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Owner Controlled Insurance Program Liability Claims Challenges, Part 8

This is the eighth article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, Part 9, Part 10, and Part 11.

Particular Challenges Of Owner Controlled Insurance Program Claims

Uncovered Damages
Under a typical general liability policy, if a claim presented against an “insured” is partially covered by the policy, the insurance carrier issues a reservation of rights. The reservation of rights letter identifies those claims, causes of action, or damages that are not covered by the policy. The insurance carrier also notifies the insured whether it will defend and whether it will allow the insured to use its choice of counsel in doing so. Significantly, however, where the insurance company does not agree to indemnify the insured for all claims and damages, the insured retains the right to pursue other responsible parties to recover those sums. In the liability Owner Controlled Insurance Program, there are two consequences of reserving rights to deny uncovered claims.

First, in underwriting an Owner Controlled Insurance Program, the insurance company hopes to enjoy cost savings by using a limited number of attorneys to defend the enrolled contractors against claims by the sponsor or by a third party. If the carrier reserves its rights to, however, it is possible, and indeed likely, that the enrolled subcontractor will seek recovery from other enrolled subcontractors under indemnity contracts. The indemnity claims a conflict preventing the retention of a single defense counsel. Second, each enrolled contractor has a right to pursue indemnity claims against other enrolled contractors for covered and uncovered claims.

Therefore, in a complex liability claim presented against the general contractor and/or several subcontractors, the insurance company must recognize early the potential for conflict between the enrolled contractors and the likely value of the uncovered claims.

Post Construction Premises Claims
In numerous Owner Controlled Insurance Programs, the sponsors request products-completed operations coverage for a period of time after construction. Premises liability claims arising after construction of the project create a particular challenge to underwriters attempting to limit their risk to construction-related liability. A typical extension endorsement provides coverage for liability occurring after construction and arising out of the construction. Under California and most states’ laws, the term “arising out of” connotes a minimal causal connection between the liability and the construction activities. Acceptance Insurance Company vs. Syufy Enterprises (1999) 69 Cal.App.4th 321. An additional insured endorsement requiring that liability “arise out of” the subcontractor’s work needs only a minimal causal connection between the subcontractor’s work and the liability of the additional insured to trigger coverage.

In a premises liability claim, the claimant alleges that the ground is slippery, uneven, or otherwise defective. In fact, in order to establish liability against the landowner, the plaintiff must establish that the premise is defective in some fashion. Accordingly, it is very likely that a premises liability claim will at least implicate a products-completed operations tail under an Owner Controlled Insurance Program. In large projects where the owner is self-insured, such as large hotels or public entities, it is likely that the only insurance coverage will be the Owner Controlled Insurance Program. An insurer may not seek contribution from its insured nor may it seek contribution against a carrier with a self-insured retention. (Truck Insurance Exchange vs. Amoco Corporation (1995) 35 Cal.App.4th 814.) Accordingly, notwithstanding that there may be both a “condition” component of the loss as well as a “maintenance” component of the loss, there may be a more significant exposure to the Owner Controlled Insurance Program than the underwriters contemplated.

Owner Controlled Insurance Program Liability Claims Challenges, Part 7

This is the seventh article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 8, Part 9, Part 10, and Part 11.

Liability Defenses Unique To Owner Controlled Insurance Programs

Waiver of Subrogation/Insurance Clauses
In the construction contract, there will be contractual language relating to the procurement of insurance and the operation of the Owner Controlled Insurance Program. In the context of property damage claims for damage occurring to the project itself, those contracts may articulate defenses available to the enrolled contractors. Two of the most important would be the waiver of subrogation clause and the identification of builders risk insurance.

With regard to the waiver of subrogation, the clause would typically find that the owner, as part of procuring the Owner Controlled Insurance Program, would waive its right to subrogation on behalf of the builders risk carrier against the enrolled contractor. Under this scenario, the builders risk carrier could not satisfy a loss on behalf of the contractor for damage occurring during construction, then turn around and sue the subcontractor causing the damage. (See, e.g., Affiliated FM Insurance Co. vs. Patriot Fire Protection, Inc. (2004) 120 WN App. 1039 (Washington).) In that case, Patriot Fire Protection, Inc., installed a fire sprinkler system at the Owner Controlled Insurance Program insured premises. As part of the Owner Controlled Insurance Program, the builders risk policy issued through Affiliated FM Insurance contained a waiver of subrogation clause. In the subcontract agreement, there was a waiver of subrogation granted in favor of the subcontractors by the owner. The court found in this instance that the builders risk carrier had no rights against the enrolled contractors.

A second contractual defense would exist where the owner promises to obtain builders risk coverage in favor of the enrolled contractors with a set deductible. Under that scenario, the enrolled contractor may be able to assert that the owner’s claims against it are limited to amounts which are not covered by the builders risk policy. Such amounts would include the deductible (which is an uninsured loss) stated in the contract would be the amount, which is not covered by the builders risk policy.

While there are no cases that directly address the second point, the issue arises frequently. The enrolled contractors believe that there is builders risk coverage available and that there will be a set amount deductible. Lack of adequate builders risk coverage creates a number of interlocking questions which will have to be clarified through subsequent case law including:

  1. If the owner changes the builders risk program to a higher deductible and/or more narrow coverage, what are its rights against the enrolled contractors who understood that broader coverage was being provided?
  2. Does a waiver of subrogation condition apply to limit the owners’ claims against enrolled contractors for losses not covered by the builders risk policy or which are within the deductible of the builders risk policy?
  3. If the owner chooses not to present a builders risk claim, may it still pursue a liability claim against the enrolled subcontractor; and what is the effect of the waiver of subrogation clause in that event?

To answer these questions under any particular fact setting, we suggest the following will have to be reviewed by the liability underwriters:

  1. The builders risk policy, to see the terms of the waiver of subrogation clause and/or the deductible clause and named insureds under the policy;
  2. The construction contract and Owner Controlled Insurance Program manual to determine whether there was a mutual intent between the enrolled contractors and the owner concerning risk of loss occurring at the job site; and
  3. The marketing and enrollment documentation, to the extent that the relationship between the owner and enrolled contractors concerning insurance and risk of loss were not spelled out in the contract or insurance policy.

Owner’s Waiver By Using Owner Controlled Insurance Program Contractor For Repairs
One of the most problematic claim scenarios that occurs is that of emergency repairs. When there is a large loss that requires immediate repair, there may be insufficient time to document and present a formal insurance claim. The owner will be inclined to use the contractors already mobilized to repair the damage that they just caused.

In some instances, the owner issues a change order to the enrolled contractor for the increased work that they have performed. Assuming that is the case, what is the legal effect of the change order? Is it an acquiescence or agreement by the owner that the contractor was not at fault? Certainly, it would be a strange claim or lawsuit indeed that has the plaintiff (owner) paying the defendant (contractor) to perform work at the job site caused by the contractor’s negligence. In that event, the plaintiff’s damages would be the amount that they already paid the contractor for the work that was done.

A second problem can occur when the enrolled contractor performs the work as requested by the owner, but the owner then refuses payment. Let us assume that the condition is one that is otherwise covered by the policy and one for which the enrolled contractor is liable. Should the carrier assume that the costs incurred by the enrolled contractor are roughly equal to that which would be paid to an outside vendor and adjust the claim accordingly? Alternatively, should the liability carrier view the claim as one for partial payment by the owner? In this scenario, the subcontractor may enjoy a liability defense to the owner’s claim, since the owner acquiesced to any additional work being performed and agreed to pay for it. Simultaneously, there may be no coverage for the owner for this enrolled contractor’s claim because it is one for contractual damages due under the contract.

The topic of emergencies and emergency repairs must be discussed with the sponsor at the time of the policy issuance. If the parties intend that the contractor should mitigate the damages and repair the loss as quickly as possible while reserving all rights under the liability policy, and modifications to the “Voluntary Payments” conditions, the reporting conditions and the like can be designed into the program. Clearly, however, most carriers will not agree to pay uncovered claims and damages as part of the concession.3

3 For example, we think it unlikely that a carrier would agree that the discovery of defective work constitutes such an urgency, assuming such a condition would not otherwise be the liability of a subcontractor and/or be one for covered damages under the policy.

Owner Controlled Insurance Program Liability Claims Challenges, Part 6

This is the sixth article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 7, Part 8, Part 9, Part 10, and Part 11.

Owner Controlled Insurance Programs From The Perspective Of Liability Claims (continued)

C. Voluntary Payments by the Insured, and Right and Duty To Defend

There are two “conditions” to the policy which are particularly relevant to the typical Owner Controlled Insurance Program claims. When property damage claims occur at an Owner Controlled Insurance Program location, there is an added incentive for prompt remedial action on the part of enrolled contractors, as well as the owner. Assuming there is a retention or retrospective premium applicable to the policy, the owner has an immediate concern to rectify problems as soon as they occur. Furthermore, assuming that it is an “operations” type loss, it is typical that the contractors are mobilized performing work at the time the loss occurs. Therefore, there is a built-in incentive to use the contractors that caused the loss to repair the damage.

Take, for example, the situation where there is an accident causing property damage that relates to work performed by a subcontractor. The owner takes control of the loss and hires contractors to remediate the problem. The owner then seeks reimbursement from the Owner Controlled Insurance Program for costs incurred, ostensibly as a claimant against the responsible subcontractor, and separately as an insured facing liability to the third party.

Presenting a claim against the enrolled contractors, while simultaneously using them to repair damage, can create some challenges for the claims department. It can also create friction between the interpretation of the policy as a stand-alone insurance contract and the expectation of the sponsor or owner with regard to reimbursement of costs relating to damage caused by subcontractors.

The liability policy provides that the company has a duty to defend any “insured” in any “suit” seeking covered damages. As to the enrolled subcontractor, therefore, the insurance company has the right to defend that subcontractor and assert liability defenses on that subcontractor’s behalf to defeat liability to the claimant/sponsor of the program. The separation of insureds provision requires the carrier to defend the rights of each insured separately. In contrast to the defense, the carrier’s duty to indemnify that enrolled subcontractor occurs only when liability for damages is assessed against it, at least under California law. Certain Underwriters at Lloyds of London vs. Superior Court (2001) 24 Cal.4th 945. Assertion of these defenses will, however, create friction.2

In addition to pursuing the enrolled contractors, Owner Controlled Insurance Program sponsors/owners also may pursue the insurance company directly, on the theory that what was settled and paid for was a claim by a third party against the owner/sponsor. As a direct claim by the owner/sponsor, in addition to the coverage issues raised above, the following are the critical coverage issues under a liability policy:

  1. Did the owner settle a “claim” and not a “suit” such that the claim by the third party triggered a defense by the insurance company;
  2. As far as indemnity, was the owner/sponsor’s liability to the third party ever finally determined;
  3. To the extent that the owner/sponsor, an insured, agreed to pay any sums or make repairs, it may constitute a violation of the “voluntary payments” condition of the policy.

In one unpublished decision in California, arising out of claimed construction deficiencies at a hotel/casino in Las Vegas, Nevada, the court found that the general contractor was not entitled to indemnity under the Owner Controlled Insurance Program for amounts incurred to make repairs at the request of the owner.

2 Other jurisdictions may require the insurer to be more proactive and require the carrier to try and effect settlement of a claim where liability is clear.

Owner Controlled Insurance Program Liability Claims Challenges, Part 5

This is the fifth article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11.

Owner Controlled Insurance Programs From The Perspective Of Liability Claims (continued)

Covered Damage
The first issue that the carrier and the policyholders must address is whether the loss resulted in “covered damage.” However, with an Owner Controlled Insurance Program, the analysis with regard to the particular insured is critical. There are numerous exclusions in the commercial general liability coverage form that apply differently, depending on whether the named insured enrolled contractor is an owner, general contractor, or subcontractor. The following exclusions illustrate why the policy may provide coverage or not, depending on which insured is seeking coverage:

Expected or Intended Injury Exclusion

This insurance does not apply to:

a) Expected or Intended Injury

“Bodily injury” or “property damage” expected or intended from the standpoint of the insured …

Use of the phrase “the insured” refers to the insured seeking coverage. This phrase is contrasted to an exclusion that applies to an injury which is expected or intended from the standpoint of “an” or “any” insured, which would preclude coverage entirely under the policy if an insured or any insured intended the act. (See, e.g., National Union Fire Insurance Company vs. Lynette C. (1991) 228 Cal.App.3d 1073 — a wife who negligently failed to prevent molestation by her husband was covered; Fire Insurance Exchange vs. Altieri (1991) 235 Cal.App.3d 1352 — parents sued in connection with their son’s arson of a school building.) The phrase “the insured” also is contrasted to exclusions that apply to “you,” which is the named insured. In the context of an Owner Controlled Insurance Program, where virtually every contractor is an insured, particular attention has to be paid to whether the claims of “supervision,” “vicarious liability,” or other non-direct liability could create coverage where the exclusions apply to “the insured.”

For example, in a claim that a contractor’s employee intentionally damaged another contractor’s work, the employee would be an insured, but the exclusion would bar coverage. His employer, assuming it was enrolled, would likely be a named insured; the exclusion would not apply to the employer, or any other enrolled contractor on the project.

Contractual Liability Exclusion
A second example is the contractual liability exclusion, which provides:

This insurance does not apply to: …

b) Contractual Liability

“Bodily injury” or “property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages: …

(2) Assumed in a contract or agreement that is an “insured contract” …

The typical construction project contains indemnity flowing uphill in favor of the owner and general contractor. The liability of the owner or general contractor is generally passed down to the lowest level subcontractor.

Under contractual liability coverage, the Owner Controlled Insurance Program assumes every enrolled contractor’s indemnity obligations upward to the general contractor and owner. Contractual liability coverage allows owners/sponsors to settle claims with third parties and seek recovery from responsible subcontractors under the indemnity agreement. Thus, the insurance company must be mindful that any enrolled contractor may be both an insured as well as a claimant against the downhill subcontractors for any uncovered damages.

Damage to Project Work
The next series of exclusions are those dealing with damage to the work which is the subject of the Owner Controlled Insurance Program:

This insurance does not apply to: …

j. Damage to Property

“Property Damage”

1) Property you own, rent or occupy; …

4) Personal property in the care, custody or control of the insured;

5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf or performing operations, if the “property damage” arises out of those operations; or

6) That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.

Paragraph 6 of this exclusion does not apply to “property damage” included in the “Products-Completed Operations Hazard.”

k. Damage to Your Product

“Property Damage” to “your product” arising out of it or any part of it.

l. Damage to Your Work

“Property Damage” to “your work” arising out of it or any part of it, and included in the “Products-Completed Operations Hazard.”

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.1

With regard to property damage claims arising out of “operations” (as distinct from “completed operations”), Exclusion “j.” is critical. In light of the “separation of insureds” condition, Exclusion j(1) would exclude coverage to the program sponsor for damages occurring to the construction project itself. (Assuming the sponsor is the owner.)

Exclusions j(5) and j(6) preclude coverage for damage to the construction project, but not entirely. Viewing the construction project from the standpoint of a general contractor, the entire project is “real property” on which the named insured (defined alternatively as “you”) or its subcontractors are performing operations. As to the owner or general contractor, virtually any damage would be excluded if it is within the basic scope of the construction project and the project is not completed.

However, each enrolled contractor must be viewed separately. If there is an allegation of damage caused by a subcontractor to work other than its own, this exclusion would not bar coverage. An example would be a residential developer with an Owner Controlled Insurance Program covering its projects that experiences a fire at a home under construction caused by the negligence of the roofer. As to the owner/developer, exclusion j. precludes coverage entirely. As to the roofer, exclusion j. only precludes coverage for damage to the roofer’s own work, but not resulting property damage caused by the roofer, i.e., the burned down home.

This scenario constitutes the primary overlap with builders risk coverage. The owner/ general contractor may pursue a subcontractor for negligence arising out of performance of work under its contract, and the subcontractor’s liability will be covered by the Owner Controlled Insurance Program. This gap presents an exposure to the liability Owner Controlled Insurance Program insurer for the builders risk deductible (since the amount is not covered by builders risk insurance).

This scenario also illustrates that for owners or insurance companies, the proper analysis is to review any “operations” loss — those that occur while the project is under construction — first from the perspective of the responsible contractor (from the bottom up) rather than from the perspective of the owner (from the top down).

1 The terms “you” and “your” refer to the named insured, not to anyone qualifying as an insured.

Owner Controlled Insurance Program Liability Claims Challenges, Part 3

This is the third article in an 11-part series on Owner Controlled Insurance Programs. Preceding and subsequent articles in this series can be found here: Part 1, Part 2, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, and Part 11.

Liability Owner Controlled Insurance Program From The Underwriting Perspective (continued)

Who Qualifies as Named Insureds?
Deciding who qualifies as an insured has a great impact on what risks are ultimately assumed. Does the policy apply to damage caused by contractors at the project; does it include material suppliers; does the program cover design liability, including reworking portions of the project that do not meet the intended strength and stability requirements? Deciding who is not an insured is also important. Any party that is not a part of the Owner Controlled Insurance Program is a source of recovery or offset to a loss covered by the Owner Controlled Insurance Program.

There is a distinction in the policies, discussed in more detail below, between a “named insured” and an “insured.” The rights of the contractor and the application of the policy may be very different if each contractor is a “named insured” or an “insured.”

Liability Insurance Protects the Contractor, Not the Owner Presenting a Claim
The purchaser of the Owner Controlled Insurance Program is the owner. However, the “insured” under a wrap-up policy that is entitled to defense and indemnity is the contractor. There is a natural tension between the owner who wishes to purchase complete protection for himself and the contractors, who are entitled to that protection. Under a liability policy, the carrier defends the insured (each contractor) against claims by others (i.e., the owner) for bodily injury or property damage. Thus, in providing liability coverage, the owner is assuring that the contractor can defend himself and that he has the financial ability to pay the claims.

Since the policy covers the contractors, who are entitled to be “defended” against covered claims, the investigation must be conducted on behalf of the “insured,” and all privileges maintained. Accordingly, a liability investigation would be conducted on the part of the contractor, not the owner; absent an agreement to the contrary, the owner is not entitled to any reports on the investigation. In some cases, there is a claim for damage to a portion of the building under construction. In that case, the owner will want that damage repaired and will point to the Owner Controlled Insurance Program, as carrier for the contractors, to do so. It may ask the carrier for the status of the investigation, including the results of any testing that has occurred. However, no liability insurer wants to be accused of waiving its insured’s privileges by sharing the reports of investigation with the plaintiff, who is in that case the owner of the project. Therefore, the carrier must be very careful to guard those privileges while promptly handling the claim and in making sure the owner of the project understands this relationship at the outset.

Do the Owner Controlled Insurance Program Coverages Work Together?
The broker and underwriter need to address the unintended consequences of insuring all parties on the project, while assuring that the endorsements to the liability policy are consistent with the underwriting intent. By way of example, the typical Owner Controlled Insurance Program may contain builders risk, workers compensation, and general liability/umbrella coverage. Here are a few examples of overlapping coverage:

  1. The workers compensation claim by an employee of a subcontractor and a “third party” liability claim by that same employee against the general contractor or another subcontractor (overlapping workers compensation and general liability);
  2. A builders risk claim by the owner for damage to the structure caused during construction and a liability claim against the subcontractor who caused the damage in the first instance (overlapping builders risk and general liability); and
  3. An alleged poor design causes a “loss of use” claim because an affected business is shut down after construction; for example, due to a redirected street. This claim may generate an eminent domain lawsuit (overlapping design E&O and general liability).

The decisions concerning the basic scope of coverage and the overlap with other policies, to the extent they can be anticipated by underwriters, need to be addressed in the policy contracts.