Construction contracts frequently include a provision calling for a contractor or subcontractor to waive subrogation rights. If such a waiver remains in a contract, the party providing the waiver strips its insurance carrier from potentially recovering payment for the claim.
Given the frequent inclusion of waivers of subrogation in construction contracts, it is important to understand the legal concept of subrogation and potential effect of a waiver of subrogation clause. However, these waivers may vary and how to approach them depends on how a waiver may be applied in the future.
What is subrogation?
In its simplest form, subrogation is the right of one party to "stand in the shoes" of another party to enforce the first party's rights by bringing a legal claim. When discussing subrogation, specific terminology often is used to describe the parties and concepts involved. The "subrogee" is the party that seeks to enforce the rights of another party through subrogation. The "subrogor" is the party whose rights are being enforced by the subrogee.
The typical example of subrogation involves a lawsuit filed by an insurance company that has paid a claim for which the insurance company believes a third party is responsible. In this case, the insurance company is the subrogee and the insured in the subrogor. By paying the claim, the insurance company is "subrogated" to the rights of the insured against the third party that is responsible for a loss or damage and can file a lawsuit against that third party to recover for the claim.
For example, if your vehicle is damaged in an automobile accident and another driver is at fault for the accident, your automobile insurer will pay your claim to have the damage to your vehicle repaired. When your insurer pays to repair this damage, your insurer becomes subrogated to your rights for that damage and can stand in your shoes to file a lawsuit against the other driver as though you were filing the lawsuit yourself. In most states, the lawsuit filed by your insurance company would be brought in your name or your company's name.
Subrogation serves two primary goals. First, it prevents the party suffering the loss or damage from recovering twice for that loss or damage. In the example, double recovery would occur if you were paid by your automobile insurance company for the damage to your vehicle and then were able to sue and recover your damages from the driver who caused the accident.
The second goal of subrogation is to ensure the party that pays for the loss or damage (your insurer) is reimbursed by the party that caused the loss or damage.
An insurance company's right to subrogation may be created in two ways: through an agreement, which almost always takes the form of language in an insurance policy, or through a state statute explicitly granting the insurance company the right to subrogation.
Waivers of subrogation
Construction contractors are routinely asked to sign contracts containing clauses that waive their insurers' subrogation rights or requiring contractors to obtain endorsements to their insurance policies that waive their insurers' subrogation rights. These provisions cut off insurers' rights to recover from those responsible for covered losses.
In a typical roofing contract, a roofing contractor may be required to waive his or her rights (and, therefore, his or her insurer's rights) against the general contractor or owner to recover for injuries or damages covered by workers' compensation insurance, commercial general liability (CGL) insurance, automobile liability insurance, excess liability insurance or other property insurance.
To illustrate how a waiver of subrogation operates, consider the following example: You contract with a general contractor to roof a new elementary school. The general contractor-drafted subcontract requires you to comply with state law by obtaining workers' compensation coverage for your workers on the project. The subcontract also requires you to waive subrogation against the general contractor and owner for claims covered under your workers' compensation insurance, and you pay the additional premium to add the appropriate endorsement to the policy.
While working on the project, one of your employees is severely injured when he falls through an opening in the roof made by the general contractor, who failed to cover the opening. As a result of the injury, your workers' compensation carrier pays your employee's medical expenses, lost wages and rehabilitation costs. Your insurer wants to bring a claim against the general contractor to recover the benefits paid to your employee, but the waiver of subrogation precludes this, ultimately causing an increase in your workers' compensation experience modifier and premium.
A waiver of subrogation may occur in an explicit provision in a contract's insurance section either stating you waive your rights to recover against certain parties (which are typically the general contractor and/or owner) for damages or losses covered by specific insurance coverage you provide for the project or simply requiring you to ensure specific insurance policies covering the project contain a provision waiving your rights and the insurer's rights to recover against those parties.
Regardless of the form of the waiver of subrogation, it is intended to ensure your insurer cannot file a lawsuit to attempt to recover from the parties covered by the waiver. The waiver's scope will vary depending on the specific type of coverage to which it applies.
Although waiver of subrogation clauses vary, the following are examples of clauses you could see in a typical one-sided owner- or general contractor-drafted contract:
The contractual waiver of subrogation typically occurs through an endorsement added to your insurance policy. As alluded to in the examples, such an endorsement states the insurance company will not enforce its rights to recover against other parties under the policy. Waiver of subrogation endorsements take two general forms—either a blanket endorsement, which applies to all parties with whom the insured has a written contract requiring a waiver of subrogation, or a scheduled endorsement, which applies to only those parties actually listed on its schedule.
Most insurance policies will allow a waiver of subrogation provided the waiver is made before a loss covered under the policy occurs. Sometimes, the policy explicitly states this pre-loss waiver requirement. In other instances, the prohibition on post-loss waivers of subrogation is stated more generally.
For instance, condition 8 of Insurance Services Office (ISO) Form CG 00 01, the standard CGL insurance policy, contains the following provision: "If the insured has rights to recover all or part of any payment we have made under this Coverage Part, those rights are transferred to us. The insured must do nothing after loss to impair them. At our request, the insured will bring 'suit' or transfer those rights to us and help enforce them."
This provision affirms the insurance company's right to subrogation against third parties and explicitly prohibits the insured from taking any action "after loss" to impair the insurance company's subrogation rights, prohibiting any waiver of subrogation to be given after a covered loss occurs.
Identifying the scope
Not all waivers of subrogation negatively affect contractors. In fact, in certain situations, waivers of subrogation make good business sense. They encourage parties to anticipate risks that may arise during a project and procure insurance covering those risks, avoiding potential litigation that could negatively affect the project.
Therefore, when faced with a waiver of subrogation clause in a general contractor- or owner-drafted contract, the first step in determining how to approach the waiver is to identify the waiver's true scope. This will involve a careful reading of the waiver and other related paragraphs of the contract.
Waivers of subrogation can be one-sided, with you being the only party agreeing to waive your rights and your insurer's rights, or mutual, applying to both parties. Generally, mutual waivers of subrogation are preferred over one-sided waivers of subrogation.
The waiver's scope also will be dictated by the insurance policies that are included in and covered by the waiver. The example clauses included in this article demonstrate two distinct approaches in this regard. Sometimes, a roofing contractor will only be required to waive subrogation with respect to injuries or damages covered under certain enumerated insurance policies (such as in the example involving CGL and automobile liability insurance). However, more frequently, general contractors and owners are requiring roofing contractors and their insurers to waive all rights of subrogation under any policies obtained by roofing contractors for projects (as in the second example).
With one major exception that will be discussed later, the fewer insurance policies that are included and covered by a waiver of subrogation, the better positioned you and your insurer(s) will be to limit unrecoverable losses and the resulting premium increases.
A sliding scale
After identifying the precise scope of a waiver of subrogation, you will be able to evaluate and decide how to approach the waiver. Because of the differences in coverage providedunder various types of insurance that may be required for a particular project, you should employ a sliding scale approach to waivers of subrogation. With this approach, generally delete waivers of subrogation with respect to workers' compensation insurance and include waivers of subrogation with respect to builder's risk or other property insurance.
Please note that though this article is limited to waivers of subrogation with respect to workers' compensation, liability (CGL and automobile), and builder's risk or other property coverage, the principles discussed easily can be applied to other types of coverage provided for a given project.
Workers' compensation
As you are aware, workers' compensation insurance is mandatory, no-fault insurance that provides lost wages, medical costs, rehabilitation expenses and, if necessary, death benefits for employees who are injured at work. The no-fault system that is universal to state-administered workers' compensation programs allows an employee to obtain payment for these expenses without regard to the employee's personal negligence or fault. In exchange for this right, employees give up the right to sue their employers directly for injuries.
Generally, if one of your employees suffers an injury that arises out of his or her employment and that occurs in the course of his or her employment, your workers' compensation carrier will pay for the injury. Your carrier will pay workers' compensation benefits to your injured employee regardless of whether another party, such as a general contractor or owner, was responsible for the injury. Consequently, it is important your insurer is not precluded from recovering against those who may be responsible for the injury. If a general contractor or owner proposes a contract to you that contains a waiver of subrogation that includes claims covered by workers' compensation insurance, make every attempt to negotiate that waiver out of the contract.
Given the fact that workers' compensation coverage is almost always required in the U.S., the issue of waivers of subrogation is hotly debated, and states address these waivers in a number of ways.
A majority of states, including Florida, Georgia, Illinois, Maryland, Michigan, New York, North Carolina, Ohio, Tennessee, Virginia and Washington, recognize the enforceability of workers' compensation waivers of subrogation.
A smaller number of states, such as Kentucky, New Hampshire, New Jersey and Missouri, do not allow waivers of subrogation for workers' compensation coverage, declaring these waivers void as contrary to public policy.
Liability insurance
A waiver of subrogation for claims covered by liability insurance (such as CGL, automobile and excess liability insurance) falls in the center of the sliding scale. When possible, attempt to negotiate these waivers out of your contracts. However, because of the nature of liability coverage, pushing for the removal of these waivers is not as critical as it is with workers' compensation insurance.
CGL insurance generally will cover claims for bodily injury or property damage for which the insured is legally liable. The requirement that the insured must be responsible for the injury or damage differs greatly from the no-fault system employed in workers' compensation insurance. As a result, unlike workers' compensation insurance, your insurance carrier typically should not pay a claim under your CGL insurance or other liability insurance that was not your fault.
Builder's risk and other insurance
Mutual waivers of subrogation with respect to builder's risk or other property insurance obtained by an owner fall at the more reasonable end of the sliding scale. These waivers generally are fair to all parties involved and benefit roofing contractors in some situations, so they should not be deleted from contracts.
Builder's risk insurance applies to new construction projects only, covering property damage that occurs during the course of constructionand that is caused by external, fortuitous events for which no one is generally at fault, including lightning, windstorm, hail, vandalism or theft. It also covers damage caused by fire that may be caused by a party performing construction work or by an event for which no one is responsible.
Builder's risk insurance covers damage to the work itself rather than other portions of the existing building that are not part of the work. Builder's risk coverage is necessary because a typical CGL policy does not cover a new building or work to an existing building until construction is completed and the structure is approved for occupancy by the local building inspector.
When faced with this type of damage, it is beneficial for all parties to look to one source of recovery for the loss so project completion will not be affected by disputes between those working on the job or their insurance companies as to who should be responsible for the loss. This is the intent behind the waiver of subrogation found in AIA A201 General Conditions of the Contract for Construction.
Section 11.3.1 of the most current edition of the AIA General Conditions (AIA Document A201-2007) requires owners to purchase and maintain, unless the parties have agreed otherwise, a builder's risk policy covering the total value of the entire construction project. This insurance is intended to protect the interests of the owner, contractor, subcontractors and sub-subcontractors and covers loss or damage caused by fire, theft, vandalism, malicious mischief, collapse, earthquake, flood or windstorm.
Section 11.3.7 contains the actual waiver of subrogation and a "flow down" provision that requires contractors to obtain similar waivers of subrogation from subcontractors and sub-subcontractors. Section 11.3.5 contains a separate waiver of subrogation that applies in certain limited situations. When read together, Sections 11.3.5 and 11.3.7 contain two waivers of subrogation.
Section 11.3.7 contains a mutual wavier of subrogation for all losses covered by the builder's risk insurance the owner was required to obtain or by other property insurance applicable to the contractor's work. As a result of this waiver, all parties are to look to the property insurance coverage provided for the project as the exclusive source of recovery for loss or damage to the work and no claims or lawsuits for such losses can be asserted by one party against another.
On the other hand, Section 11.3.5 contains a one-sided waiver by the owner in favor of the contractor and his or her subcontractors, sub-subcontractors, agents or employees. This waiver is for any damage covered by other property insurance purchased by the owner that insures property at or adjacent to the site during construction or insures the completed project after final payment is made. Because most building owners purchase property insurance for their completed projects, this waiver provides substantial protection to contractors and subcontractors for losses caused by fire or other events covered by the owner's insurance.
AIA's waiver of subrogation can potentially benefit contractors. Take, for example, the 1997 Colorado case Town of Silverton v. Phoenix Heat Source Systems, Inc. In that case, the town of Silverton contracted with J-M Constructors Inc. for the installation of a new roof on the town hall. The parties used a standard AIA form contract that incorporated a previous version of the AIA A201 General Conditions containing the waivers mentioned previously. J-M Constructors subsequently entered into a subcontract with Phoenix Heat Source Systems Inc. to design, manufacture and install an electric snow melting system on the town hall's roof.
About 18 months after the project was complete and the town had made final payment to J-M Constructors, a fire occurred. A claim for the fire damage to the town hall was paid by the town's insurance company, which then filed suit against J-M Constructors and Phoenix Heat Source Systems based on the belief the fire had been caused by problems in the snow melting system installed by Phoenix Heat Source Systems.
In response to the lawsuit, J-M Constructors and Phoenix Heat Source Systems argued the town had waived its insurer's right to subrogation against them with respect to damages to the roof and snow melting system, which were considered part of J-M Constructors' "Work" under the contract. (For more information about differing applications of AIA's waiver of subrogation to property damage not considered part of a contract, see "Precedents and contract provisions," February 2004 issue, page 16.)
The court agreed, holding the AIA A201 waiver of subrogation clauses precluded the town from bringing a claim against J-M Constructors and Phoenix Heat Source Systems for the fire damage.
Given the waiver in Section 11.3.7, the result would have been the same had fire damage to the roof occurred during construction rather than after the roofing project was completed, provided damage was covered by the owner's builder's risk insurance.
Summing up
When faced with a waiver of subrogation, identify the waiver's scope so the appropriate approach can be taken. You should not agree to waivers that apply to losses covered by workers' compensation insurance. Although not as critical, try to avoid waivers that apply to losses covered by CGL or other liability insurance. No action is necessary if a contract contains a mutual waiver, similar to AIA's waiver of subrogation applying to losses covered by builder's risk or other property insurance.
Brian P. McCormick is an attorney with the Atlanta-based construction law firm Hendrick, Phillips, Salzman & Flatt.
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