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How Insurance, Contracts Can Protect General Contractors from Liability Caused by Subs
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April 6, 2009
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(This article first appeared in the spring 2008 edition of The Brief, published by the American Bar Association, and was reprinted in the “Best of ABA Sections” issue of ABA’s GPSolo Magazine in September 2008.)
By Andrew M. Reidy and Seth Lamden
Howrey LLP
General contractors sometimes face liability for the acts of their subcontractors. The most common ways to protect general contractors from liability are by indemnification agreements with subcontractors and with additional insured endorsements to subcontractors’ liability insurance. The general contractor is best-protected against third-party liability claims if it has both types of protection. This article examines issues relating to contractual indemnification and to additional insured status for general contractors.
The Limits of Contractual Indemnification
Nearly every construction subcontract contains an obligation requiring the subcontractor to indemnify the general contractor for liability stemming from the subcontractor’s acts or omissions. The indemnity obligation typically covers settlements, judgments and defense costs. For example, the subcontractor and general contractor might agree to the following provision in their subcontract:
Subcontractor shall indemnify and hold harmless General Contractor and all of its agents and employees from and against all claims, damages, losses, and expenses, including all defense costs, attributable to bodily injury or to injury to or destruction of tangible property caused in whole or in part by any negligent act or omission by Subcontractor.
Although this type of contractual indemnification provision is common, it may give only limited protection to a general contractor. For example, it will not apply to a claim in which the general contractor was solely negligent or to a claim if there is no negligence by the subcontractor. Further, a general contractor’s failure to give timely notice of a claim to the subcontractor could result in the general contractor losing its right to indemnity. 1/
State statutes also may limit a general contractor’s ability to be indemnified. Most states have some type of “anti-indemnity” statute that prohibits one party from indemnifying another party for that other party’s own negligence in certain types of contracts, including construction contracts. For example, Mississippi law provides:
With respect to all public or private contracts or agreements, for the construction, alteration, repair or maintenance of buildings, structures, highway bridges, viaducts, water, sewer or gas distribution systems, or other work dealing with construction, or for any moving, demolition or excavation connected therewith, every covenant, promise and/or agreement contained therein to indemnify or hold harmless another person from that person’s own negligence is void as against public policy and wholly unenforceable.
This section does not apply to construction bonds or insurance contracts or agreements. 2/
Thus, if a general contractor is sued for both its own negligence and the negligence of its subcontractor, an anti-indemnity statute might limit or destroy any contractual indemnity obligation of the subcontractor. When there is no “anti-indemnity” statute or when the contract does not fall within the scope of the anti-indemnity statute, most states will enforce contracts of indemnity that include protection against one’s own negligence. 3/
Even if a claim falls within the contract’s indemnity clause, it may not provide immediate protection for the general contractor. Depending on the language of the indemnity agreement – which rarely specifies exactly when the indemnity obligation arises – a general contractor’s right to indemnification for defense costs could arise at the time a claim is brought or only when there is a judgment or settlement in the underlying action. 4/ In many situations, a general contractor often ends up paying for its own defense and for any settlement or judgment and then pursuing reimbursement from the subcontractor.
Finally, a contractual indemnification provision is only useful if the party providing indemnification is solvent. Many subcontractors are not financially stable, and either may fail to provide indemnity or attempt to negotiate paying for something less than the full indemnification called for in the contract. If the subcontractor refuses to honor its indemnification obligations, the general contractor must incur attorney fees to sue the subcontractor for breach of the indemnity agreement, and depending on the applicable law, these costs may or may not be recoverable.
Naming the General Contractor as an Additional Insured
Because of the problems that arise in connection with enforcing contractual indemnity provisions, many general contractors require the subcontractor to add the general contractor to the subcontractor’s commercial general liability (CGL) insurance policy as an additional insured. 5/ This not only avoids the possibility that a general contractor will have to incur significant attorney fees defending itself and/or pursing indemnity but allows the general contractor to be defended and indemnified by an insurer other than its own. Ultimately, this saves the general contractor from paying increased insurance premiums.
Additional insured endorsements vary in the scope of coverage they provide. Nevertheless, additional insured coverage is valuable to a general contractor, and an indemnification agreement should not be considered to be a substitute for this type of coverage.
Some older versions of additional insured endorsements provide coverage to the additional insured to the extent that the claim arises out of the named insured’s work or product. 6/ Courts have found that the scope of coverage provided by the term “arising out of” is broad. 7/ In general, “arising out of” requires only some sort of causal relationship between the named insured’s work and the additional insured’s liability. 8/ Although “arising out of” relates to causation, some courts have held that it does not rise to the level of proximate cause. 9/ Consequently, to the extent that a claim against a general contractor involves the work of a subcontractor, the general contractor should be entitled to a defense as an additional insured. Given the breadth of the phrase “arising out of,” additional insured coverage provided by such an endorsement should include coverage for claims for which the additional insured is solely negligent.
The 2004 version of the Insurance Services Office (ISO) additional insured endorsement also provides broad coverage. It provides as follows:
A. Section II—Who Is An Insured is amended to include as an additional insured the person(s) or organization(s) shown in the Schedule, but only with respect to liability for “bodily injury,” “property damage” or “personal and advertising injury” caused, in whole or in part, by:
| 1. | Your acts or omissions; or
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| 2. | The acts or omissions of those acting on your behalf;
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in the performance of your ongoing operations for the additional insured(s) at the location(s) designated above. 10/
Under this endorsement, additional insureds may have coverage for direct and vicarious liability. There is nothing in the endorsement that requires that the named insured be negligent as a prerequisite to coverage for the additional insured. Rather, the additional insured is entitled to coverage if the named insured’s “acts or omissions” cause, “in whole or in part,” the additional insured’s liability.
When an injured party sues the general contractor for bodily injury or property damage caused by the subcontractor’s work, the general contractor should give notice of the lawsuit to its own CGL insurer, the subcontractor and the subcontractor’s insurer. Notice to each of these entities will avoid any arguments about forfeiture of insurance coverage or of rights of contractual indemnification due to late notice. Typically, in the first instance, the general contractor will pursue coverage under the subcontractor’s policy. 11/ If the subcontractor’s insurer denies coverage, the insurer actually may increase its liability, as the insurer may become liable for both the general contractor’s defense and indemnity costs in connection with the underlying tort action and also for the subcontractor’s defense costs in the indemnity action.
One obvious limitation on the scope of additional insured coverage is the policy limits. Generally, the additional insured shares policy limits with other insureds on the policy, and an insurer must treat all insureds equally. Sometimes an insurer is faced with the dilemma of whether it can exhaust remaining policy limits to settle a matter for one insured without violating its duties to other insureds. The cases involving situations in which an insurer exhausts policy limits for some, but not all, insureds arise under a wide variety of factual contexts. Many courts have addressed whether exhausting limits for the benefit of some of the insureds is bad faith. For example, some courts have held that an insurer can be liable for bad faith if it settles for remaining policy limits on behalf of one insured and withdraws its defense of an additional insured without also obtaining a release for the additional insured. 12/ Other courts, however, have found that it is not improper for an insurer to settle on behalf of one insured and to terminate its defense obligations to other insureds. 13/
CGL Insurer’s Duty to Defend
An issue that frequently arises is whether a subcontractor’s CGL insurer must defend the general contractor who is not an insured but has an indemnification agreement with the subcontractor. There are two independent ways a general contractor may be entitled to a defense in this situation.
First, in some CGL policies, if the indemnitee (i.e., the general contractor) is entitled to a defense from the subcontractor under the indemnification agreement and if the claim against the general contractor involves liability covered by the insurance policy, the subcontractor’s CGL insurer must pay for the defense of the indemnitee general contractor. In this situation, the defense costs may be treated as “damages” and, therefore, may be subject to the policy limits. Thus, this alternative is not as desirable for a general contractor as a defense as an additional insured, which would not deplete policy limits.
Second, the indemnitee general contractor may be entitled to a defense pursuant to the “supplementary payments” section of the CGL policy if a number of conditions are satisfied. 14/ These conditions include:
| 1. | Both the indemnitee and the indemnitor are defendants in the third-party lawsuit;
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| 2. | The third-party lawsuit seeks damages for which the insured has assumed the liability of the indemnitee in an “insured contract”;
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| 3. | The liability assumed by contract is for damages for property damage or bodily injury caused by an occurrence that is not excluded by any policy exclusion;
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| 4. | The indemnitor has assumed the indemnitee’s costs of defense in the insured contract;
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| 5. | There is no conflict between the interests of the indemnitor and the indemnitee in the lawsuit;
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| 6. | Both the indemnitee and the indemnitor ask the insurer to conduct and control the defense and consent to the same counsel defending both parties;
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| 7. | The indemnitee agrees in writing to cooperate with the insurer; and
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| 8. | The indemnitee agrees in writing to notify any other insurer whose coverage is available to the indemnitee.
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Although a defense under this section requires the insurer to pay for the defense without depleting policy limits, from the perspective of the indemnitee general contractor, this type of defense may not be desirable because, among other things, the indemnitee may not want to cede control of its defense to the insurer.
Covering a General Contractor’s Indemnity Claim
The insuring agreement of a standard CGL policy obligates the insurer to provide coverage for “all sums that the insured shall become legally obligated to pay as damages because of bodily injury or property damage… caused by an occurrence.” 15/ A lawsuit by a general contractor for indemnification may fall within coverage because the term “damages” has been construed to include an indemnification obligation. 16/ Therefore, a subcontractor’s liability insurance might cover such a claim.
Because of the breadth of the insuring agreement described above, insurers attempt to limit their liability for certain contractual liabilities. For example, exclusion (b) in some CGL policy forms eliminates coverage for “ ‘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.” 17/ Some coverage for contractual liability – including agreements to indemnify or hold harmless – remains. However, because the exclusion contains an exception that restores coverage, among other things, for liability assumed in an “insured contract.” 18/ “Insured contract” is defined to mean “[t]hat part of any other contract or agreement pertaining to your business… under which you assume the tort liability of another party to pay for ‘bodily injury’ or ‘property damage’ to a third person or organization.” 19/ Thus, any contract under which the insured expressly assumes the tort liability of another – including an indemnity agreement – can be an “insured contract.” 20/
The policy defines “tort liability” to mean “a liability that would be imposed by law in the absence of any contract or agreement.” 21/ Although there is nothing in the definition of “tort liability” that limits it solely to negligence claims, some courts have construed the definition of “tort liability” to mean only negligence. For example, in Hankins v. Pekin Insurance Co., 22/ the court held that the term “tort liability” in the context of an insured contract is limited to negligence and ruled that the insured contract exception did not apply to cover an indemnity agreement in which the indemnitor did not agree to indemnify the indemnitee for its own negligence. 23/
Other courts have recognized that the term “tort liability” in this context is not limited to negligence and can include vicarious liability. 24/ When claims are made against an indemnitor that include both tort liability and non-tort liability, the court may elect to wait until the case is settled or a judgment is entered before it will rule as to whether the liability is covered. 25/
Conclusion
When a general contractor hires a subcontractor, the general contractor wants assurances that it will not be held liable for the negligence of the subcontractor. The general contractor also wants assurances that it will not have to spend its own money to defend claims arising out of the negligence of the subcontractor.
There are several ways for a general contractor to ensure that it has comprehensive protection from such risk. It is important that a general contractor negotiate indemnity agreements with its subcontractors that are specific and enforceable under the law of the state that governs the contract. It also is important that the general contractor negotiate (and enforce) insurance specifications by which the subcontractor names the general contractor as an additional insured and procures liability coverage that is broad enough (and has sufficient limits) to cover the subcontractor’s indemnity obligations pursuant to the insured contract.
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For more information about the issues covered in this report, please contact Andrew Reidy in our Washington, D.C., at 202-383-7485 or at reidya@howrey.com; Seth Lamden in our Chicago office at 312-846-5677 or at lamdens@howrey.com; or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
ENDNOTES
| 1. | See, Kreckel v. Walbridge Aldinger Co., 721 N.W.2d 508 (Wis. App. 2006).
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| 2. | See, Mississippi Code Annotated §31-5-41 (2008).
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| 3. | See, e.g., Avalos v. Pulte Home Corp., No. 04 C 7092, 2006 WL 3813735 at *4 (N.D. Ill. Dec. 22, 2006); Motiva Enterprises, LLC v. Liberty Mutual Insurance Co., No. H-05-1473, 2006 WL 3246039 at *4-7 (S.D. Tex. Nov. 6, 2006) [under Texas or Delaware law, contracts to indemnify a party against the consequences of its own negligence, though disfavored, are enforceable when they demonstrate a “clear and unequivocal” intent to indemnify a party for its own negligence].
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| 4. | Compare, Hutton Construction Co., Inc. v. County of Rockland, 52 F.3d 1191, 1193 (2d Cir. 1995) with Farber v. State, 682 P.2d 630, 631 (Idaho 1984).
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| 5. | Most state statutes prohibiting indemnity for a party’s sole negligence do not prohibit providing insurance for such negligence. See, e.g., Shell Oil Co. v. National Union Fire Insurance Co. of Pittsburgh, Pa., 52 Cal. Rptr. 2d 580 (Cal. Ct. App. 1996). Some courts, however, have held that a state anti-indemnity statute bars an indemnitee from shifting the risk of its own negligence by requiring an indemnitor to sign an indemnification agreement or furnish insurance covering the indemnitee’s negligence. See, Walsh Construction Co. v. Mutual of Enumclaw, 104 P.3d 1146 (Or. 2005).
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| 6. | See, e.g., Insurance Services Office (ISO) Form CG 20 10 11 85 – Additional Insured-Owners, Lessees or Contractors-Scheduled Person or Organization [providing coverage for an additional insured “with respect to liability arising out of [the named insured’s] work for that insured by or for [the named insured]”].
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| 7. | See, McIntosh v. Scottsdale Insurance Co., 992 F.2d 251, 254 (10th Cir. 1993) [additional insured endorsement conditioned on liability “arising out of” named insured’s work is “ambiguous as to whose negligence is covered and whose negligence is excluded from coverage”].
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| 8. | Id. The phrase “arising out of” has been interpreted similarly in the context of indemnity agreements. See, e.g., BBL-McCarthy, LLC v. Baldwin Paving Co., 646 S.E.2d 682 (Ga. App. 2007) [in context of indemnity provision, “we construe this phrase in an indemnity clause to mean ‘had its origins in’ or ‘grew out of,’ and to encompass almost any causal connection or relationship”].
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| 9. | McIntosh, 992 F.2d at 255; see also, Merchants Insurance Co. of New Hampshire, Inc. v. U.S. Fidelity and Guaranty Co., 143 F.3d 5, 9-10 (1st Cir. 1998); Mid-Continent Casualty Co. v. Swift Energy Co., 206 F.3d 487, 499-500 (5th Cir. 2000) [“arising out of” does not require the named insured to be negligent for additional insured to be entitled to coverage].
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| 10. | ISO Form CG 20 10 07 04.
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| 11. | In some jurisdictions, the policyholder can chose which insurer(s) it wants to defend and indemnify it when the policyholder is entitled to coverage under more than one policy. This rule is referred to as “targeted tender.” See, e.g., Kajima Construction Services, Inc. v. St. Paul Fire and Marine Insurance Co., 227 Ill.2d 102, 879 N.E.2d 305 (2007). John Burns Construction Co. v. Indiana Insurance Co., 727 N.E.2d 211 (Ill. 2000).
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| 12. | See, e.g., Shell Oil Co. v. National Union Fire Insurance Co. of Pittsburgh, Pa., 52 Cal. Rptr. 2d 580, 587 (Cal. Ct. App. 1996).
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| 13. | See, e.g., Country Mutual Insurance Co. v. Anderson, 628 N.E.2d 499, 504 (Ill. App. Ct. 1993).
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| 14. | The supplementary payments section of the policy provides as follows:
If we defend an insured against a “suit” and an indemnitee of the insured is also named as a party to the “suit”, we will defend that indemnitee if all of the following conditions are met:
| a. | The “suit” against the indemnitee seeks damages for which the insured has assumed the liability of the indemnitee in a contract or agreement that is an “insured contract”;
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| b. | The insurance applies to such liability assumed by the insured;
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| c. | The obligation to defend, or the cost of the defense of, that indemnitee, has also been assumed by the insured in the same “insured contract”;
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| d. | The allegations in the “suit” and the information we know about the “occurrence” are such that no conflict appears to exist between the interests of the insured and the interests of the indemnitee;
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| e. | The indemnitee and the insured ask us to control and conduct the defense of that indemnitee against such “suit” and agree that we can assign the same counsel to defend the insured and the indemnitee; and
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| f. | The indemnitee:
| (1) | Agrees in writing to:
| (a) | Cooperate with us in the investigation, settlement or defense of the “suit”;
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| (b) | Immediately send us copies of any demands, notices, summonses or legal papers received in connection with the “suit”;
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| (c) | Notify any other insurer whose coverage is available to the indemnitee; and
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| (d) | Cooperate with us with respect to coordinating other applicable insurance available to the indemnitee; and
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| (2) | Provides us with written authorization to:
| (a) | Obtain records and other information related to the “suit”; and
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| (b) | Conduct and control the defense of the indemnitee in such “suit.”
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So long as the above conditions are met, attorneys fees incurred by us in the defense of that indemnitee, necessary litigation expenses incurred by us and necessary litigation expenses incurred by the indemnitee at our request will be paid as Supplementary Payments. Notwithstanding the provisions of paragraph 2.b.(2) of COVERAGE A — BODILY INJURY AND PROPERTY DAMAGE LIABILITY (Section I —Coverages), such payments will not be deemed to be damages for “bodily injury” and “property damage” and will not reduce the limits of insurance….
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| 15. | See, ISO Form CG 00 01 12 07.
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| 16. | See, Hart Construction Co. v. American Family Insurance Co., 514 N.W.2d 384, 390 (N.D. 1994) [term “damages” in the insuring agreement of a CGL policy was broad enough to include a suit for indemnification and insurer therefore had duty to defend indemnification claim for property damage resulting from an occurrence].
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| 17. | See, ISO Form CG 20 10 12 07.
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| 18. | The exception states that:
This exclusion does not apply to liability for damages:
| (1) | That the insured would have in the absence of the contract or agreement; or
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| (2) | Assumed in a contract or agreement that is an “insured contract,” provided the “bodily injury” or “property damage” occurs subsequent to the execution of the contract or agreement. Solely for the purposes of liability assumed in an “insured contract,” reasonable attorneys fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages because of “bodily injury” or “property damage,” provided
| (a) | Liability to such party for, or for the cost of, that party’s defense has also been assumed in the same “insured contract”; and
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| (b) | Such attorney fees and litigation expenses are for defense of that party against a civil or alternative dispute resolution proceeding in which damages to which this insurance applies are alleged.
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| 19. | See, ISO Form CG 20 10 12 07.
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| 20. | See, New Hampshire Insurance Co. v. Mendocino Forest Products, Co., LLC, 2007 WL 2875683, at *6 (N.D. Cal. Sept. 27, 2007) [contractual promise to indemnify distributor for “losses arising, or alleged to have arisen out of… [manufacturer’s] merchandise or its use” is an insured contract]; Truck Insurance Exchange v. BRE Properties, Inc., 81 P.3d 929, 934-935 (Wash. Ct. App. 2003) [rejecting argument that indemnity claim did not fall within insuring agreement and applying “insured contract” exception when general contractor’s tort liability for injury suffered by third party was expressly transferred by agreement to insured subcontractor].
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| 21. | See, ISO Form CG 20 10 12 07.
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| 22. | 713 N.E.2d 1244, 1248-1249 (Ill. App. 1999). Hankins was followed by the Illinois Supreme Court, which held that an agreement to indemnify a general contractor for “claims ‘arising out of or resulting from the performance of the subcontractor's work’ ” is nothing more than a waiver of a right of contribution and is not the equivalent of a contractual assumption of tort liability in the context of a lawsuit brought by the subcontractor’s employee against the general contractor for bodily injury. See, Virginia Surety Co., Inc. v. Northern Insurance Co. of New York, 224 Ill. 2d 550, 565 (2007). Under Illinois law, an employer can raise as an affirmative defense in a contribution action by a third party that its liability is limited to an amount equal to its statutory liability under the Illinois Workers’ Compensation Act [see, Kotecki v. Cyclops Welding Corp., 146 Ill. 2d 155, 585 NE2d 1023 (1991)] unless the employer contractually waived such protection by contracting with another party to assume its full share of contribution liability should an employee be injured. See, Braye v. Archer-Daniels-Midland Co., 175 Ill.2d 201 (1997). The Virginia Surety Co. court found that an agreement to waive the Kotecki limitation on contribution is not an “insured contract” because the subcontractor merely chose to remain fully liable for its employee's injuries by not asserting the Kotecki limitation as an affirmative defense. 224 Ill. 2d at 566. In so ruling, the court distinguished between contribution and indemnification:
There is an important distinction between contribution which distributes the loss among the tortfeasors by requiring each to pay his proportionate share, and indemnity, which shifts the entire loss from one tortfeasor who has been compelled to pay it to the shoulders of another who should bear it instead….
Id. at 565.
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| 23. | See also, American Economy Insurance Co. v. Texas Instruments Inc., No. Civ. A. 305CV0019K, 2006 WL 616017 (N.D. Tex. Mar. 9, 2006) [indemnity agreement was not “insured contract” when contractor did not agree to indemnify owner for tort liability]; Energy Corp. of America v. Bituminous Casualty Corp., 2008 WL 313948, at *10 (S.D. W.Va. Feb 4, 2008).
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| 24. | See, John Deere Insurance Co. v. De Smet Insurance Co., 650 N.W.2d 601, 607 (Iowa 2002) [when policy definition of “insured contract” is not limited to negligence, it can include assumption of liability even when the liability would otherwise be imposed by law].
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| 25. | See, KBS, Inc. v. Great American Insurance Co. of New York, No. 3:04cv730, 2006 WL 3538985, at *10 (E.D. Va. Dec. 7, 2006) [finding that no coverage determination was possible before judgment or settlement when both covered and uncovered claims were brought against the insured because “[t]o be an ‘insured contract’ under the policies in this case, the indemnity agreement must assume an actual tort liability. But if a claim is made against [the insured] which does not provide a basis for tort liability, then there is no insured contract status under the definition of an ‘insured contract’ in the policies, and [the insurer] would have no duty to indemnify [its insured]”].
Coverage for an “insured contract” is limited to occurrences after execution of the contract or agreement. Thus, if an accident occurs before the time that a subcontractor executes the contract or agreement, there would be no insured contract coverage. However, nothing in the CGL policy requires that the “insured contract” be in writing. Thus, while there must be an agreement that constitutes an “insured contract” for the exception to apply, the agreement can be oral. See, John Deere Insurance Co., 650 N.W.2d at 606-607 [finding insured contract based on express oral agreement to indemnify].
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©2009 Howrey LLP
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