New Developments in Insurance Coverage

New Developments in Insurance Coverage

May 1, 2005

By Dean B. Thomson

Introduction

Not only is the price of Commercial General Liability (CGL) insurance in flux, but so also is the coverage actually available. One of the unique but common features of construction contracts is a complicated indemnity provision followed by the requirement that the indemnitor procure insurance covering the indemnity agreement. Everyone in the industry should know, however, that the ability of the indemnitor to obtain insurance insuring its indemnity obligation has become more difficult due to recent changes in the coverage offered under the standard Insurance Services Organization’s (ISO) standard CGL policy. This briefing paper will review the changes that the ISO made to its 2004 forms that affect indemnity coverage and then conclude by discussing two cases that significantly expanded CGL insurance coverage.

Insuring the Indemnity

Most construction contracts contain an indemnity obligation requiring one contracting party (the indemnitor) to assume the liabilities of the other contracting party (the indemnitee) in the event of a claim brought by a third party. Traditionally, indemnity agreements have been placed into one of three categories depending on the degree to which the indemnitor assumes liability for the negligence of the indemnitee. See Contractual Risk Transfer, IV.D.1 (IRMI 2005).

For example, there are “limited form” indemnity agreements in which the indemnitor only agrees to indemnify the indemnitee to the extent of the indemnitor’s fault. This type of indemnification agreement simply memorializes the liability that the common law would impose on the indemnitor without a contract. The “intermediate form” of indemnification agreement expands the indemnitor’s obligation to cover the independent negligence or fault of the indemnitee as long as the indemnitee was not solely at fault for the damages. In other words, if the indemnitor was at fault for any of the damages, the indemnitor must pay for all of the damages, even if some were caused by the independent fault of the indemnitee. The third category of indemnity is the “broad form” agreement in which the indemnitor agrees to indemnify the indemnitee even if the indemnitee is solely responsible for the damages. Id.

No matter what type of indemnity is contained in the construction contract, it is invariably accompanied by an obligation that the indemnitor procure insurance covering the scope of the promised indemnity. Those requesting indemnity know that the promise is only as good as the financial health of the indemnitor, so they want insurance coverage to better secure that the indemnity can be meaningfully performed. In addition, Minnesota as well as approximately 40 other states have statutes prohibiting to varying degrees intermediate or broad form indemnity agreements unless the indemnitor can procure insurance covering the indemnity. See e.g. Minn. Stat. § 337.01-.05. As a result, it is important for indemnitees – and especially indemnitors – to know whether they have CGL insurance covering the scope of the requested indemnity.

There are two main routes by which CGL coverage for indemnity agreements can be found or created in a CGL policy. The first route is to list the indemnitee as an additional insured under the indemnitor’s CGL policy, which effectively allows the indemnitee to benefit from whatever coverage the indemnitor may have under its policy. The second route is for the indemnitor to seek coverage for its contractual indemnity promise under the contractual liability coverage in its CGL policy. Unfortunately, the 2004 changes to the ISO policies made insurance coverage under either route more difficult to obtain.

For example, the 2001 ISO policy defined a contract that would be covered under the CGL’s contractual liability coverage as “a contract under which you [the insured] assume the tort liability of another party.” The 2004 policy, however, redefines the definition of an insured contract to cover only a contract “under which you assume the tort liability of another party…provided the ‘bodily injury’ or ‘property damage’ is caused in whole or in part by you…” The clear intent of the 2004 change is to exclude coverage for broad form indemnity agreements (i.e., those that indemnify the indemnitee for its sole negligence). A similar 2004 change was made to the additional insured endorsement available through ISO. The 2004 additional insured endorsement makes two important changes. First, it attempts to limit coverage for broad form indemnity agreements. Second, it limits coverage to ongoing operations and excludes completed operations. Therefore, if you want to purchase ongoing as well as completed operations coverage for additional insureds, you must purchase two separate endorsements.

The end result of the recent changes to the ISO forms is that insurance coverage for broad form indemnification agreements may no longer be available. In addition, if you thought that you had or were providing completed operations coverage under an Additional Insured endorsement, you may want to investigate your assumption further.

Whether or not promised insurance coverage actually exists can be vitally important. For example, under Minnesota law, an indemnity agreement promising to hold the indemnitee harmless from its own negligence is unenforceable, but promises to procure insurance are enforceable. See Minn. Stat. § 337.04. If someone promises to procure insurance for a broad form indemnity and that coverage is no longer available, then the promisor is still liable to the extent of its contractual promise to procure the promised insurance. In other words, the indemnitor in effect becomes the insurer if the promised insurance coverage does not exist. Therefore, it is essential to know the scope of the requested indemnity and whether there is insurance coverage for it. If there is no coverage for the requested indemnity, the indemnitor must (i) advise the indemnitee of that fact before the contract is signed or (ii) sign the contract subject to a written exception for the available insurance. If no such notice or reservation is given, the indemnitor will be liable for the promise to procure the requested insurance irrespective of whether the insurance exists.

Recent Cases

Although certain types of CGL coverages may appear to be shrinking, two recent court decisions have expanded CGL coverage to its originally intended scope.

In Westfield Insurance Company v. Kroiss, et al., 2005 WL 757879 (Minn. Ct. App., April 5, 2004 ), the Minnesota Court of Appeals held that the insurer’s duty to defend a claim is broader than its indemnity obligations under the policy. According to the court, the “duty to defend a claim against an insured arises when any part of the claim is ‘arguably’ within the scope of the policy’s coverage.” Many claims are “arguably” covered by the policy, and it is not known whether they “actually” are covered until the facts are finally determined at trial. The court ruled that if there are disputed factual issues that need to be determined before a coverage decision can be made, then the insurer owes a defense until those issues are resolved at trial. The implications of this decision are far reaching. Insurers can no longer refuse to accept a tender of defense due to factual determinations that the insurers make against coverage. The Kroiss case holds that the insurers owe a defense until those disputed factual issues are determined by a court, not the insurer.

In Westfield Insurance Company v. Weis Builders, Inc., et al., 2004 WL 163087 (D. Minn. 2004) (Hon. Joan N. Ericksen), the insurer accepted the contractor’s tender of defense, but denied all but $36,000 of a multi-million dollar claim. The Owner alleged that the interior courtyards of several buildings leaked causing interior property damage of $36,000. Much more significantly, however, the Owner also alleged that water damage caused by construction errors resulted in diminution in property value of over $10 million and future repair costs exceeding $7 million. Relying on many prior cases that held that coverage was unavailable for claims for either diminution in value or the cost of repairs, the insurer argued that it was only liable for the $36,000 of property damage. On behalf of the Contractor, this law firm argued that the Contractor was entitled to coverage for the Owner’s entire claim because the policy’s insuring clause provided coverage not just for “property damage” but for “damages because of ‘property damage’.”

The U.S. District Court for Minnesota agreed with the contractor and held that as long as there was actual property damage, even as little as $36,000, the insured contractor was entitled to recover for all consequences “because of” that property damage. Even though diminution in property value by itself may not be covered “property damage” under the policy, diminution in property value can serve as a measure of “property damage” and in that sense is recoverable. This case serves as a powerful antidote to insurers who deny coverage whenever the terms “diminution in value” or “cost of repair” are stated in the claim.

Conclusion

Indemnity agreements and insurance coverages are the basis of any risk management program. Given the shifting language in CGL policies and the constant stream of cases interpreting those policies, it is difficult to know what protections you actually have. We would be pleased to review your coverages with both you and your insurance advisor.

This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T

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