Settlement of Construction Defect Claim Without Involvement and Participation of Insurance Carrier is a poor idea


The Fourth Circuit has provided a reminder for lawyers to obtain consent from its insurers when settling construction defect claims. Otherwise, you risk losing coverage for the claim, which will prevent recovery from the insurer of any settlement amount that you paid.

Gaylord National, LLC hired Perini/Tompkins Joint Venture (PT) in 2005 to serve as the construction manager for a $900 million hotel and convention center project at the National Harbor along the Potomac River in Maryland. Gaylord purchased WRAP insurance from ACE American Insurance Co. (ACE), which included commercial general liability (CGL) and excess liability policies which named PT as additional insured. The project also was insured by a builder’s risk policy.

During construction, a portion of an 18-story, 2,400 ton glass atrium collapsed, causing damage and delaying final completion. Shortly after completion, PT sued Gaylord to establish and enforce a mechanic’s lien and for breach of contract, claiming that Gaylord still owed it $79,656,098. PT reasoned that it’s damages stemmed from delays in furnishing design documents and changes to the original scope of work. Gaylord filed a counterclaim for negligence, warranty breaches and breach of contract.

The parties ultimately settled the dispute in November 2008, with Gaylord paying PT an additional $42,301,875, which was set off in favor of Gaylord in the amount of 26,157,912.

PT did not seek ACE’s consent prior to entering into the settlement agreement with Gaylord. Nevertheless, six months later, PT sent a letter to ACE, advising that, to the extent the builder’s risk policy did not cover the claim related to the glass atrium collapse, PT intended to seek reimbursement under the CGL and excess liability policies. The letter failed to mention the Gaylord counterclaim and set off, which was a large piece of the settlement.

Ten months later, ACE issued a reservation of rights letter, citing business risk exclusions, late notice, and voluntary payments made without ACE’s consent as possible grounds for coverage being denied.

PT thereafter sued in the U.S. District Court of Maryland for breach of contract, bad faith, and a declaratory judgment. After limited discovery, ACE filed a motion for summary judgment, arguing that PT had failed to obtain ACE’s consent prior to entering into the settlement with Gaylord, and that this failure breached the following clauses in the CGL policy:
Voluntary payment clause: “No insured will, except at that insured’s own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.”

— and —

No-action clause: “No person or organization has a right under this Coverage Part: … [t]o sue us on this Coverage Part unless all of its terms have been fully complied with. A person or organization may sue us to recover on an agreed settlement. … An agreed settlement means a settlement and release of liability signed by us, the insured and the claimant or the claimant’s legal representative.”

Such clauses are standard in CGL and excess liability policies and, from the perspective of an insurer, designed to protect it from indemnifying an insured for a collusive, overly generous, or unnecessary settlement. According to ACE, because PTJV failed to satisfy the “prior consent” conditions, it could not seek reimbursement for the monies paid to Gaylord.

PT countered that ACE could not deny liability coverage under Maryland law unless it established that the lack of notice resulted in actual prejudice to ACE.

The District Court agreed with ACE and granted its motion for summary judgment. On appeal, the Fourth Circuit affirmed that decision, analyzing the coverage issue under the laws of Maryland (where the project was built) and Tennessee (where the liability policies were made). Under Maryland law, the Fourth Circuit rejected PT’s prejudice argument, finding that prior consent conditions in the policy are a condition precedent. The no-action clause served to bar ACE from recovery due to failure to follow all terms of the CGL and excess liability policies and, moreover, that PT could not sue unless the settlement agreement was signed by ACE. The voluntary payment clause, in turn, required PT to get ACE’s consent.

CONCLUSION

The Fourth Circuit concluded that the prior consent provisions in the no-action and voluntary payment clauses were conditions precedent to coverage. Because PT did not obtain ACE’s consent prior to settling with Gaylord, Ace was excused from having to demonstrate prejudice.

The Court then took the opportunity to discuss prejudice. In particular, the Fourth Circuit found that an insurer is prejudiced if its insured unilaterally settles a claim without obtaining prior consent because (1) the insurer loses its right to investigate, defend, control, or settle the claim, and (2) the insurer would always have the nearly impossible burden of proving collusion or demonstrating, after the fact, the true value of the settled claim.

What strikes me as odd is the behavior of the insured. With such large sums involved it would seem logical that a policyholder would not gamble on its insurer indemnifying it on such a large claim. There might have been circumstances which would explain the seemingly careless behavior of the insured although the opinion does not cite any facts or testimony.

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