the owner and contractor.
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The court followed the second approach. It reasoned that this was consistent with ¶11.4.5, which the court concluded applies to non-Work Owner property at or adjacent to the property. “[A]pplying subparagraphs 11.4.5 and 11.4.7, the owner waives damages to both the Work and the non-Work property when the owner obtains two separate policies. We see no reason why the parties would intend a different result when, instead of purchasing two separate policies, the owner relied on one policy covering the Work and the non-Work property as [the Owner] did here.”
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ENDNOTES
| Some of the material in this paper was used in a paper presented at the fall 2010 meeting of the American Bar Association’s Forum on the Construction Industry by the author and Arlan Lewis of Bradley Arant Boult Cummings.
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The Supreme Court accepted the reasoning in Town of Silverton v. Phoenix Heat Source System, Inc., 948 P.2d 9 (Colo.Ct.App. 1997) and looked to precedent from other jurisdictions, including Midwestern Indemnity Co. v. Systems Builders, Inc., 801 N.E.2d 661 (Ind.App. 2004); Fidelity & Guarantee Insurance Co. v. Craig-Wilkinson, Inc., 948 F.Supp. 608 (S.D. Miss. 1996); Butler v. Mitchell-Hugeback, Inc., 895 S.W.2d 15 (Mo. 1995); Public Employees Mutual Insurance Co. v. Sellen Construction Co., 48 Wn.App. 792, 740 P.2d 913 (1987); Travelers Insurance Cos. v. Dickey, 799 P.2d 625 (Okla. 1990). The Supreme Court also noted the contrary authority in cases holding that AIA ¶11.4.7 “bars an owner’s claim for damages to non-Work property to the extent the owner’s insurance policy covering Work also covers the non-Work property”: Trinity Universal Insurance Co. v. Bill Cox Construction, Inc., 75 S.W.3d 6 (Tex.App. 2001); Employers Mutual Casualty Co. v. A.C.C.T., Inc., 580 N.W.2d 490 (Minn. 1998).
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