For The Client: The Pros and Cons of Waving Subrogation

 

October 2012

COMMUNITIES: PRIVATE PRACTICE
For The Client: The Pros and Cons of Waving Subrogation

BY KEVIN R. SIDO

KEVIN R. SIDOProperty insurance covers accidental and fortuitous events, such as fires and storms. The risk of financial loss from damage caused by accidental events is transferred by the purchase of insurance to the insurance carrier, which is compensated by a premium for undertaking the risk. During the construction process, a particular form of such property insurance is builders risk coverage.
 
In the event of an accidental loss, the policyholder (whether owner, contractor, or design professional) is compensated for its loss and made whole by the builders risk coverage. Insurance companies may wish to step into the shoes of its insured (e.g., the general contractor) and sue in the name of that insured someone else (e.g., owner) thought to be responsible. That is "subrogation," a legal term meaning that an insurer that has paid its insured succeeds to the rights of its insured against others who may have negligently caused the loss. Subrogation is a common concept in property insurance. Apart from deductibles, if the subrogation action is successful the insurer need not and does not share its own proceeds with its insured who, by definition, has already been reimbursed. Nonetheless, if the insurer elects to pursue a subrogation action, the insured must cooperate by contributing the time and effort of its employee witnesses.
 
Once sued by the insurance carrier in the name of the policyholder, the defendant may retaliate with a counterclaim against the policyholder/insured. In that event, the property carrier is not likely to have any obligation to defend the policyholder. Good working relations developed during the construction project can be shattered by the arrival of the subrogation lawsuit.
 
For these reasons and more, the industry favors waiver of subrogation provisions to prevent divisive lawsuits whose sole purpose is to repay the carrier, which was already paid a premium to accept the risk in the first place. Waivers of subrogation do not prevent an owner's action for breach of contract against a contractor or design professional, allegedly at fault. The waiver applies only to the extent insurance was purchased and covers the loss. The waiver simply does not apply to those matters not covered by insurance.
 
Standard contract documents from the American Institute of Architects and the Engineers Joint Contract Documents Committee call for owners, contractors, and design professionals to waive their property insurers' rights of subrogation. For example, the Standard General Conditions of the Construction Contract, 5.07 (EJCDC C-700 (2007 ed.)) states:

 
Construction siteOwner and Contractor intend that all policies purchased in accordance with Paragraph 5.06 will protect Owner, Contractor, Subcontractors, and Engineer, and all other[s]...identified in the Supplementary Conditions as loss payees...in such policies and will provide primary coverage for all losses and damages caused by the perils or causes of loss covered thereby. All such policies shall contain provisions to the effect that in the event of payment of any loss or damage the insurers will have no rights of recovery against any of the insureds or loss payees thereunder. Owner and Contractor waive all rights against each other and their respective...consultants and subcontractors of each and any of them for all losses and damages caused by, arising out of or resulting from any of the perils or causes of loss covered by such policies and any other property insurance applicable to the Work; and, in addition, waive all such rights against Subcontractors and Engineer, and all other...loss payees.... [emphasis added]
 
The effect of such clauses is that the property insurers of the owner, engineer, and contractor are barred from pursuing actions in the name of their insured against other parties at the construction site.
 
The waiver of subrogation rights contemplated by the standard contract documents is intended to apply to acts occurring during the construction process. Given certain wording, the waiver may survive the completion of construction. It also may bar claims by the property insurer once the project is in use, the waiver being effective through the running of the applicable statute of limitations or statute of repose. Some owners realize the benefits of harmonious relations with their consultant engineers and provide a waiver for all claims that might arise after construction, to the extent insurance is available.
 
When parties coordinate their property insurance and share in the premiums paid to transfer the loss, a win-win situation results. Courts have long since generally recognized that waivers of subrogation are valid and well-reasoned to promote job-site harmony. The construction industry, through consensus contract clauses, supports that view.
 
Kevin R. Sido is a partner in the Chicago office of Hinshaw and Culbertson, a firm with 24 offices throughout the United States. He has an active practice in construction law, representing design professionals in litigation, contracts, and related matters.