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.

Owners and Contractors Protective Liability Coverage Form

I intend to devote several upcoming posts on Owner Controlled Insurance Policies (“OCIP”) or “WRAP” coverage due to its continued emergence in the construction, insurance, and legal industries.  In an effort not to confuse, this article deals (“OCP”), which is an acronym for Owners and Contractors Protective Liability insurance coverage.  Coverage for Operations of Designated Contractors (CG 00 09 12 07) is,  as suggested by the title, intended to protect certain owners and contractors, but only for operations performed for the named insured by the “designated” contractor.  The Designated Contractor is listed on the Declarations Page to the policy.   

THE NAMED INSURED

In addition to being limited to certain tasks performed by a specific contractor, OCP coverage is further narrowed to protect the interests of a party other than the policyholder.  Consider the following hypothetical to illustrate the “protective” nature of OCP coverage.  Protective policies are designed quite differently than most liability insurance policies purchased by contractors.  Consider a construction agreement between Owner and Contractor which requires Contractor to purchase and carry OCP for the benefit of the Owner.  The plain language within the policy will list Owner as the policy’s named insured.  Despite purchasing and paying the premium, Contractor is not a named insured and, thus, not protected by the policy.    

While helpful to Owner, OCP coverage is not as broad as the sweeping coverage provided by traditional CGL policies.  In almost all circumstances, the Owner is protected by the OCP policy in just two factual circumstances.  These relate to incidents of (a) vicarious liability and (b) supervisory liability which might be imputed upon the Owner for the acts or omissions of Contractor.  Plainly stated, the Owner is not protected or indemnified for the active negligence or omissions created via its own making.

VICARIOUS LIABILITY AND THE GENERAL CONTRACTOR’S ACTS

Since coverage is limited to the vicarious liability of the named insured, coverage applies only to liability imposed on the named insured as a result of the designated contractor’s acts and not as result of the named insured’s own acts or failure to act.  Courts have also allowed coverage for acts and omissions resulting from a subcontractor’s work.  Although the OCP does not use the phrase “vicarious liability,” one court stated:

“… the courts must construe the “arising out of [the subcontractor’s work]” provision as one providing coverage in cases                                       where the alleged liability is vicarious.”  [Emphasis added.]  See St. Paul Fire & Marine Ins. and Hardin Constr. Grp., Inc. v. Hanover Ins. and Travelers Ins., 187 F. Supp. 2d. 584 (E.D.N.C. 2000)

However, conventional wisdom to the contrary, one who engages an independent contractor is usually not vicariously liable for the acts or omissions of the independent contractor.

DIRECT OR GENERAL SUPERVISION

Courts have provided some guidance as to what it considered to be “general supervision.” In Union Electric v. Pacific Indem., 422 S.W.2d 87 (Mo. App. 1967), an employee (Palmer) of the subcontractor (Davey) was seriously injured when he came into contact with an uninsulated power line when trimming trees around the line pursuant to a contract with Union Electric. Palmer brought a complaint against Union Electric, alleging Union Electric was negligent in failing to warn Palmer of inadequately insulated power lines. Union Electric’s insurer contended that Union Electric’s alleged liability did not result from Union’s supervision of Davey in that Union supervised only the result of the work did not supervise the method, manner, or means of performance of the work.

The court ruled:

The factual situation presented shows the insured’s contract with Davey required the insured [Union Electric] to designate the areas along the distribution and transmission lines of the insured where Davey would cut and trim trees. … we hold that the words “general supervision” as used in the policy in question do not mean supervision of the method, manner, and/or means employed by Davey…We hold that the words mean supervision of the work of Davey only to the extent necessary to see that the work was done in accordance with the contract…and to provide the area of the transmission lines where Davey would cut and trim the trees. Palmer’s claim fell within the coverage of the policy. Insured’s failure to warn Palmer arose out of its supervisory function. [Emphasis added.]

COST OF PREMIUM AND COVERAGE

The premium for the OCP policy is based on the contract price between the named insured and the designated contractor (usually with a rate per $1,000 of the contract price). Thus, a separate OCP can be several thousand dollars of premium (or more) depending on the size of the project, the limits required, etc.

The OCP policy excludes coverage for bodily injury or property damage if such injury or damage takes place after the earlier of when the operation has been completed or put to its intended use by anyone other than another contractor or subcontractor working for the Designated Contractor on that project.

DETERMINING COVERAGE FOR LOSS UNDER MULTIPLE POLICIES

An OCP policy can reduce disputes between insurance companies concerning which policy should be the first policy to respond to a claim (i.e. which policy will be considered primary). For example, when an owner is a named insured under its own CGL policy and an additional insured under the contractor’s CGL policy, the two insurance companies have to determine which of their respective policies is primary. This often leads to disputes because each carrier argues that the other’s policy should be considered primary. An OCP policy minimizes these disputes because an OCP carrier agrees that its insurance policy provides primary coverage to the owner and that it will not seek contribution from the owner’s own insurance policy or from the CGL policy of the contractor that purchased the OCP policy.

CONTRACTUAL PITFALLS

A contractor must be careful when negotiating his or her construction contract with the owners. Contractors must understand the unintended consequences that arise when the owner requires the contractor to purchase the OCP policy and to indemnify the owner for personal injury and property damage arising from the contractor’s negligence in performing its work. In practice, if an accident occurs during construction—an employee of a subcontractor is injured, for example—the employee will sue both the contractor and the owner. The owner will respond by seeking coverage under the OCP policy. The contractor, in turn, tenders to its own CGL carrier, expecting that the OCP carrier will defend the owner and that the contractor’s GL carrier will defend the contractor.

What occurs is the attorney appointed by the OCP carrier to defend the owner asserts a claim against the contractor for contractual indemnification and demands that the contractor (Contractor’s CGL carrier) defend and indemnify the owner pursuant to the indemnification provision in the construction contract. Under these circumstances, not only does the contractor have to pay for an entirely separate OCP policy for the owner, but once coverage under the OCP policy is triggered, the OCP carrier circles back and tenders the claim on the contractor’s CGL policy through the construction contract’s indemnification provision. Simply put, the contractor pays for the OCP policy and then faces increased CGL premiums because of the costs associated with responding to the contractual indemnification obligation.

Contractors (and owners) must understand the interplay between an OCP policy and a contractual indemnification provision. To the extent that an owner is demanding that a contractor purchase an OCP policy, the contractor should attempt to negotiate the elimination of any contractual indemnification provision that requires the contractor to defend and indemnify the owner for claims for personal injury and property damage that are covered by the OCP policy.