Some subcontractors and suppliers may be under the impression that being included as a named insured, additional insured, or loss payee under the owner's builders risk policy protects their supplies, materials and equipment at the project and while in transit, and insulates them from subrogation threats. However, that is not always the case. In the Fall 2011 issue of the Construction Lawyer, the authors of this article published another article on builders risk insurance detailing how this impression could be misconstrued. Mark M. Bell, Christopher S. Dunn, James H. Costner, Confronting Conventional Wisdom on Builders Risk: From Named-Insured Status to Concurrent Causation, 31-Fall Construction Lawyer 15 (2011).
The previously published article also discussed additional problems with including subcontractors and suppliers as named insureds. As the authors, we pointed out that including various parties as named insureds on the builders risk policy can create problems for owners because the additional named insureds, among other things, can (a) void the policy by committing any act of fraud against the insurance company, (b) modify the policy, (c) delay recovery of covered losses, and (d) initiate unnecessary claims proceedings. To avoid these risks, we suggested that owners limit the number of parties they include as named insureds on the builders risk policy. We also advised owners to carefully review the contract documents to ensure consistency with actual policy language. This is particularly important because of the high degree of variability in language among builders risk policies.
Recently, the well-regarded Insurance Risk Management Institute (IRMI) featured an opposing viewpoint by Steven A. Coombs, who disagreed with our argument for limiting the number of parties included as named insureds. Steven A. Coombs, Should Builders Risk Policies Cover Nonowner Entities as Insureds? You Bet, and Here is Why. An article noting both viewpoints recently appeared in this space as well.
The opposing viewpoint asserts that limiting named insureds can lead to (a) breach of contract, (b) increased construction costs, and (c) increased litigation. It also argued that some of our concerns can be limited with "non-vitiation" or similar severability endorsements intended to protect innocent insured's from the excluded or fraudulent acts of coinsureds.
Respectfully, we stand by the recommendations expressed in our article. We also question the commercial availability of obtaining non-vitiation endorsements as recommended by Mr. Coombs and the cost of these endorsements.
More importantly, simply using non-vitiation clauses and adhering to standard form contracts, as suggested by Mr. Coombs, leaves the majority of the problems cited in our article unresolved. Mr. Coombs' suggestions also may increase the risk of unnecessary construction costs, administrative overhead, and litigation, and does not insulate subcontractors from subrogation.
We agree wholeheartedly with Mr. Coombs that builders risk policies should be the risk-financing tool of choice for property damages losses during the course of construction. We also agree that all the subcontractors and sub-subcontractors should be free from subrogation exposure to the builders risk insurance carrier.
Our focus on an owner's interests, and Mr. Coombs' focus on adhering to the standard form contracts, represents the fundamental distinction between the two differing viewpoints.
Assertion That Litigation Will Increase Is Unfounded
The opposing approach does not solve the subrogation-related litigation issues it raises and actually could generate additional litigation due to the need for interpleader actions.
Mr. Coombs argues that there are "scores of cases involving litigation surrounding subrogation provisions contained in AIA contracts." No one disagrees with that point, but it is not clear that including subcontractors, suppliers, agents, employees, officers, and directors as additional insureds or additional named insureds will reduce subrogation-related litigation.
The opposing viewpoint might lead one to believe that subrogation rights against subcontractors and suppliers are systematically waived when the owner includes subcontractors and suppliers as named insureds or loss payees. That is simply not the case. Some policies expressly state that named insureds can still be subject to subrogation:
It is a condition of this policy that the Company shall be subrogated to all the Insured's rights of recovery against: . . . any manufacturer or supplier of machinery, equipment or other property whether named as an Insured or not . . .
Similarly, the AIA's A201-2007 General Conditions document's formulation of the subcontractor and suppliers' interests in the property does not insulate them from subrogation. The A201 vaguely requires the owner to "include interests of . . . the Subcontractors and Sub-subcontractors" within the policy. The phrase "including the interests of the subcontractors" hardly immunizes subcontractors from subrogation despite the assurances of the Response to the contrary.
A previous article by Mr. Coombs' may demonstrate this point. That article states that the language "as their interests may appear" is routinely challenged by insurers. He also cites cases finding that the "as their interests may appear" language only insulates subcontractors and suppliers from subrogation relating to their work at the project and not the entire project. As Mr. Coombs states: "There have been many cases involving insurers' subrogation attempts against contractors and subcontractors who were insureds ATIMA [As Their Interests May Appear]."
Thus, even if the right of subrogation is waived by adding subcontractors as named insureds, which is not necessarily the case, subrogation may only be waived to the extent of the subcontractor's work on the project, thereby exposing the subcontractor to subrogation for every part of the project it did not work on.
Also, no support exists for the proposition that a subcontractor's status as a loss payee would ever insulate the subcontractor from subrogation. Loss payees are fully subject to subrogation by builders risk carriers, and loss payee status typically conveys only a right to be listed on a policy-proceeds check.
In addition to not reducing subrogation-related litigation, Mr. Coombs' approach might actually increase litigation and generate unnecessary claims delays. With scores of parties as loss payees, additional insureds, and named insureds, either the insurer — or more likely the owner — will be forced to interplead the insurance proceeds into court or risk being sued by a loss payee or named insured. Naturally, the owner will not be able to access the interpleaded funds during the pendency of the litigation and may not be able to resume the work or pay its contractors and subcontractors until the interpleader action concludes. It is unclear to us how this could be viewed as a benefit.
Limiting the named insured status to the owner, contractor, and those subcontractors or suppliers with significant in-transit risk eliminates the need for interpleader actions and streamlines the process for re-commencing construction and getting all parties paid. This is in everyone's best interest. As we argued in our initial article, the way to ensure that everyone is paid for their work and free from subrogation is to draft appropriate contract documents and require the carrier to waive subrogation on the front end.
Impossibility of Compliance with Standard Construction Forms
We advise owners to modify the terms of the standard contracts on the front end to ensure that the owner actually has contract documents in sync with insurance provisions that are achievable in the market. If they fail to, they likely breach their agreement with the contractor. Mr. Coombs asserts that our approach leads to breach of contract, but we don't agree and contend that blindly following the standard contracts as the Response suggests will lead to breached contracts.
While Mr. Coombs appears to be satisfied with the terms of the industry form agreements, it bears noting that it is virtually impossible to comply with the builders risk insurance terms of the industry contracts. Examples include the standard form policies to insure against flood and earthquake without sublimits. But these coverages are often not commercially available. The form contracts also require the owner to include the interests of myriad parties as either named insureds or additional insureds, or simply include the subcontractors "interests." It also bears noting that to be included as an insured on an insurance policy, the insurer typically requires the name and address of the insured.1 For projects of any meaningful scale, it is implausible for the owner to know everyone who will eventually supply labor or materials to the project. Thus, it often is not possible to comply strictly with the standard forms. By following the standard forms, owners likely may breach their contracts.
For example, both the standard DBIA and EJCDC forms require the Owner to include as additional insureds the interests of [the] Owner, Design-Builder, Design Consultants, Contractors, . . . and the officers, directors, members, partners, employees, agents, consultants, and subcontractors of each and any of them . . . as loss payees. First, "additional insureds" do not commonly exist in the builders risk context. Major builders risk insurers do not often offer "additional insured" status to anyone, preferring instead to use the term "named insureds" or "additional named insured." Second, even if the "additional insured" status were available on a builders risk policy, a major project would require significant administrative effort to add every "subcontractor[s] of any tier" who ever did work on the project as an "additional insured." Even if the owner had a full-time employee dedicated to this task, it is unlikely that the employee would be able to capture everyone.
We understand that there are certain material suppliers and subcontractors who may have significant exposure for materials in transit or materials stored at the construction site. Including these subcontractors and suppliers as loss payees does not grant them any additional protection. Rather than adhering to the standard forms, the prudent owner and contractor will ensure that critical suppliers and subcontractors are adequately insured against perils for in-transit and on-site materials. This can be done through insurance products purchased by the supplier or subcontractor. Alternatively, the owner could consider a limited number of suppliers or subcontractors who will be supplying significant materials to the project as named insureds on the project builders risk policy, but with limited powers, if any, to effect policy modification.
Construction Costs Will not Increase
It is not as though subcontractors and suppliers lose their rights in the event of a loss covered by builders risk insurance. The subcontractors and suppliers are fully entitled to be paid for their work. But they do not need to be named insureds to be paid what they are owed. Should the owner default on its obligations, subcontractors and suppliers have lien remedies, prompt payment remedies, and all other contract or tort remedies that are otherwise available to them for any of the owner's breaches of contract or payment obligations. It is unclear to us, from our perspective, why the subcontractor needs to have additional protection in the event of a loss covered by builders risk insurance. It also seems unlikely that the subcontractors or suppliers would need to place a meaningful premium on their work in the event they are not covered as named insureds under the insurer's policy.
Rather than reducing construction costs, we think Mr. Coombs' approach will actually increase construction costs. First, requiring the owner to include all parties that show up at the job site as named insureds will be a significant administrative cost and burden to the owner. The owner will effectively need to monitor all subcontractors and suppliers that enter the project or supply any work to the project. For large projects, this could be a significant and, arguably, a wasteful expense and unlikely to capture every party required to be included as a named insured by the form contracts. Second, even if the owner expends the resources to fulfill that obligation, the insurer will charge for its administrative services of constantly endorsing the policy and may also charge additional premiums. The owner will be forced to absorb that cost. Thus, any potential savings in bids — if they even exist at all — will be offset by the additional costs of administering the builders risk policy and securing the additional endorsements, thereby leading to a net increase in construction costs.
Other Problems May Be Created
In addition to not remedying the problems raised in our initial article, the response to our article seems to assert that if contractors force an owner to adhere to the form contracts, the contractors will be adequately protected. That is incorrect. Subcontractors and suppliers adhering to form contracts without revision may not be insulated from subrogation. Named insureds may not be adequately insulated from subrogation, particularly if insurers revise their policies to expressly allow for subrogation, and loss payees are generally subject to subrogation.
Similarly, following the AIA's requirement to "include the interests of the subcontractor" does not insulate the subcontractor from subrogation, and some policies expressly state that the insurer retains its rights to subrogate against the subcontractors. For example, a Zurich form fulfills the requirement that it include the interests of the subcontractors, but also indicates that they retain their right of subrogation against the insurers. "We cover the interest which your subcontractors, your sub-subcontractors and your suppliers have in the Covered Property . . . This condition does not impair any right of subrogation we would otherwise have." Zurich Form 40471 (04-09) (emphasis added).
It also is not clear whether the non-vitiating endorsements are commercially available, and if they are, how much they cost. In theory, non-vitiating endorsements solve one of the four problems associated with adding named insureds — that a subcontractor or supplier could void the policy. This supposed solution however does not address (a) whether these endorsements are commercially available, (b) the administrative burdens of adding hundreds of subcontractors and suppliers to the builders risk policy, (c) the cost of adding hundreds of subcontractors and suppliers to the builders risk policy, or (d) the increased cost, litigation, and time created by forcing the owner or insurer to interplead the insurance proceeds into court pending the resolution of all claims to the insurance proceeds.
Conclusion
Owners seek builders risk policies for three distinct reasons. First, to finance the risk of physical loss or damage to the project so the owner will have the necessary funds to complete the project in the event of a loss; second, to comply with the loan covenants on the project; and third, to ensure that everyone is paid according to the project agreements following a loss. This is the essence of builders risk insurance to the Owner, not providing insurance for subcontractors and suppliers.
The non-vitiation endorsements proffered by Mr. Coombs in his response to our article, if commercially available, still leaves the significant practical problems addressed in that article. Accordingly, we reaffirm that, in our opinion and given our viewpoint, consider that the owner typically may be best served by including only the general contractor as the named insured under the policy, but not the majority of subcontractors and suppliers.
Originally published in American Bar Association - Vol. 14 No. 3, September 2012.
Footnote
1. There are a few exceptions to this rule and some insurers, like Zurich and Chubb, are beginning to offer "additional insured" status to contractors and do not require naming them on the policy; however even the "additional insured" status of these contractors is not as protective as the authors believe Mr. Coombs' response leads one to believe.
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