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Illinois Construction Cases Illustrate Gaps Between Insurance Coverage and Contractual Liability for Injury, Damage
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September 21, 2009
By Seth D. Lamden
Howrey LLP
Introduction
Given the inherently risky nature of construction projects, parties to construction contracts – owners, general contractors and subcontractors – continue to wrestle with developing effective contractual risk shifting solutions.
For example, the Illinois Supreme Court has held that a commercial general liability (CGL) policy does not provide coverage for an insured-subcontractor’s contribution liability to a general contractor when an employee of the subcontractor is injured at a jobsite and brings an action against the general contractor. The court held that this was true regardless of whether the subcontractor had contractually agreed to assume some or all of the general contractor’s liability. Virginia Surety Co., Inc. v. Northern Insurance Co. of New York, 224 Ill.2d 550, 565, 866 N.E.2d 149 (2007),
Recently, the Illinois Appellate Court held that under the reasoning of Virginia Surety, a CGL policy does not cover a general contractor’s contribution liability to a project owner arising out of injuries to employees of the project owner that were caused by the work of a subcontractor. American Family Mutual Insurance Co. v. Fisher Development, Inc., 391 Ill.App.3d 521, 909 N.E.2d 274 (2009).
Background Regarding CGL Policies
Generally, 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.” See, e.g. ISO CGL Policy at §I(1)(a). Because of the breadth of the insuring agreement in a CGL policy, insurers attempt to limit their liability for certain contractual liabilities. For example, CGL policies eliminate coverage for “ ‘bodily injury’ or ‘property damage’ for which the insured is obligated to pay as damages... by reason of the assumption of liability in a contract or agreement.” Id. at §I(2)(b).
But, some coverage for contractual liability -- including agreements to indemnify or hold harmless -- remains because the exclusion contains an exception that restores coverage for, among other things, liability assumed in an “insured contract.” Id. “Insured contract” means “[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.” Id. §V(9). The CGL policy, in turn, defines “tort liability” to mean “liability that would be imposed by law in the absence of any contract or agreement.” Id. Thus, a contract pursuant to which the insured expressly assumes the tort liability of another -- including pursuant to an indemnity agreement -- can be an “insured contract.”
When an employee of a subcontractor or project owner is injured at a jobsite, it is not uncommon for the employee to sue the general contractor. Under Illinois law, the employer can raise as an affirmative defense in a contribution action brought by a third-party that its liability is limited to its statutory liability under the Illinois Workers’ Compensation Act. See, Kotecki v. Cyclops Welding Corp., 146 Ill.2d 155, 585 N.E.2d 1023 (1991). But, that affirmative defense fails if the employer had contractually waived such protection by contracting with another party to assume its full share of contribution liability if an employee is injured. See, Braye v. Archer-Daniels-Midland Co., 175 Ill.2d 201, 676 N.E.2d 1295 (1997).
Virginia Surety Co., Inc.
In Virginia Surety, the Illinois Supreme Court considered whether an agreement between a subcontractor and a general contractor, under which the subcontractor agreed to indemnify the general contractor for “claims ‘arising out of or resulting from the performance of the subcontractor's work’ ” -- a so-called “Kotecki waiver” -- constitutes an “insured contract” such that a contribution claim against a subcontractor by a general contractor would be covered under the subcontractor’s CGL policy.
The coverage dispute in Virginia Surety arose when an employee of the insured subcontractor was injured at a construction site. The injured employee filed a worker’s compensation claim against the subcontractor and a negligence claim against the general contractor. The general contractor, in turn, brought a third-party action for contribution against the subcontractor. But for the “Kotecki waiver” in its subcontract, the subcontractor, as the employer of the injured party, could have asserted, as an affirmative defense, that its liability was limited its statutory worker’s comp liability.
The subcontractor tendered the claim to its CGL insurer, which denied coverage. In the ensuing declaratory judgment action, the Virginia Surety court found that the “indemnification agreement” between the subcontractor and the general contractor was not the equivalent of a contractual assumption of “tort liability” as the CGL policy defined the term. The subcontractor did not assume “tort liability” of the general contractor -- liability that otherwise would be imposed under law -- but merely contracted to remain fully liable for its employees’ injuries by not asserting the Kotecki limitation as an affirmative defense.
While labeled an indemnity agreement, the court concluded that “the effect of the provision is nothing more than a simple anticipatory waiver of an affirmative defense in a contribution action.” In this regard, the court observed that both parties are liable at common law for their own negligence. While an employer may limit its common law liability by asserting immunity under the Illinois Workers’ Compensation Act up to the amount it paid in worker’s compensation benefits, under Illinois law an employer also may waive these protections. A waiver, however, does not shift liability in the same manner as an indemnity agreement is intended to do. The court also rejected assertions that the employer “assumes” the joint and several liability of the non-employer sufficient to bring it within the definition of “insured contract.” Joint and several liability is pre-existing and imposed by operation of law, not “assumed” by the insured through contract.
American Family Mutual Insurance Co.
The Illinois Appellate Court recently held that a general contractor’s agreement to indemnify a project owner for the general contractor’s own negligence is no more an “insured contract” under a CGL policy than the subcontract between a general contractor and a subcontractor at issue in Virginia Surety.
In American Family, Fisher Development, Inc., a general contractor, entered into a construction contract with The Gap, Inc. under which Fisher agreed to provide labor and materials for improvements to two Gap stores. The Fisher-Gap contract obligated Fisher to maintain CGL coverage during the project for “personal injury” and to indemnify the Gap as follows:
FDI [Fisher] agrees to indemnify and hold harmless The Gap, its officers, employees and agents, from and against any and all liability, loss and expense (including reasonable attorneys’ fees) resulting from (i) personal injury... arising in whole or in part by reason of, or in any way resulting from, the performance of the Work, whether by FDI or by any subcontractor, or anyone directly or indirectly employed by either of them....
Fisher subcontracted with Shanahan Drywall Service, Inc. Shanahan procured a CGL policy from American Family Mutual Insurance Co. that named Fisher as an additional insured for liability “arising out of [Shanahan’s] ongoing operations provided for [Fisher].” The American Family policy contained a clause excluding coverage for liability for bodily injury “for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.” That policy also included an exception to this exclusion for an assumption of “tort liability,” which the American Family policy defined as “liability for damage[] [t]hat the insured would have in the absence of the contract or agreement.” The American Family policy refers to the contract mentioned in the exception as an “insured contract.”
While Shanahan was performing its work at the Gap, two Gap employees were injured. The employees filed worker’s compensation claims against the Gap and sued both Fisher and Shanahan, alleging that their injuries arose out of Shanahan’s work. American Family accepted Fisher’s tender and defended it in both actions. Fisher brought third-party contribution claims against the Gap in both suits. Subsequently, the Gap filed a separate lawsuit against Fisher alleging that Fisher was obligated to indemnify it under the Gap-Fisher contract for the worker’s compensation awards it paid to its employees. The Gap claimed that because it had been joined as a third-party defendant in the employees’ negligence actions against Fisher and Shanahan, Fisher must reimburse the Gap for its defense and indemnity expenses.
Fisher tendered its defense of the Gap lawsuit to American Family. American Family refused the tender on the basis that the “assumption of liability in a contract or agreement” exclusion barred coverage. After defending and ultimately obtaining a dismissal of the Gap’s claims, Fisher brought a declaratory judgment action against American Family. Fisher alleged that American Family had improperly denied coverage because the assumption of liability exclusion did not apply to the Gap’s claims. Fisher contended that because it did not assume any liability not already imposed by Illinois law, the exception to the exclusion for the assumption of contractual liability restored coverage. As Fisher alleged, “the ‘indemnification’ clause in the Gap-Fisher Contract was nothing more than an agreement by [Fisher] to remain liable in contribution for its pro rata share of the common liability for [the Gap employees’] bodily injuries.”
As support for this argument, Fisher contended that the Virginia Surety decision supported the proposition that “the pro rata share of the common liability of the general contractor and the subcontractor/employer of the injured party does not shift between the parties even in the face of a hold harmless agreement given by the subcontractor in favor of the general contractor” because: 1) under the Joint Tortfeasor Contribution Act (740 ILCS 100/1 et. seq.), the parties remained liable for their pro rata share of liability, regardless of the language of the indemnification agreement; and 2) the Construction Contract Indemnification for Negligence Act (749 ILCS 35/0.01 et. seq.) prohibited the Gap from shifting responsibility for its own negligence to Fisher in the indemnification agreement. In essence, Fisher argued that under the indemnification provisions in the Gap-Fisher construction contract, it did not assume liability other than what Illinois law already imposed on Fisher through the Contribution Act.
The American Family court expressly rejected Fisher’s argument that the Virginia Surety decision rendered the “contractual assumption of liability” exclusion in the CGL policy inapplicable by bringing the claim within the “insured contract” exception. As the American Family court explained, the Virginia Surety court had based its holding on the fact that the “portion of the common liability above the Kotecki cap is not ‘imposed by law’ upon [the general contractor], but remains with [the subcontractor]....” As such, an agreement to waive the Kotecki cap cannot be an “insured contract” because “by virtue of the waiver agreement, the subcontractor was assuming liability it would otherwise not have been forced to assume. Consequently, the waiver agreement was not an insured contract; the exception to the exclusion provision was not met and no duty to defend was triggered....”
Conclusion
Many subcontractors routinely enter into contracts containing “indemnity” provisions that actually are Kotecki waivers. Virginia Surety and American Family make clear that an employer that enters into such an “indemnity agreement” in the context of a construction contract potentially is exposing itself to significant uninsured liability.
First, an insured employer’s agreement to waive its Kotecki affirmative defense is not an “insured contract” that is covered under its CGL policy. Second, because most worker’s compensation/employer’s liability insurance policies exclude coverage for “liability assumed under a contract,” the gap between the subcontractor’s protection under the “Kotecki cap” and its full liability under the Contribution Act also would be uninsured.
Thus, subcontractors that enter into what appear to be routine construction contracts and assume that their CGL policies will cover any resulting losses may be taking on uninsured exposure by executing such contracts.
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For more information about the issues covered in this report, please contact Seth D. 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.
©2009 Howrey LLP
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