Steven G.M. Stein, Stein Ray LLP, Chicago 3

“Cover Me”1: Owner’s Requirements for Additional Insured Status on Contractor’s General Liability Policies and Professional Liability Insurance2

Steven G.M. Stein, Stein Ray LLP, Chicago3

I. Introduction

Sophisticated owners seek to create a web of commitments to safeguard them from most construction project risks. When skillfully assembled, commitments obtained from others backstop the risks of calamity, defective work, defective design, and claims made by third parties. When inexpertly considered, these safeguards are mere illusions. This paper will explore one of the least well understood forms of insurance coverage, the status of an additional insured under a contractor’s general liability policy, and a safeguard that is thought to be well understood but in practice is less so—professional liability insurance of design professionals.

II. Project owner’s risk environment

In any construction project there are a variety of risks to be accounted for and, to the extent possible, insured against or otherwise covered. These risks fall into four4 categories: (i) the risk of damage to or loss of the structure being built, ordinarily covered by a builder’s risk insurance policy5; (ii) the risk of a design professional’s errors or omissions insured under a professional liability insurance policy6; (iii) the risk that the construction work will be defective for which the contractor’s promise to provide for remediation may be financially secured through a performance bond or for which coverage may be available through the contractor’s Commercial General Liability (CGL) policy7; and (iv) the risk of liabilities to third-parties arising during construction from personal injuries or property damage which is insured against

1 BRUCE SPRINGSTEEN, Cover Me, on BORN IN THE U.S.A. (Columbia Records 1984).

2 The information contained herein may not be appropriate for your particular needs and laws in your jurisdiction, are offered for informational purposes only, and should not be construed as legal advice. No attorney/client relationship is created between you and the author of this article by your viewing or use of any information contained herein. The information contained herein is provided without any warranty, express or implied, as to its legal effect, completeness, currency, and relevance.

3 http://www.steinraylaw.com. Brandon Clark, an associate of the firm, assisted in the authorship of this paper.

4 A fifth category of risk common to construction projects is delay. That risk, however, is ordinarily not covered by bonds or insurance.

5 4 STEVEN G.M. STEIN, CONSTRUCTION LAW ¶ 13.01[3][g] (LexisNexis Matthew Bender); Mark M. Bell, Christopher S. Dunn & James H. Costner, Confronting Conventional Wisdom on Builder’s Risk: From Named- Insured Status to Concurrent Causation, 31-FALL CONSTR. LAW. 15, 15 (Fall 2011).

6 CLARANCE E. HAGGLUND, ET AL., CGL POLICY HANDBOOK xix-xx (1st ed. Supp. 2002); 4 STEIN, supra note 5, ¶ 13.06. through a CGL policy.8 A general overview of these risks and the ways in which they are protected against are examined next.

A. Damage to or loss of the structure

Construction projects are at risk for damage or destruction by a number of events ranging from fires, windstorms, hail and floods, to catastrophic natural phenomena such as hurricanes and earthquakes. Many of these may be insured against through the purchase of builders’ risk policies. 9 Builder’s risk policies are first party insurance10; accordingly, third party claims for damage are not covered. Instead, the policy provides direct reimbursement to the policyholder for covered damage to or loss of the property.11 The insured usually includes the owner, contractor, and subcontractors to the extent of their interest in the property protected.12

Although characterized as “all risks,” the builder’s risk policy is actually substantially limited.13 Most importantly, it typically will not cover remediation of defective work,14 losses

7 Edwin L. Doernberger & Theresa A. Guerin, Construction Defects as an “Occurrence”: State Legislatures Weigh In, 21-6 COVERAGE 18, 18 (Nov./Dec. 2011); Marc A. Sanchez & Brad D. Reed, Bad Faith Claims and Performance Bonds 33-Summer CONSTR. LAW. 36, 36 (Summer 2013).

8 4 STEIN, supra note 5, ¶¶ 13.02[1]-[2].

9 Id. at ¶ 13.05[1].

10 Bell, et al., supra note 5, at 15.

11 Steven A. Coombs, Builders Risk Insurance: When Coverage Interpretation Relies on Nonpolicy Documents, IRMI ONLINE (July 2012), http://www.irmi.com/expert/articles/2012/coombs07-builders-risk-insurance.aspx.

12 Bell, et al., supra note 5, passim (questioning practice of providing coverage to contractors and subcontractors).

13 Id. at 23-24.

14 Metric Constr. Co. v. Allianz Global Risks U.S. Ins. Co., Ventura Cty. Super. Ct. No. SC034886, 2006 WL 3008451, at *1 (Ct. App. Cal. Oct. 24, 2006) (policy exclusion provided that there was no coverage for “cost of making good faulty or defective workmanship, material, construction, designs, plans and/or specifications but this exclusion shall not apply to direct physical loss or direct physical damage resulting from such faulty or defective workmanship, material, construction, designs, plans and/or specifications”) (emphasis omitted); Stagl v. Assurance Co. of Am., 539 S.E. 2d 173, 176 (Ga. Ct. App. 2000) (builder’s risk policy excluded coverage for poor workmanship); Wolstein v. Yorkshire Ins. Co., Ltd., 985 P. 2d 400, 408 (Ct. App. Wash. 1999) (“to hold that a builder’s risk insurance policy covers defective workmanship would convert the policy into a performance bond); 4 STEIN, supra note 5, ¶ 13.05[6]. arising from defective design15 or, because it is first party insurance, claims of others.16 The builder’s risk policy is simply not designed to cover these sorts of risks. Moreover, these risks are better protected against by other insurance or indemnity agreements.

B. Design negligence or malpractice

Losses and damages arising from design professionals’ errors or omissions are insured against through professional liability insurance. Regardless of the purchaser, professional liability insurance insures only design professionals.17 Neither owners nor contractors are insured parties and carriers do not permit them to be additional insureds.18 These policies are written on a “claims made” basis which requires the policy to be enforced when a claim is made against the insured.19 There are two typical regimes for the purchase of such policies. Policies purchased by the design professional itself and insuring all of its work across all of its projects are “practice policies.” The limits of such policies are available to all the design professional’s projects and claims made for any deplete the limits for others.20 Project policies, on the other hand, are usually purchased by the owner and have limits dedicated to the owner’s project; however, as with any professional liability policy, the design professional is the insured on the policy. 21 The primary benefit of such a policy to the owner is that in the event of a claim the owner will have access to the entire amount of coverage specified, because the coverage may not be reduced by other claims against the design professional that are unrelated to the owner’s project. Usually all design professionals and their consultants are insured through the same policy.22 Generally, professional liability policies are thought to cover all acts or omissions of design professionals. This is one fallacy to which this paper will return.

15 Mission Nat’l Ins. Co. v. Coachella Valley Water Dist., 210 Cal. App. 3d 484, 493 (Cal. Ct. App. 1989) (“defective design was an exclusion” of the contractor’s builder’s risk policy); Stagl, 539 S.E. 2d at 176 (policy exluded coverage for design work); 4 STEIN, supra note 5, ¶ 13.05[6].

16 Bell, et al., supra note 5, at 15.

17 3 ROBERT A. BREGMAN & JACK P. GIBSON, PROFESSIONAL LIABILITY INSURANCE, at XVII.E.39 (IRMI 2006).

18 4 STEIN, supra note 5, ¶ 13.06[3]; David H. Collings, Project Specific Professional Liability: Who Really Pays for Design Errors?, IRMI ONLINE (May 2000), http://www.irmi.com/expert/articles/2000/collings05.aspx.

19 3 BREGMAN, supra note 17, VIII.C.1.

20 Id. at VII.C.3.

21 4 STEIN, supra note 5, ¶ 13.06[8]; Collings, supra note 18; Rodney J. Taylor, Professional Liability Insurance for Construction Projects, IRMI ONLINE (April 2012), http://www.irmi.com/expert/articles/2012/taylor04-risk- management-environmental.aspx.

22 4 STEIN, supra note 5, ¶ 13.06[3]; Taylor, supra note 21.

3 C. Construction defects or failure to complete work

There are several options an owner has to backstop the contractual obligation a contractor usually has to remediate construction defects and the damages caused by them. Upon a default of a contractor to make good its work, the owner’s claim against the contractor may be covered by the contractor’s general liability policy.23 Alternately, a performance surety, if a performance bond has been secured, may be obligated to perform in the contractor’s stead.24 However, both potential sources of performance or recovery are problematic.

With respect to general liability coverage, the first hurdles arise from the fact that the general liability policy responds to third party claims for “occurrences.”25 Thus for an owner to recover losses sustained from defective work, its claims would necessarily have to be made against the contractor who performed the defective work but failed to remediate it. This poses several problems, first among them whether the existence of defective work is an “occurrence” covered by the policy.26 Courts have variously reached three different conclusions on whether defective work can be an “occurrence.”27 Those in some jurisdictions have reached the conclusion that construction defects never constitute occurrences, unless the defect causes damage to property other than the construction project itself.28 Those in a second group of jurisdictions have found that defective work is an occurrence when it causes damage to property other than the “insured’s work product,” including coverage for damage to the project if the insured’s work product damaged another part of the project.29 Those in a third group of

23 Shannon J. Briglia & Edward Etcheverry, The Construction Defect Hot Potato: The Interplay Between the Performance Bond and CGL Policy – A Surety’s Perspective, 77 DEF. COUNS. J. 30, 31 (Jan. 2010).

24 Id.; Doernberger & Guerin, supra note 7, at 20; Sanchez & Reed, supra note 7, at 36.

25 See generally, HAGGLUND, supra note 6, ch. 3.

26 J. Stephen Berry & Jerry B. McNally, Recent Developments in Insurance Coverage of Construction Defects, 41-4 TORT TRIAL & INS. PRAC. L.J. 1079, 1080 (Summer 2006) (“Whether a construction defect is an ‘occurrence’ has been hotly constested in many jurisdictions.”); see also Clifford J. Shapiro, The Good, the Bad, and the Ugly: New State Supreme Court Decisions Address Whether an Inadvertent Construction Defect is an “Occurrence” Under CGL Policies, 25-Summer CONSTR. LAW. 9 (Summer 2005) (discussing courts’ various methods of approaching the issue).

27 See generally Shapiro, supra note 26.

28 L-J, Inc. v. Bituminous Fire & Marine Ins. Co., 621 S.E. 2d 33, 36 (S.C. 2005); see also Shapiro, supra note 26, at 13-14 (discussing the predecessor to this opinion, which reached substantially same conclusion).

29 Auto-Owners Ins. Co. v. Home Pride Cos. Inc., 684 N.W. 2d 571, 578 (Neb. 2004); see also Shapiro, supra note 26, at 11 (discussing the case). jurisdictions have reached the conclusion that a defect is (not, may be) an occurrence; however, coverage for defects may still be excluded.30, 31

As alluded to above, even in jurisdictions that recognize defective work as an occurrence, coverage may nonetheless be unavailable because of policy exclusions. Key is the “your work” exclusion, which typically excludes coverage for “property damage to your work.”32 In many jurisdictions, however, this does not preclude coverage when the defective work was completed by a subcontractor, because the language of the exclusion usually includes an exception to the effect that it will not apply to work “performed on your behalf by a subcontractor.”33

For example, in Cherrington v. Erie Insurance Property & Casualty Co., the plaintiff homeowner sued her general contractor for various construction defects,34 including negligence in pouring and finishing concrete, finishing and painting of the structure, and placing and securing the foundation.35 The contractor sought coverage from its insurer, Erie.36 Erie denied coverage claiming the policy provided no coverage for construction defects, and won dismissal by summary judgment on that ground, and several others.37 This dismissal was appealed, and upon review the West Virginia Supreme Court held that the “your work” exclusion “does not operate to preclude coverage . . . for work performed by [the general contractor’s] subcontractors.”38 Specifically, this was because the second paragraph (which read “[t]his exclusion does not apply if the damaged work or the work out of which the damage arises was

30 Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 673 N.W.2d 65, 76 (Wis. 2004); see also Shapiro, supra note 26, at 9-11 (discussing the case).

31 See Doernberger & Guerin, supra note 7 (in an attempt to either bring some clarity to the issue, or perhaps lend some aid to the construction community, the state legislatures of Arkansas, Colorado, Hawaii, and South Carolina have recently enacted legislation making construction defects “occurrences” covered by CGL policies).

32 Steven G.M. Stein & Jean Gallo Wine, The Illusions of Additional Insured Coverage, 34-Spring CONSTR. LAW. 14, 18 (Spring 2014) (emphasis added).

33 R. Steven Rawls & Rebecca Appelbaum, Cover Me: The Subcontractor Exception to the Your [Completed] Work Exclusion, IRMI ONLINE (Apr. 2007), http://www.irmi.com/expert/articles/2007/rawls04.aspx; Id.

34 745 S.E.2d 508, 513 (W. Va. 2013) (the homeowner also filed a claim against a third-party who was involved in the project, but this aspect of the case is of no interest to this paper).

35 Id.

36 Id.

37 Id. 514-15.

38 Id. at 524.

5 performed on your behalf by a subcontractor”) acted to restore coverage for subcontractor’s work that would otherwise be excluded by the “your work” exclusion.39

Another example is the case of Broadmoor Anderson v. National Union Fire Insurance Co. of Louisiana, in which a subcontractor was found to be at fault for a construction defect that caused significant rework to a hotel after the project had been completed.40 At issue in the litigation was whether each of the construction defects was an “occurrence” for which the general contractor’s CGL policy provided coverage.41 Final disposition of the question rested on other grounds, but the court in Broadmoor clearly stated its position on the “your work” exclusion in dictum.42 The court stated: “[W]hile the ‘your work’ exclusion would broadly exclude property damage (as opposed to ‘bodily injury’) arising from the insured's own defective work on a construction project, an insured/general contractor which experiences the unanticipated risk of its subcontractor's defective work remains covered for that risk under the products-completed operations coverage.”43 Numerous other courts have reached similar conclusions.44

The preceding discussion is problematic in that it addresses the scope of general liability coverage and, confusingly for this paper, those aspects of such coverage not associated with the status of an owner as an additional insured. As an additional insured under a contractor’s general liability policy, an owner has no recourse against the policy for its own damages such as remediation costs or damages from defective work. Recall that the general liability policy responds to claims against insureds only—it is third party insurance coverage. This paper focuses on the status of the owner as an additional insured under a contractor’s policy with respect to the coverage enjoyed (or not enjoyed) by the owner for third party claims made against the owner.

39 Id.

40 912 S. 2d 400, 402-03 (La. Ct. App. 2005).

41 Id. at 403.

42 Id. at 407.

43 Id. at 408.

44 See, e.g., Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A. 3d 961, 983 (Conn. 2013) (“When read together, the ‘your work’ exclusion and the ‘subcontractor exception’ eliminate coverage for property damage caused by an insured contractor's work, but restore coverage for property damage caused by a subcontractor's work.”); K & L Homes, Inc. v. Am. Family Mut. Ins. Co., 829 N.W. 2d 724, 732 (N.D. 2013) (explaining Exclusion L was added to the standard CGL policy language in 1986 because “[t]he insurance and policyholder communities agreed that the CGL policy should provide coverage for defective construction claims so long as the allegedly defective work had been performed by a subcontractor rather than the policyholder itself”) (internal quotations and citation omitted). Another source of “coverage” for construction defects is a performance bond.45 Where the bond incorporates the construction contract, the surety will usually be responsible to complete the contractor’s obligations including to remediate defects46 and the damages caused thereby.47 But where a performance bond does not incorporate the underlying contract, the duties of the surety are limited to those on the face of the bond, which may not include defect remediation.

D. Claims made by third parties for bodily injury or property damage

Owners, developers and contractors purchase Commercial General Liability (CGL) insurance policies to cover potential liabilities to third parties for bodily injury and property damage.48 Bodily injury may include death, and lesser physical injuries, including sickness and even shock and mental anguish.49 It does not, however, cover personal injuries, such as defamation of character, slander or libel.50 Property damage covers loss of use of the property due to physical injury to or destruction of the property, along with damage to other property under the control of the named insured, such as the property of contractors and subcontractors that is on site.51

III. Additional insured coverage dissected

Part of the set of coverages and risk transfers used by owners to protect themselves is obtaining the status of additional insured on a contractors general liability policy. Owners/developers, general contractors, and higher-tier subcontractors will typically contractually require downstream parties to grant them additional insured coverage on the CGL policies.52 This shifts a portion of the cost to contractors and subcontractors where, arguably, it may be absorbed more efficiently, because the typical contractor will carry insurance policies that span multiple projects.53 This shift also incentivizes cautious behavior on the part of a

45 Sanchez & Reed, supra note 5, at 36.

46 Doernberger & Guerin, supra note 7, at 20; Sanchez & Reed, supra note 7, at 36.

47 Auto Owners Ins. Co. v. Travelers Casualty & Surety Co., 227 F. Supp. 2d 1248 (M.D. Fla. 2002) (surety may be forced to bear cost of damages incidental to remediation).

48 4 STEIN, supra note 5, ¶ 13.02[1].

49 HAGGLUND, supra note 6, 1-16; 4 STEIN, supra note 5, ¶ 13.02[2][a].

50 4 STEIN, supra note 5, ¶ 13.02[2][c].

51 HAGGLUND, supra note 6, 2-25 to -26; 4 STEIN, supra note 5, ¶ 13.02[2][b].

7 contractor, because its insurance may be called upon to cover the owner’s liabilities if the liability stems from the action of the contractor.54

A. Obtaining additional insured status

Owners become additional insureds on the CGL policies of their contractors and subcontractors because they contractually require that status. The way the owner imposes this obligation on its contractors, and in turn the way its contractors impose the duty on their subcontractors, can greatly affect the benefits conferred on the owner. Consider first the following example from the standard form AIA documents:

The Contractor shall cause the commercial liability coverage required by the Contract Documents to include (1) the Owner, the Architect and the Architect’s Consultants as additional insureds for claims caused in whole or in part by the Contractor’s negligent acts or omissions during the Contractor’s operations; and (2) the Owner as an additional insured for claims caused in whole or in part by the Contractor’s negligent acts or omissions during the Contractor’s completed operations.55

Compare the preceding contractual obligation with the following, based on language I routinely advise clients to use:

All insurance policies, except Workers' Compensation and Professional Liability, shall be endorsed to include the Owner and its members, managers, officers, directors, employees and agents ("Additional Insureds") as additional insureds, and shall contain express waivers by the insurance company of its rights of

52 Roberta Anderson, ISO’s 2013 “Additional Insured” Endorsement Changes Merit Close Attention, 23 A.B.A. SEC. INS. COVERAGE LITIG., no. 3, May-June 2013; Lynda A. Bennett & Andrew S. Zimmerman, Additional Insured Coverage in the Construction Setting, 277-Aug N.J. LAW. 78, 78 (2012); David M. McLain & Alex M. Nelson, Additional Insured and Insured Contract Liability Insurance Coverage for General Contractors, 36- Nov. COLO. LAW. 45, 45 (2007); Trisha Strode, From the Bottom of the Food Chain Looking Up: Subcontractors and the Full Costs of Additional Insured Endorsements, 25-Summer CONSTR. LAW. 21, 21 (Summer 2005).

53 Strode, supra note 52, at 22 (article claims this was original rationale for such coverage but that it may no longer be the primary objective).

54 Id.

55 Am. Inst. of Architects, AIA Document 201-2007 § 11.1.4). subrogation against such Additional Insureds. Additional Insureds shall be insured on all such insurance policies with at least the same coverages and limits as the named insured. All such insurance policies shall contain a severability of interest provision; shall be primary insurance as regards to any other insurance maintained by the Additional Insureds; and shall provide that the insurers shall have no recourse against the Additional Insureds for payment of any premium or assessment or reimbursement of any defense fees. Prior to commencement of the Work, Contractor shall provide Owner with copies of endorsements evidencing such additional insured coverage.

First, the recommended language clearly requires broader coverage, in that it requires coverage be extended to “all insurance policies,” which would expressly apply to umbrella coverages. Second, the language requires not only that the owner, but also “its members, managers, officers, directors, employees and agents” be protected. Under the standard AIA language, a contractor could comply by obtaining coverage for only the owner’s corporate entity. Third, the recommended language requires that the additional insured be covered to at least the same limits as the named insured. The value of this provision is twofold: the owner will not have less coverage than the named insured even if the limits of insurance in the contract are lower than the contractor’s actual coverage. And it protects the Owner from illusory coverage described below.

This latter issue became more important upon a recent revision to the standard endorsement forms that introduced language that limits additional insured coverage to the lesser of the amount the primary insured is contractually obligated to provide and the amount of the primary insured’s CGL policy limit.56 This can have implications on whether the owner will be able to access a contractor’s umbrella coverage (under which the owner may also be an additional insured). If, for example, a contractor agrees contractually to provide additional insured coverage to an owner for $1 million, but has a CGL policy with a $2 million coverage limit, under the new language of the additional insured coverage endorsements, the owner’s coverage under the contractor’s CGL policy would be limited to $1 million.57 If the contractor’s umbrella coverage is not accessible until the CGL policy is exhausted, then the owner may have

56 Stein & Wine, supra note 32, at 16.

57 Id.

9 no coverage between the two limits. Under the old endorsement language, the owner’s coverage was not limited to the lesser of the two values, so this issue would not have arisen.58

By requiring a severability of interest clause, the additional insured coverage takes the form of a separate policy, which has two very important benefits for the additional insured. First, it ensures that the policy will respond to claims brought by one insured against another insured.59 Without such a clause, as an example, if the owner were to sue a contractor for defective work the insurance policy would not provide coverage, because the cross liability exclusion precludes one insured from recovery under a policy of insurance issued in the favor of another insured on the same policy. However, a severability of interests clause acts to create a separate insurance policy for each insured in all respects, except that the liability limits remain shared by all insureds, and there remains only a single named insured.60

The second benefit to the additional insured is that a severability of interest clause removes many impediments to coverage for the owner. The case of Swank Enterprises, Inc. v. All Purpose Services, Ltd. is illustrative of this second benefit. Swank was general contractor to the City of Libby, Montana in the construction of a water treatment facility.61 Swank subcontracted with All Purpose to paint certain tanks and pipes at the facility and their contract required that All Purpose procure additional insured status for Swank under its CGL policy, which All Purpose did.62 After All Purpose had completed its work it was discovered that the wrong paint was applied and the work had to be redone, during which time the water treatment facility was not able to be in service.63 Following this discovery and rework, the City of Libby sued Swank and Swank tendered the claim to All Purpose’s insurer who refused coverage, citing the policies’ “your work” exclusion.64 Thereafter Swank was forced to tender the claim to its own insurer, and after settling the claim, Swank and its own insurer sought indemnification from

58 Id.

59 Jeff Woodward, “What Does “Separation of Insureds” Mean – Part 1, IRMI ONLINE (June 2001), http://www.irmi.com/expert/articles/2001/woodward06.aspx; see also, Parker v. John Moriarty & Assoc. Inc., No. 050981, 2007 WL 2429719, at *8 (Mass. Super. Ct. July 29, 2007) (holding that a severability of interests clause helped overcome a cross-suits exclusion in the additional insureds CGL coverage).

60 Jeff Woodward, supra note 59.

61 154 P.3d 52, 54 (Mont. 2007).

62 Id.

63 Id.

64 Id. at 54, 56. All Purpose’s insurer.65 The district court ruled, and the supreme court of Montana later agreed, that All Purpose’s insurer had inappropriately refused coverage and was liable to Swank and its insurer.66 In reaching this conclusion, the district court found, and the supreme court later agreed, that the severability of interests clause provided “All Purpose, as the named insured, and Swank, as the additional insured, with separate coverage, as if each were separately insured with a distinct policy. As the exclusions only reference the ‘named insured,’ they do not apply to Swank as an ‘additional insured.’”67 As such, Swank’s coverage as an additional insured, was broader than All Purposes’, as the named insured.68

As a side note, should the contractor or its subcontractors fail to obtain the specified coverage, they would be in breach of contract and would, therefore, most likely be liable for any damages that their insurance would have covered had they complied with the contract.69 However, this is plainly a less secure position for the owner, as the substantial balance sheet of the insurer is undoubtedly better insurance than the assets of the vast majority of contracting firms. This explains why owners should require certificates be provided by contractors from a broker or carrier indicating that the required insurance is in place. However, because the mere existence of a certificate does not prove coverage,70 it is prudent for the owner also to obtain copies of the policies in question.

In theory, when procured carefully, an additional insured is entitled to the same coverage as the primary insured party to the policy.71 For example, if a general contractor’s negligence results in an injury to a passerby and the general contractor’s Comprehensive General Liability (CGL) insurance policy names the project’s owner an additional insured, then should a claim be made against the owner by the injured passerby, the general contractor’s insurer should both defend and indemnify the owner for any resulting liability. Reality, however, often departs from theory. This departure is the focus of the next section of this paper.

65 Id. at 54.

66 Id. at 58.

67 Id. at 56.

68 See Douglas R. Richmond & Darren S. Black, Expanding Liability Coverage: Insured Contracts and Additional Insureds, 44 Drake L. Rev. 781, 808 (1996) (“When determining whether an exclusion should bar coverage for an additional insured, the presence of a severability of interests clause in the policy is construed to mean the policy should be read as if each insured were the only insured. Such a reading tends to expand coverage . . . .”).

69 Id. at 796.

70 Bennett & Zimmerman, supra note 52, at 79; id.

71 Strode, supra note 52, at 21.

11 B. Procurement of additional insured coverage by the contractor

There are primarily two ways a contractor may procure additional insured coverage for others. The first is through an omnibus clause, which automatically grants coverage to those who the contractor has agreed to make additional insureds, without the need for a specialized endorsement to its CGL policy. An example of a typical omnibus clause reads “[a]n additional insured is (a) any person, organization, trustee or estate to whom the named insured is obligated by virtue of a written contract or permit to provide insurance such as is afforded by the terms of this policy.” 72 The more widely employed means of granting additional insured status is by endorsement to the CGL policy.73 The language of these endorsements, across the insurance industry, is quite similar if not identical, because they tend to be either copies of, or based closely on, forms written by the Insurance Services Office (ISO), an insurance industry trade organization.74 Despite the lack of variation among these endorsements, courts do not always interpret them identically from jurisdiction to jurisdiction.75

C. Where additional insured status may be illusory

In response to what insurers have felt is broader than intended coverage, the language of the standard endorsements for additional insured coverage have undergone a series of revisions intended to rein in the coverage they grant additional insureds.76 Before revisions in 2004, the standard endorsement language granted coverage to additional insureds for liability “arising out of” the ongoing operations of and supervision of operations by the primary insured.77 After 2004, “arising out of” was traded for “caused, in whole or in part, by.”78 Numerous articles have pondered what effect this change in language would have.79 Now, ten years later, the answer is

72 See Richmond & Black, supra note 68, at 799.

73 Id.

74 Id.

75 Joseph P. Postel, How Will Courts Construe ISO’s New Additional Insured Endorsements?, IRMI ONLINE (July 2004), http://www.irmi.com/expert/articles/2004/postel07.aspx.

76 Se, generally Anderson, supra note 52; id.; Stein & Wine, supra note 32.

77 The injury “arising out of” the insured’s activities that are covered are usually limited to “bodily injury,” “property damage,” and “personal and advertising injury.” See McLain & Nelson, supra note 52, at 47; Stein & Wine, supra note 32, at 15.

78 Postel, supra note 75.

79 See, e.g., Anderson, supra note 52; Bennett & Zimmerman, supra note 52, at 78; McLain & Nelson, supra note 52, at 45; Postel, supra note 75; Stein & Wine, supra note 32. still not entirely clear. There are vast differences in the interpretation of these endorsements across jurisdictions, sometimes based on minor changes in language, and the interpretations are always in a state of flux—making it exceedingly difficult for an additional insured to know its scope of coverage. Worse, in some instances courts have read the language to exclude coverage for one’s own negligence, instead requiring that the primary insured be vicariously liable in order for the additional insured to enjoy coverage.80 In essence, under such a reading, the additional insured is only covered if they don’t need it. This is the very definition of illusory coverage, and is explored in detail by Worth Construction Co., Inc. v. Admiral Insurance Co.81

In Worth Construction, the New York Court of Appeals ruled that when the primary insured on a CGL policy is not itself liable in some way for the injury for which coverage is being sought, its additional insureds have no coverage.82 In the case, Worth Construction Company (“Worth”) was the general contractor on a project and had subcontracted the erection of a staircase to Pacific Steel Inc. (“Pacific”), who would erect the steel frame of the staircase, and another subcontractor, who was to pour associated concrete.83 As part of its subcontract with Worth, Pacific made Worth an additional insured on its CGL policy.84 After completing the initial erection of the steel, Pacific left the site, but was to return to the site following the pouring of all the associated concrete in order to add a railing to the staircase.85 After leaving the site, and before returning to install the railing, a worker for a third subcontractor was injured on the staircase when he slipped on fireproofing that had been placed on the staircase by yet another subcontractor.86 Predictably, the injured worker sued Worth for his injuries, and Worth tendered the claim to Pacific’s insurer who denied coverage.87 Worth then initiated a third-party claim

80 Worth Constr. Co., Inc. v. Admiral Ins. Co., 10 N.Y.S. 3d 411, 416 (N.Y. App. 2008); Bennett & Zimmerman, supra note 52, at 78; Engineering & Construction Innovations, Inc. v. L.H. Bolduc, 825 N.W.2d 695 (Minn. 2013); Stein, supra, ¶ 13.16[5]

81 10 N.Y.S. 3d 411 (N.Y. App. 2008); Strode, supra note 52, at 26; 4 STEIN, supra note 5, ¶ 13.16[5].

82 10 N.Y.S. 3d at 416.

83 Id. at 413.

84 Id.

85 Id. at 413-14.

86 Id. 414.

87 Id.

13 against Pacific seeking contribution and indemnification and a declaratory judgment action against Pacific’s insurer seeking defense and indemnification.88

Worth’s third-party claim against Pacific was eventually dismissed, because “any negligence claim [Worth] asserted against Pacific . . . lacked factual merit.”89 Following this dismissal, the trial court held in the remaining declaratory judgment action that the injured worker’s injuries did not “arise out of Pacific’s operations and therefore [its insurer] was not required to defend or indemnify Worth under the terms of the [additional insured] policy.”90 Upon review, the appellate court overturned this ruling, but it was subsequently reinstated by the Court of Appeals.91 Worth Construction, therefore, stands for the proposition that additional insured coverage does not apply to protect the additional insured from its own negligence.

In the above recommended language for requiring contractors and subcontractors to provide additional insured coverage to owners, the phrase “Additional Insureds shall be insured …with at least the same coverages as the named insured” is meant to address the holding of Worth Construction and other similar decisions. This is because the named insured is clearly covered for liability arising out of their own negligence—that is the very definition of the coverage. Explicitly stating that the Additional Insured’s coverage should include “at least the same coverages,” ensures that the Additional Insured will also be covered for their negligence.

Other jurisdictions have come to the opposite conclusion and have explicitly stated that additional insured coverage is to include coverage for the additional insured’s own negligence.92 For example, in Merchants Ins. Co. of New Hampshire, Inc. v. U.S. Fidelity & Guarantee Co., at issue was whether the general contractor’s insurer had a duty to defend, and to contribute to the eventual settlement that arose from an injury to a subcontractor who was injured in part due to the general contractor’s “own negligence.”93 The court held that because the injured worker was

88 Id.

89 Id. at 414-15.

90 Id. at 415.

91 Id. at 416.

92 See, e.g., Merchants Ins. Co. of N.H., Inc. v. U.S. Fid. & Guar. Co., 143 F.3d 5, 9–10 (1st Cir. 1998) (holding that an “additional insured” general contractor is covered for its “own negligence”); McIntosh v. Scottsdale Ins. Co., 992 F.2d 251, 254 (10th Cir. 1993) (“[W]e believe . . . like courts in other jurisdictions that liberally construe ambiguous insurance policy provisions in favor of the insured . . . that the additional insured endorsement does not limit the policy's coverage to cases where [the additional insured] is held vicariously liable for [the primary insured’s] negligence.”).

93 Merchants Ins. Co. of N.H., 143 F.3d at 6-7. working within his scope of employment and would not have been at the work site if not for the general contractor, his injury “arose out of” the general contractor’s work, and, therefore, the general contractor’s insurer was required to defend and indemnify the general contractor.94

Clearly, regardless of the care put into precise drafting of the endorsements’ language, there will remain some question as to the true extent of the additional insured coverage granted. Moreover, the landscape continues to change—the most frequently used endorsements in the industry were revised again in 2013.95

Compounding the illusory nature of additional insured coverage, at least one state appellate court has ruled that purchasing insurance to provide coverage for another party’s negligence is in violation of that state’s anti-indemnity laws.96 Such a holding clearly ignores commercial reality; however, it nonetheless eviscerates additional insured coverage in the state.

IV. Professional liability insurance coverage and exclusions

CGL policies routinely exclude coverage for professional services,97 which in the construction context most often impacts architectural and engineering services, but can also implicate land surveys, landscaping design, and others similar services, making the scope of this exclusion difficult to ascertain.98 Therefore, any design professional with whom the owner contracts with should be required to carry professional liability insurance coverage. The process by which the owner ensures this, and the extent of the coverage this provides, is the focus of the remainder of this paper.

A. Ensuring design professionals are appropriately insured

Owners typically require design professionals (e.g., architects, engineers) to carry professional liability insurance.99 Since the majority of claims against professional liability

94 Id. at 9-10.

95 See generally Anderson, supra note 52; Stein & Wine, supra note 32.

96 Liberty Mut. Ins. Grp. v. Travelers Prop. Cas., No. 80560, 2002 WL 1933244, *4 (Ohio App. Aug. 22, 2002).

97 3 BREGMAN, supra note 17, VII.F.1.

98 Id. at XVII.B.3. See also, e.g., Continental Cas. Co. v. Hartford Accident & Indem. Co., 836 F. Supp. 246, 250 (E.D. Pa. 1993) (obligation of engineer to assist owner with respect to site safety was non-professional duty; what constitutes “professional service” may be difficult to determine); Leverence v. U.S. Fidelity & Guar., 462 N.W. 2d 218, 227 (Wis. App. 1990) (“[T]he term ‘professional services’ has a broad meaning;” collecting cases), overruled on unrelated grounds by Wenke v. Gehl Co., 682 N.W. 2d 405 (Wis. 2004).

99 Taylor, supra note 21.

15 insurance policies are made by owners seeking damages for failings of their design professionals,100 it is in the owner’s best interest to carefully consider the needs of its project in regard to professional liability coverage.101

We recommend the following language (with limits that vary from project to project) be used by owners in their contracts with design professionals regarding the purchase by the design professional of professional liability insurance:

Architect shall maintain professional liability insurance with respect to its services under this Agreement in an amount not less than Five Million Dollars ($5,000,000) per claim and aggregate limit for each policy year (subject to increase in accordance with the following paragraph). The Architect covenants and agrees to maintain such coverage for a period of not less than three years following substantial completion of the Project.

The professional liability policy shall be written on a claims-made basis with retroactive coverage (allowing claims arising from acts which occur prior to the policy year of any such insurance including the entire prior period in which the Architect provides services in connection with the Project and thereafter). Architect shall regularly monitor the claims asserted against the Architect in any given policy year which are covered by such professional liability insurance (“Covered Professional Liability Claims”). In the event the Covered Professional Liability Claims collectively exceed Two Million Dollars ($2,000,000), the Architect shall (a) notify the Owner within five (5) business days of Architect’s discovery thereof and (b) if and to the extent requested by the Owner, purchase additional professional liability insurance in an amount necessary to ensure that at least Five Million Dollars ($5,000,000) of professional liability insurance remains available to cover Covered Professional Liability Claims made by the Owner under this Agreement or otherwise relating to the Project (and, in

100 Id.

101 It may also be that the best interests of the owner will be served by another arrangement for supplying professional liability insurance coverage, such as an Owner’s Professional Protective Indemnity (OPPI), or a project specific professional liability policy. However, in-depth discussion of these is beyond the scope of this article. such event, provide the Owner with such evidence thereof as the Owner may reasonably request). The deductible on the professional liability policy insurance required hereunder shall not exceed $250,000 without the prior written consent of the Owner.

The requirement to maintain coverage past substantial completion and the reporting requirements act to ensure coverage will be available at all times throughout the project and beyond. Moreover, should other claims threaten the coverage, the owner has authority to require the architect to increase its insurance coverage. The reasons for these requirements are explored below.

Requiring that coverage continue to be provided beyond completion of the project is important because of basic differences between typical professional liability insurance policies and CGL policies. Professional liability insurance is written almost exclusively on a claims made basis,102 whereas CGL policies are written almost entirely on an occurrence basis.103 The difference between the two is that to determine whether there is coverage for a claim under an occurrence based policy the determinative factor is when the injury occurred; that is, was the policy in question in effect at the time of the injury.104 For a claims based policy, the question is whether the policy in question was in effect when the claim was made.105 As many, if not most, claims against design professionals are made after the project is completed, it is thus important that the policy remain in place through the period when claims are most likely to be made. If a professional retires, or stops carrying insurance, or changes insurers and the new insurer disclaims any responsibility for past projects, no coverage will be available. These are reasons for the contractual obligation to maintain coverage.106

Allowing for replenished coverage is also wise. The typical professional liability policy will include an aggregate annual limit,107 which erodes with costs of defense and payment of claims.108 The reporting requirements and authority to demand increased coverage allow the owner to rectify any potential shortfalls in coverage.

102 3 BREGMAN, supra note 17, IV.H.12; 4 STEIN, supra note 5, ¶ 13.06[2].

103 Craig F. Stanovich, The Claims-Made CGL Policy, IRMI ONLINE (Nov. 2012), http://www.irmi.com/expert/articles/2012/stanovich11-cgl-general-liability-insurance.aspx.

104 See id.

105 Id.

106 4 STEIN, supra note 5, ¶¶ 13.06[2], [2][b].

107 Id. at ¶ 13.06[7].

17 Finally, specifying deductibles that are commensurate with the financial strength of the design professional ensures that coverage will be available before the design professional is crippled by claim-associated costs. Many, if not most, design professionals do not maintain large cash reserves, and therefore, in most instances a modest deductible will be preferable.

B. Procuring professional liability insurance by the design professional

What qualifies as professional services, and determining which ones are covered, is not entirely straightforward. As stated previously, courts have struggled to define what are and are not professional services. Perhaps in response, some insurers will only cover those services disclosed on the design professional’s application for insurance.109 This issue is important only on the fringes where design professionals render atypical services. More important are a number of coverage exclusions that may take the injury outside the policy’s coverage.110 Some of the more common and important of these exclusions, from the perspective of the owner, are discussed below.

Warranties and guarantees exclusion

Coverage for warranties and guarantees made by the insured professional are all but certain to be excluded from a professional liability insurance policy.111 Design professionals traditionally provide a service (design work) and promise (implicitly or explicitly) that it will be rendered to a certain standard of care; however, they do not warrant or guarantee that any specific result will be achieved.112 Therefore, professional liability insurance policies exclude coverage for warranties or guarantees made by the design professional. For coverage of the warranty or guarantee divorced from the professional’s standard of care, a separate insurance policy or performance bond will be required.

Indemnification exclusion

Professional liability insurance policies routinely exclude coverage for contractually assumed indemnification requirements.113 Though insurers may be willing to provide coverage for indemnification agreements after review of the underlying the contract, and payment of

108 Id. at ¶¶ 13.06[5][a]-[b], [7].

109 Id. at ¶ 13.06[1].

110 3 BREGMAN, supra note 17, XVII.E.20 et seq.; 4 STEIN, supra note 5, ¶¶ 13.06[4][a]-[r].

111 3 BREGMAN, supra note 17, XVII.E.24; 4 STEIN, supra note 5, ¶ 13.06[4][a].

112 Bates & Rogers Constr. Corp. v. N. Shore Sanitary Dist., 414 N.E. 2d 1274, 1280 (Ill. App. 1980); City of Mounds View v. Walijarvi, 263 N.W. 2d 420, 423 (Minn. 1978). additional premium, by default such agreements will not be covered.114 It is important to note, however, that this exception applies only to contractually assumed duties. If the duty to indemnify would exist in absence of the contract—for example, if a design professional agreed to indemnify an owner for damages the owner suffered as the result of the design professional’s negligence—coverage would exist. This is because this duty to indemnify would exist independent of the contractual agreement.115

Non-completion or delayed completion exclusion

Some policies may contain an exclusion for coverage for failure to complete work in a timely fashion or complete it at all, unless the failure is the result of a breach of the professional’s standard of duty.116

Estimates of cost, quantity, and time exclusion

Coverage for incorrect cost, quantity and time estimates is generally excluded.117 These can be considered, in a sense, a special subset of the exclusion of warranties and guarantees, or non-completion, in that the cost or quantity that was promised was exceeded and the estimated completion deadline was missed. Though coverage for these transgressions may arguably be excluded on these grounds alone, some policies will have an explicit exclusion just in case.

Extraordinary professional services exclusion

Insurers evaluate the risk of their policies in full knowledge of the type of services provided by their policyholders and the professional standards to which their policyholders are held.118 It is with knowledge of this level of risk that insurers determine their expected losses and intelligently set their rates; therefore, only known or “normal” professional services will enjoy coverage.119

113 3 BREGMAN, supra note 17, XVII.E.27.

114 Id.

115 Id.; see also 4 STEIN, supra note 5, ¶ 13.17[8].

116 4 STEIN, supra note 5, ¶ 13.06[l]; JUSTIN SWEET, LEGAL ASPECTS OF ARCHITECTURE, ENGINEERING AND THE CONSTRUCTION PROCESS 285 (6th ed. 2000).

117 4 STEIN, supra note 5, ¶ 13.06[f].

118 SWEET, supra note 116, at 284.

119 Id. at 283-84.

19 Joint ventures exclusion

Work performed as part of a joint venture is not typically covered by default by professional liability insurance.120 Some insurers, upon notice and request, may cover their own insured’s work completed as part of the joint venture, but most likely would not cover the work of the other joint venturer.121 Thus, in dealing with a design professional who is working as part of a joint venture, it is important to ensure that either both joint venturers are insured for their own actions while a member of the joint venture, or that the joint venture acquires its own professional liability coverage.

Others

A number of other exclusions are sometimes included in professional liability insurance policies, but are invoked fairly rarely in comparison to those discussed above. Some examples of these are exclusions for dishonest acts, pollution related claims, asbestos related claims, and punitive damages.122 It is difficult, if not impossible, to assemble a comprehensive list of all the various exclusions that might apply; therefore, it is imperative that the owner’s attorney closely examine the actual policy in place and evaluate the coverage provided in light of the project being undertaken. Failure to do so may well result in unwelcome, and likely unnecessary, coverage gaps.

Exclusions in effect

Despite the ubiquity of these and other exclusions, very few reported cases address them squarely. What’s more, those few reported cases seemingly construe them narrowly, a good example being Comstock Insurance Co. v. Thomas A. Hanson & Associates, Inc.,123 in which the court held that if a failure to exercise the standard of care resulted in a misestimate of costs, coverage existed.

In order to resolve the dispute in Comstock, the court closely examined a policy exclusion similar to the “cost, quantity, and time estimates” exclusion discussed previously.124 In

120 4 STEIN, supra note 5, ¶ 13.06[i].

121 Id.

122 3 BREGMAN, supra note 17, XVII.E.30; id., ¶¶ 13.06[h], [p], [q], [r]; SWEET, supra note 116, at 284-85.

123 550 A. 2d 731 (Md. Ct. Spec. App. 1988). Another reported case reaching a similar conclusion, McMahan & Baker, Inc. v. Continental Casualty Co., 843 P. 2d 1133 (Wash. Ct. App. 1993), relied in part on Comstock Insurance Co.

124 550 A. 2d 731 (Md. Ct. Spec. App. 1988). Comstock, an architect was retained to conduct a feasibility study for renovating a building.125 Based on the architect’s representations that the renovations could be completed at a particular cost, his clients purchased the property.126 Subsequently, they discovered that the architect’s analysis was deeply flawed and the contemplated renovations were not actually possible at a profitable cost.127 After settling with his former clients, the architect and his former clients sought indemnification from his professional liability insurer, but were rejected on the basis of a clause in his policy that excluded coverage for “express warranties or guarantees, estimates of probable construction or cost estimates being exceeded.”128

The court began its analysis of the policy exclusion with the presumption that the employer of an architect “generally wants, and is given, either explicitly or implicitly, some assurance that the project as designed can be built within a certain cost range.”129 It then hypothesized that nearly any negligence by the architect could adversely affect this assurance, and therefore many, if not most, claims of negligence against the architect could be framed as a breach of this assurance.130 Extrapolating from this, the court reasoned that to apply the exclusion so broadly would exclude coverage for “precisely what the policy is intended to cover.”131 Therefore, the court held that the better approach is to examine the “nature and cause of the cost overrun” in order to determine whether the exclusion applies.132 Doing so, the court held that if events outside the control of the architect or that the architect could not “reasonably have anticipated or measured in the preparation of his cost estimate” were the cause of the cost overrun then the exclusion should apply.133 Because the architect in Comstock breached the

125 Id. at 732.

126 Id.

127 Id. at 732-33.

128 Id. at 734.

129 Id. at 739.

130 Id.

131 Id. at 740.

132 Id. at 739.

133 Id. at 739 (the court noted that under its reading this would be more of a clarification than an exclusion, since errors in estimating due to events beyond the control or prediction of the architect, would not be the result of the architect’s negligence, and therefore, no liability should attached to the architect).

21 professional standard of care, the court ruled that his professional liability insurer owed coverage, even though the end result of this breach manifested as an erroneous cost estimate.134

Conclusions

Additional insured coverage and professional liability coverage are two frequently employed means of risk shifting in construction projects, but the requirements of the contractor and the design professional to procure their coverages must be well tailored.

134 Id. at 733, 740.