A legal out

Clearly, mistakes happen. But did you know you may not always be on the line for them? For example, if your negligence caused damage to an owner's building, carefully review the insurance provisions in the contract documents to ascertain whether you or the owner, through its property insurer, must pay for the property damage. The American Institute of Architects (AIA) construction contract documents frequently have been interpreted to shield contractors from liability and require payment by owners' property insurers.

In May 2015, the Indiana Supreme Court joined a growing number of courts ruling the property insurance and waiver of subrogation provisions in standard AIA contract documents bar a claim against a contractor whose alleged negligence caused property damage to the owner's building.

In the case Board of Commissioners of County of Jefferson v. Teton Corporation, Innovative Roofing Solutions, Gutapfel Roofing, Inc. and Daniel L. Gutapfel, the Indiana Supreme Court ruled the AIA A201 General Conditions precluded the owner's property insurer, who had paid for damage to an existing building caused by the roofing contractor, from seeking recovery from the roofing contractor.

In this case, the owner, Jefferson County, entered into a construction contract in October 2008 with Teton Corp., Madison, Ind., in the amount of $87,280 to perform roof repairs on the Jefferson County courthouse in Madison. Teton subcontracted the work to Innovative Roofing Solutions, Batesville, Ind., who then sub-subcontracted the work to Gutapfel Roofing Inc., Batesville. The contract between the owner and Teton was Standard Form of Agreement between Owner and Contractor, AIA Document A101-1987, and General Conditions of the Contract for Construction, AIA Document A201-1987.

Property insurance

For many years, the AIA General Conditions have included provisions requiring the owner to purchase and maintain property insurance written on a builder's risk all-risk or equivalent policy form in the amount of the contract sum, including modifications, and waiving subrogation claims applicable to the property insurance obtained by the owner per AIA contract requirements. The all-risk or equivalent property insurance to be obtained by the owner is to include, without limitation, coverage against the perils of fire and physical loss or damage, including theft, vandalism, collapse and windstorm.

If the owner does not intend to purchase property insurance stipulated in the AIA contract, the owner is to inform the contractor in writing before work begins and the contractor may procure the insurance and add the cost by change order. The AIA General Conditions go on to state that if the owner fails or neglects to purchase the insurance without notifying the contractor in writing, the owner is liable for all reasonable costs properly attributable to the owner's failure to obtain the insurance.

The AIA waiver of subrogation provision, which is Article 11.3.7 in the current (2007) edition of the AIA A201 General Conditions, states the owner and contractor waive all rights against each other and any of their subcontractors, sub-subcontractors, agents and employees, as well as the architect, architect's consultants and separate contractors retained by the owner. The waiver covers damages caused by fire or other causes of loss to the extent covered by the property insurance obtained by the owner applicable to the work included in the construction contract except such rights to the proceeds of the insurance held by the owner as fiduciary.

Article 11.3.7 goes on to state even though the contractor may have a contractual duty to indemnify the owner, the waiver of subrogation supersedes the indemnification obligation when the waiver of subrogation applies.

The case

In accordance with the AIA insurance requirements, Jefferson County was required to obtain builder's risk property insurance. Jefferson County could have satisfied this requirement by acquiring a separate builder's risk policy that would apply only to the courthouse renovations included in Jefferson County's contract with Teton or by relying on its existing all-risk property insurance, which applied to the entire courthouse in addition to the renovation work. Jefferson County chose to rely on its existing property insurance policy it had purchased from St. Paul Fire and Marine Insurance Co., St. Paul, Minn.

On May 20, 2009, the Jefferson County courthouse was substantially damaged by fire during the renovation work. Jefferson County alleged the fire began when Daniel Gutapfel, the owner of Gutapfel Roofing, was soldering copper downspouts near the wood frame of the courthouse. The damages far exceeded the amount of the roofing renovation contract. Jefferson County's damages were fully covered by its property insurance policy with St. Paul Fire and Marine Insurance.

Jefferson County filed a subrogation lawsuit against Teton, Innovative Roofing Solutions, Gutapfel Roofing and Daniel Gutapfel to recover the damages to the courthouse paid by the insurance company. The contractors defended the suit on the grounds Jefferson County had waived subrogation rights to recover the damages to the courthouse based on the AIA waiver of subrogation provision. Jefferson County argued the AIA waiver applied only to the damages to the roofing work that was to be covered by builder's risk insurance that was to be obtained by the owner.

The trial court found for the contractors and ruled Jefferson County had waived subrogation rights for all claims because it had insurance that covered all the damages caused by the fire. The Indiana Court of Appeals affirmed the trial court's decision in a split decision. The case then was appealed to the Indiana Supreme Court.

The Indiana Supreme Court was asked to consider the scope of the AIA waiver of subrogation and specifically whether the waiver applied only to the work covered in the construction contract, which would be covered under a builder's risk policy that Jefferson County was required to obtain, or would apply to all the damage to the courthouse covered in Jefferson County's property insurance policy with St. Paul Fire and Marine Insurance. The Indiana Supreme Court ruled in favor of the contractors and dismissed Jefferson County's claim.

Examining the text of the AIA waiver of subrogation provision, the Indiana Supreme Court ruled the language stating the owner and contractor waived all claims for damages caused by fire or other perils to the extent covered by the property insurance the owner was to maintain applied to all property damages covered under the insurance policy. Based on the language in the AIA contract documents, the court said it is the insurance policy applicable to the damages that governs the scope of the subrogation waiver not whether the damage is to the contractor's work or to nonwork (the balance of the courthouse in this case).

If the insurance policy the owner uses to satisfy the owner's obligation to maintain builder's risk coverage is the same policy as that which covers the entire building, the subrogation waiver applies to all the property damage covered under the policy and is not limited to the contractor's work. In other words, the critical legal determinant is not whether the damage is to the work of the contractor or nonwork but rather the coverage of the insurance policy the owner obtains to cover the contractually required property insurance and respond to the loss.

In this case, because Jefferson County satisfied its obligation to maintain builder's risk insurance through its existing property damage policy rather than purchasing a separate builder's risk policy and the policy covered all damages, the waiver of subrogation extended to all damages.

Approaches

There have been numerous court cases and appellate court decisions pertaining to the scope of the AIA waiver of subrogation seeking to interpret the intent of the language.

One line of cases, followed by the Indiana Supreme Court in the Jefferson County case, focuses on the insurance policy that applies to the claim not on whether the damages are to the contractor's work versus damage to other property. Courts holding this view point to the AIA language that states the waiver applies to damages caused by fire or other causes of loss to the extent covered by property insurance obtained pursuant to the AIA property insurance requirements or any other property insurance applicable to the work.

If the insurance policy that meets the owner's obligation to maintain builder's risk coverage is the same policy that covers other property damage, the AIA waiver applies to all damages covered by the owner's property insurance. This line of cases now is regarded as the majority approach.

The other line of cases holds the AIA waiver of subrogation is limited to damages covered under builder's risk insurance so only the work of the contractor is subject to the waiver; nonwork of the contractor (an existing building in a reroofing scenario) that is not covered by the builder's risk insurance the owner is to maintain under the AIA contract documents is not subject to the waiver.

These cases make a distinction between work and nonwork. When a roofing contractor contracts with an owner to reroof a building, only the work that comprises the new roof would be covered. This much more limited interpretation of the scope of the AIA waiver of subrogation is the minority view.

In addition to the owner's obligation to purchase and maintain a builder's risk all-risk or equivalent policy, the AIA General Conditions state that if during construction the owner insures properties (real, personal or both) at or adjacent to the construction site under policies separate from those insuring the construction project, the owner waives all rights in accordance with the waiver of subrogation provision for damages caused by fire or other causes of loss covered by this separate property insurance. This provision, Article 11.3.5 in the 2007 edition of the AIA A201 General Conditions, has been cited by courts following the majority approach to show the intent of the AIA contract is to waive damage claims covered by property insurance beyond damages to the contractor's work.

Similar to the Indiana Supreme Court in the Jefferson County case, courts in California, Georgia, Indiana, Maine, Massachusetts, Minnesota, Nebraska, New Hampshire, New Jersey, Ohio and Texas have adopted the more expansive majority approach so all damages covered by the property insurance that includes builder's risk coverage are waived.

Courts in Colorado, Mississippi, Missouri, New York, Oklahoma and Washington have issued decisions following the minority approach, limiting the scope of the AIA waiver of subrogation to only property damage covered by builder's risk insurance so damage to an existing building during a reroofing contract would not be subject to the waiver. Some states have conflicting intermediate appellate court decisions, and in some states there is not yet a definitive decision.

Another example

The Indiana Supreme Court's decision in the Jefferson County case was similar to a 2012 decision by the Texas Court of Appeals in American Zurich Insurance Company as Subrogee of the Varsity Golf Club, Ltd. d/b/a The University of Texas Golf Club v. Barker Roofing Company.

In this case, the University of Texas Golf Club, Austin, entered into an AIA construction contract for clubhouse improvements with Harvey-Cleary Builders, Austin, who subcontracted the roofing work to Barker Roofing L.P., Austin. The university club obtained builder's risk insurance from Fireman's Fund Insurance Co., Novato, Calif., with policy limits of $5.8 million. The subcontract between Harvey-Cleary Builders and Barker Roofing stated the university club or Harvey-Cleary would provide builder's risk insurance and incorporated the AIA waiver of subrogation. The subcontract also included a broad indemnification obligation running from Barker Roofing to the university club and Harvey-Cleary Builders.

A fire started while Barker Roofing's personnel were using a propane torch, causing $8 million in damage to the clubhouse and $930,000 to contents within the building. Fireman's Fund Insurance paid $5.8 million for the damages to the building and $930,000 for the damage to property within the building. American Zurich Insurance Co., Schaumburg, Ill., paid $500,000 to the university club for business interruption losses.

American Zurich Insurance brought a subrogation suit against Barker Roofing alleging Barker Roofing's negligence caused the fire that resulted in the property and business interruption losses. The trial court granted Barker Roofing's motion for summary judgment, agreeing with Barker Roofing that the university club had contractually waived subrogation rights per the provisions in the AIA contract documents. American Zurich Insurance appealed to the Texas Court of Appeals, which also ruled the subrogation claim was barred by the waiver of subrogation provision in the contract documents.

The Texas Court of Appeals found the parties intended the language in the prime contract between Harvey-Cleary Builders and the university club served as a waiver of claims against Harvey-Cleary Builders and its subcontractors. Because an insurer's rights are limited to those of the insured, this language operated as waiver of any subrogation claims of the insurer. This waiver was effective whether the university club already had purchased insurance or later purchased insurance covering damage to the clubhouse resulting from fire or other perils.

The court of appeals also concluded Barker Roofing was entitled to benefit from the waiver provision as a third-party beneficiary because the waiver clause listed subcontractors among those against whom the owner and contractor waived rights.

American Zurich Insurance argued a broad indemnification obligation in Barker Roofing's subcontract negated the waiver provisions. The Texas Court of Appeals held the indemnification clause in Barker Roofing's subcontract, though broad, could be read in a way that it did not modify or conflict with the waiver clause. Instead, the court held the indemnification clause referred to compensation and liability losses not covered by property insurance.

The court of appeals considered American Zurich Insurance's arguments that its claim was not subject to the waiver clause because the university club's business interruption was not damage to the work itself and the business interruption insurance provided by American Zurich Insurance was not property insurance. The court held the interruption of an owner's business is a proper element of property damages. Therefore, American Zurich Insurance's business interruption insurance was considered property insurance, and because the university club had waived its rights against Barker Roofing for property damages, American Zurich Insurance's rights also were waived.

Water damage cases

Although many of the waiver of subrogation cases interpreting the scope of the AIA waiver provision pertain to losses caused by fires, the same principle has been applied to water damage claims where the owner's property insurance policy applied to the work performed by the contractor and property damage to the building and its contents. One of the leading and oft-cited cases addressing water damage to interior property and the AIA waiver of subrogation is a 1994 decision by the California Court of Appeal, 4th District, in the case Lloyd's Underwriters v. Craig and Rush, Inc.

In this case, the owner, Mercy Rehabilitation and Care Center, Oakland, Calif., using standard AIA contract documents, contracted with Craig & Rush Inc., San Marcos, Calif., and Westerly Mechanical Inc., San Diego, to perform roof system repairs. During the job, rain entered the building and damaged the building's interior. The owner's property insurer carrier, Lloyd's Underwriters, London, paid the owner's claim minus the deductible and then sued the contractors.

The AIA contract documents included the provisions that the owner was to purchase and maintain property insurance in the amount of the contract to include the interests of the owner, contractor, subcontractors and sub-subcontractors and that the owner and contractor waived all rights against each other for damages caused by fire or other perils covered by property insurance obtained pursuant to the AIA contract or other property insurance applicable to the work. To meet its insurance obligation, Mercy Rehabilitation and Care Center chose to rely on its existing all-risk property insurance policy rather than purchasing a separate builder's risk policy with coverage limited to roofing work.

In ruling against Lloyd's Underwriters and in favor of the contractors, the California Court of Appeal said the plain meaning of the AIA language is "so long as a policy of insurance applicable to the Work pays for the damage, the waiver applies." Succinctly stated, the court ruled "[t]he waived claims are not defined by what property is harmed (i.e. 'any injury to the Work'); instead, the scope of waived claims is delimited by the source of any insurance proceeds paying for the loss (i.e. whether the loss was paid by a policy applicable to the Work)."

The court said the AIA language defined waived claims not by the type of property damaged but by which policy provided coverage for the loss. Because the property insurance policy that paid for the interior damage was the insurance policy obtained by the owner applicable to the work of the contractors, the waiver applied so the contractors did not incur liability for the interior damages.

In the 2001 case Independent School District 833 v. Bor-Son Construction, the Minnesota Court of Appeals ruled the school district waived subrogation rights to pursue a substantial interior damage claim resulting from water entry during reroofing based on the waiver language in the AIA A201 General Conditions.

During the course of reroofing several schools, the roofing contractor failed to keep three elementary schools watertight, leading to a $775,086 interior property damage claim.

The school district recovered from its property insurer, and a subrogation suit was filed against the contractor to recover the payment made by the Minnesota School Board Association Insurance Trust, St. Peter, Minn., based on the argument that only damage to the roof was waived and there should be recovery for the extensive interior damages to the existing buildings. The trial court ruled in favor of the school district on the grounds the AIA waiver did not apply to "nonwork" property.

The Minnesota Court of Appeals reversed the trial court's decision because the school district had satisfied its contractual obligation to obtain builder's risk insurance by purchasing an endorsement to its existing property insurance policy. Because the builder's risk coverage was an endorsement to the existing property insurance policy rather than a separate policy that clearly distinguished between work and nonwork and the underlying policy supplemented by the endorsement covered work and nonwork property, the court ruled the school district waived its subrogation rights to sue for all damages covered under the policy.

The takeaway

At the outset of all construction projects, the parties should be sure builder's risk and property insurance are in place. The AIA contract documents call for the owner to purchase and maintain builder's risk and other property insurance. In situations where a claim is made against a contractor for property damages to an existing or adjacent building or another contractor's work during the course of construction, the contractor should review the contract documents to see how insurance obligations were allocated among the parties and whether the contract reflects an intent that such claims be handled strictly through insurance.

Courts that have been called on to interpret the AIA waiver of subrogation provision and adhere to the majority approach frequently make the point that the provision's intent reflects a policy favoring handling property damage claims arising during construction be resolved exclusively through insurance so construction proceeds without litigation among the parties. Given the widespread use of the AIA contract documents, you might be surprised to learn a claim that is being directed against you and may even be a result of your fault is to be covered by property insurance that another party is required to maintain.

Stephen M. Phillips is a partner with Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.