CGL Contractual Liability Coverage

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Presenting a live 90-minute webinar with interactive Q&A CGL Contractual Liability Coverage: Navigating the Scope of the Liability Exclusion and its Exceptions Advocating Coverage Positions for Policyholders and Insurers TUESDAY, APRIL 19, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

David M. Kroeger, Partner, Jenner & Block, Chicago

Kristine M. Sorenson, Partner, Walker Wilcox Matousek, Houston

David Taubenfeld, Partner, Haynes & Boone, Dallas

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Contractual Liability Exclusion

Kristine M. Sorenson Walker Wilcox Matousek LLP 1001 McKinney Street, Suite 2000 Houston, Texas 77002 (713) 343-6580 [email protected] Exclusion b Contractual Liability Exclusion CG 00 01 04 13 “Bodily injury” or “property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages: (1) That the insured would have in the absence of the contract or agreement; or (2) Assumed in a contract or agreement that is an “insured contract,” provided the “bodily injury” or “property damage” occurs subsequent to the execution of the contract or agreement. Solely for the purposes of liability assumed in an “insured contract”, reasonable attorneys’ fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages because of “bodily injury” or “property damage,” provided:

6 Exclusion b Contractual Liability Exclusion CG 00 01 04 13

(a) Liability to such party for, or for the cost of, that party’s defense has also been assumed in the same “insured contract”; and (b) Such attorneys’ fees and litigation expenses are for defense of that party against a civil or alternative dispute resolution proceeding in which damages to which this insurance applies are alleged.

7 History of Contractual Liability Exclusion • 1973 ISO general liability form excluded coverage for liability assumed under any contract or agreement, except an “incidental contract” • “Incidental contract” defined to include the leases, easements, indemnification of a municipality, sidetrack agreement and elevator maintenance agreement. • If construction contractor desired coverage for liability assumed in an indemnification or hold harmless agreement, had to purchase separate coverage.

8 History of Contractual Liability Exclusion • 1986 ISO general liability form revised to exclude “bodily injury” or “property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. • Exception for liability or damages “assumed in a contract or agreement that is an ‘insured contract’ or that the insured would have in the absence of a contract or agreement.” • “Insured contract” defined to include contracts encountered in the construction business including hold harmless and indemnification agreements. • Specifically references assumption of another party’s tort liability for injuries/damage to third parties.

9 Scope of Exclusion

• “Liability assumed by the Insured under a contract or agreement presents an uncertain risk which cannot be determined in advance for the purpose of fixing premiums.” Gibbs M. Smith, Inc. v. U.S.F.&G. Co., 949 P.2d 337 (Utah 1997). • Before determining if the exclusion applies, the Insured must show that the Insuring Agreement is triggered. American Family Mut. Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004). • The Insured must show that the underlying lawsuit alleges “property damage” or “bodily injury” caused by an “occurrence” and not just purely economic damage for breach of contract. Id. • Does not mean coverage is excluded for all causes of action for breach of contract. Desert Mountain Properties, Ltd. v. Liberty Mut. Fire Ins. Co., 236 P.3d 421 (Ariz. App. 2010); Olympic, Inc. v. Providence Wash. Ins. Co., 648 P.2d 1008 (Alaska 1982). • Applies solely to liability for “property damage” or “bodily injury” assumed under a contract. • Some courts apply the exclusion only to the insured’s contractual assumption of a third party’s liabilities. • Some courts also apply the exclusion also to the insured’s contractual assumption of its own liabilities, but only in certain situations.

How do Courts interpret “Assumption of Liability in a Contract or Agreement”? • When the Insured contractually assumes the liability of a third party, such as an indemnification or a hold harmless agreement. American Family Mut. Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004). • When the Insured contractually assumes any obligation (not just the liability of a third party – can be an obligation related to the Insured’s own work) that it would not ordinarily owe under a general duty of care. Gilbert Texas Const., L.P. v. Underwriters at Lloyds London, 327 S.W.3d 118 (Tex. 2010).

American Family Mut. Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004). • Insured is a construction contractor. • Contracted to design and build a distribution center warehouse. • Warranted that the design would be free from defects. • After construction completed, the warehouse began to sink, causing the property to buckle and crack. • Insured was asked to pay for repairs under a breach of contract theory. • Insurer filed declaratory judgment lawsuit. Wisconsin Supreme Court: “Assumption of liability” means situations where the insured has contractually assumed the liability of a third party. “[I]t does not operate to exclude coverage for any and all liabilities to which the insured is exposed under the terms of the contract it makes generally.” Limits exclusions to indemnification and hold harmless agreements and risks the insured cannot control or reasonably foresee. Because Insured sued for defect in its own work, exclusion does not apply.

12 Gilbert Texas Construction, L.P. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010).

• Insured is a construction contractor. • Contracted to build light rail system for Dallas Area Rapid Transit Authority. • Agreed in the contract to protect the work site and surrounding property. • Building on adjacent property flooded after heavy rains and Insured sued for negligence and breach of contract (under third party beneficiary theory). • Insurer reserved rights under contractual liability exclusion and Insured filed declaratory judgment lawsuit. Texas Supreme Court: Contractual liability exclusion is not limited to situations where the Insured assumes the liability of a third party under a hold-harmless or indemnification. Rather, the exclusion applies anytime the Insured contractually assumes a liability (even for itself) that would not be ordinarily be owed. Here, the Insured contractually agreed to protect the surrounding property, an obligation that would not have been owed absent the contract. Thus, the exclusion applies.

Ewing Const. Co., Inc. v. Amerisure Ins. Co., 420 S.W.3d 30 (Tex. 2014). • Insured is a construction contractor. • Contracted with school district to build tennis courts. • After construction completed, tennis courts flaked, crumbled and cracked. • School district sued insured for negligence and breach of contract. • Insurer denied coverage due to contractual liability exclusion. Texas Supreme Court: Contractual liability exclusion does not apply even though the Insured was sued for a defect in its own work. Rather, the contractual liability exclusion applies when the Insured’s duty of care is enlarged by a contract. The Insured was sued for failure to construct the tennis courts in a good and workmanlike manner, which is an ordinary obligation owed by a construction contractor. There is nothing in the contract that enlarges the Insured’s duty of care or creates any obligation that would not ordinarily be owed. Thus, the contractual liability exclusion does not apply.

14 Travelers Property Cas. Co. v. Peaker Services, Inc., 855 N.W.2d 523 (Mich. App. 2014)

• Insured services commercial power-generation systems. • Contracted with the University of Michigan to install an electrical system at a power plant. • Warranted its goods and services were free from defects and contractually agreed to return the University’s property to “as is” condition if damaged during construction. • The system was improperly calibrated and damaged equipment. • Insured sued for breach of contract. • Insurer defended, but reserved the right to deny coverage under the contractual liability exclusion. • Insurer filed declaratory judgment suit. Michigan Court of Appeals: “Assumption of liability” means the legal obligations or responsibilities of another (American Girl). It does not include the duty to perform a contract with ordinary care. (Gilbert) Warranting that goods and services are free from defects and agreeing to repair damages is ordinary care. Contractual liability exclusion does not apply. The Michigan Supreme Court denied application for leave to appeal on April 28, 2015.

Exceptions to Exclusion b Exception (1) Liability “[t]hat the insured would have in the absence of the contract or agreement.

Rational: Because there is common law obligation or duty to exercise due care so as not to injure someone or damage property that exists outside of any contract or agreement, the contractual liability exclusion will not apply to liability that the Insured would have even if the contract or agreement had not been executed.

16 Auto-Owners Ins. Co. v. Newmech Companies, Inc., 678 N.W.2d 477 (Minn. App. 2004). • Insured is a developer. • Entered into purchase agreements with buyers for the completion of specific condominium units. • After buyers moved in, the units experienced excessive moisture, which caused property damage. • Insured entered into an agreement with the condo association and individual owners to complete repairs. • Insured was sued by three unit owners. Insurer denied coverage due to contractual liability exclusion. Minnesota Court of Appeals: Exception to contractual liability exclusion applies because Insured was legally liable for the damage to the condominiums separate and apart from the agreements it made with the individual owners to complete repairs. The units were less than a year old and warranties existed requiring the Insured to make repairs.

Exceptions to Exclusion b Exception (2) • Liability Assumed in a contract or agreement that is an “insured contract,” provided the “bodily injury” or “property damage” occurs subsequent to the execution of the contract or agreement.

Rationale: Supposed to apply to contractual indemnification assumed by the Insured in the usual course of business. This exception is said to “swallow” or “overwhelm” the exclusion.

18 Definition of “Insured Contract”

“Insured Contract” means: a. A contract for a lease of premises - but not “that portion of the contract for lease of premises that indemnifies any person or organization for damage by fire to premises while rented to you or temporarily occupied by you with permission of the owner.”

WHY include leases in the definition of “insured contract”/except them from the exclusion? • A lease is the type of contract an Insured signs in the usual course of business. • Lease language is generally standard. • Liabilities assumed by a lessor can be determined with certainty. • Liability for damage caused by fire (if solely based on liability assumed in the lease) is not included because the landlord should have property insurance to cover this type of damage. • If the Insured is otherwise liable for the fire (i.e. negligent disposal of a cigarette), then the fire exception will not apply.

19 Definition of “Insured Contract”

b. A sidetrack agreement;

WHAT is a sidetrack agreement? Agreement between a property owner and a railroad company, which limits the railroad company’s liability for bodily injury or property damage occurring on spur tracks that run through the property owner’s land. WHY include it in the definition of “insured contract”? Many business use spur tracks for the delivery of goods. Like a lease, it’s a standard contract signed by an Insured in the course of business. Liability can generally be determined with certainty.

20 Definition of “Insured Contract”

c. Any easement or license agreement – but not in connection with construction or demolition operations on or within 50 feet of a railroad. WHAT are they? An easement is an agreement whereby a property owner gives permission to another to use a portion of the land for a specific purpose. A license agreement is an agreement whereby a property owner is allowed to use somebody else’s premises to exhibit goods and services for a limited time (such as a convention hall). WHY include these agreements in the definition of “insured contract”? Many business enter into these types of agreements in the ordinary course of business. Like a lease, they are standard contracts and liability can generally be determined with certainty.

21 Definition of “Insured Contract”

d. An obligation, as required by ordinance, to indemnify a municipality – EXCEPT in connection with work for a municipality.

WHAT is this? Applies to ordinances or laws requiring a property owner to assume liability for claims against a governmental entity for injury or damage to the public caused by changes the property owner makes on the property.

WHY include ordinance obligations in the definition of “insured contract”? These types of exposures can generally be determined with certainty. Work performed for a municipality would be covered by a contract and that is why there is an exception. Covered under part f. of the definition.

Definition of “Insured Contract”

e. An elevator maintenance agreement;

WHAT is an elevator maintenance agreement? An agreement with an elevator company to provide maintenance and repairs. Will typically include a hold harmless agreement for any injury or damage caused by the elevator company’s sole fault.

WHY include it in the definition of “insured contract”? These types of exposures can generally be determined with certainty and are entered into in the ordinary course of an Insured’s business.

23 Definition of “Insured Contract”

f. That part of any other contract or agreement pertaining to your business (including an indemnification of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for “bodily injury” or “property damage” to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.

WHAT is this? Indemnifications and Hold-Harmless Agreements wherein the Insured assumes the tort liability of another party and agrees to pay for injury or damage to a third party. Does not include causes of action for warranty of the fitness of the insured’s product or a warranty that work will be performed in a workmanlike manner. Only includes causes of action for negligence or failure to exercise proper care.

24 Tort Liability – Indemnification/Hold Harmless WHY include these agreements in the definition of “insured contract”? These types of contracts are regularly entered into in the normal course of business and exposures can generally be determined with certainty.

• Exception swallows the exclusion. • But, in States that have anti-indemnity statutes, does not apply to contracts in which the Insured agrees to assume the tort liability of another for injury or damage to a third-party, which the Insured/indemnitor would not otherwise be liable for absent the contract, i.e. agreement to indemnify for the indemnitee’s sole negligence.

25 Exceptions to part f:

That part of any contract or agreement:

(1) That indemnifies a railroad for “bodily injury” or “property damage” arising out of construction or demolition operations, within 50 feet of any railroad property and affecting any railroad bridge or trestle, tracks, road-beds, tunnel, underpass or crossing;

WHY is this exception to part f. included? Exposure too great. A separate policy can be purchased for this.

26 Exceptions to part f:

That part of any contract or agreement:

(2) That indemnifies an architect, engineer or surveyor for injury or damage arising out of: (a) Preparing, approving, or failing to prepare or approve, maps, shop drawings, opinions, reports, surveys, field orders, change orders or drawings and specifications; or (b) Giving directions or instructions, or failing to give them, if that is the primary cause of the injury or damage; or WHY is this exception to part f. included?

Professional liability exposure.

27 Exceptions to part f:

That part of any contract or agreement: (3) Under which the insured, if an architect, engineer or surveyor, assumes liability for an injury or damage arising out of the insured's rendering or failure to render professional services, including those listed in (2) above and supervisory, inspection, architectural or engineering activities. WHY is this exception to part f. included?

Professional liability exposure.

What about the part of Exception (2) that talks about attorneys’ fees and expenses? Solely for the purposes of liability assumed in an “insured contract”, reasonable attorneys’ fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages because of “bodily injury” or “property damage,” provided: (a) Liability to such party for, or for the cost of, that party’s defense has also been assumed in the same “insured contract”; and (b) Such attorneys’ fees and litigation expenses are for defense of that party against a civil or alternative dispute resolution proceeding in which damages to which this insurance applies are alleged. WHY included? Hold harmless and indemnification agreements often include an obligation for the indemnitee to defend as well as indemnify the indemnitor. If the hold harmless or indemnification agreement is an “insured contract,” then attorneys’ fees and costs to defend the indemnitee will also be covered.

29 The CGL Contractual Liability Exclusion General Case Law Discussion

David M. Kroeger

April 19, 2016 General Observations from the Case Law

• Courts are often hesitant to find coverage for what they consider to be "breaches of contract" – Some courts address this concern through the manner in which they read the CGL policy insuring agreement – Other courts address this concern through the manner in which they read the CGL contractual liability exclusion – Some courts will go so far as to ignore or recharacterize an underlying plaintiff's tort claims if they feel the "gist" of the action is really for breach of contract

31 General Observations from the Case Law

• The CGL contractual liability exclusion is not drafted as a general exclusion for any kind of contractual liability the policyholder may face – The exclusion is instead limited to the insured's "assumption of liability in a contract or agreement" – When read in conjunction with its exceptions, the exclusion arguably applies only to an insured's express, contractual assumption of liability that the insured would not otherwise have under common law – Where the express contract actually adds nothing to the insured's liability, the exclusion arguably does not apply – Most common application: The insured agrees to indemnify a third party for that third party's own tort liability

32 A Common Example

• Maxum Indemnity Co. v. Jimenez, 318 Ga. App. 669, 734 S.E.2d 499 (2012) – Problems arose after insured plumbing contractor allegedly failed to properly install pipe in a college dormitory – Court found coverage, reasoning that subcontractor's liability and obligation to pay damages was not based upon a contractual assumption of liability, but rather, was based upon his tort liability arising from his own negligent pipe workmanship

33 Some Courts: Insuring Agreement of CGL Policy Provides No Coverage for Breaches of Contract

• Structural Building Products Corp. v. Business Ins. Agency, Inc., 281 A.D.2d 617, 722 N.Y.S.2d 559, 562 (2d Dep't 2001) ("The general rule is that a commercial general liability policy does not afford coverage for breach of contract…To hold otherwise would render an insurance carrier a surety for the performance of its insured's work")

• Action Ads, Inc. v. Great American Ins. Co., 685 P.2d 42, 43-44 (Wyo. 1984) ("Courts universally have interpreted liability-coverage provisions (providing coverage for 'all sums which the insured shall become legally obligated to pay as damages') as referring to liability sounding in tort, not in contract")

• Indiana Ins. Co. v. Hydra Corp., 245 Ill. App. 3d 926, 185 Ill. Dec. 775, 615 N.E.2d 70, 73 (2d Dist. 1993) (policy provision covering damages that insured becomes legally obligated to pay "does not provide coverage for damages resulting from breach of contractual obligations")

34 Other Courts: CGL Policies May Provide Coverage for Breaches of Contract • American Family Mut. Ins. Co. v. American Girl, Inc., 268 Wis. 2d 16, 673 N.W.2d 65, 76-77 (Wis. 2004) – "We agree that CGL policies generally do not cover contract claims arising out of the insured's defective work or product, but this is by operation of the CGL's business risk exclusions, not because a loss actionable only in contract can never be the result of an 'occurrence'… This distinction is sometimes overlooked, and has resulted in some regrettably overbroad generalizations about CGL policies in our case law… (T)here is nothing in the basic coverage language of the current CGL policy to support any definitive tort/contract line of demarcation for purposes of determining whether a loss is covered by the CGL's initial grant of coverage. 'Occurrence' is not defined by reference to the legal category of the claim. The term 'tort' does not appear in the CGL policy"

Other Courts: CGL Policies May Provide Coverage for Some Breaches of Contract • Touchette Corp. v. Merchants Mut. Ins. Co., 76 A.D.2d 7, 429 N.Y.S.2d 952, 954 (4th Dep't 1980) ("It is not the form of the pleading which determines coverage, however, it is the nature of the insured's conduct and nothing in the language of the policy suggests that claims are to be covered only if sued in negligence…. [The insured] is no less 'legally obligated' to pay an award in a contract action than in a tort action…. If the proof established that the breach was occasioned by a negligent failure to perform, the errors and omissions policy unquestionably provides coverage.")

• Gassaway v. Travelers Ins. Co., 222 Tenn. 649, 439 S.W.2d 605, 607 (1969) ("The nature of the action, that is whether it be tort, contract or otherwise, may be a factor in determining if there has been an accident under a given factual situation, but the nature of the action does not per se control it")

• Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 13 (Tex. 2007) (Liability insurance policies are not limited to affording coverage for tort claims. They "make [] no distinction between tort and contract damages …. (A)ny preconceived notion that [a liability] policy is only for tort liability must yield to the policy's actual language")

CGL Exclusion for "Liability Assumed in a Contract" – Majority Rule • Olympic, Inc. v. Providence Washington Insurance Co., 648 P.2d 1008 (Alaska 1982) – "'Liability assumed by the insured under contract' refers to liability incurred when one promises to indemnify or hold harmless another, and does not refer to the liability that results from breach of contract."

37 CGL Exclusion for "Liability Assumed in a Contract" – Majority Rule • USM Corp. v. First State Ins. Co., 420 Mass. 865, 652 N.E.2d 613, 615–16 (1995) (Exclusion for "liability assumed by the Insured under any contract" applied to agreements "to indemnify or hold another harmless." The insured's liability for a breach of express warranty was a liability "incurred" under its contract, not "assumed" under its contract)

• American Family Mut. Ins. Co. v. American Girl, Inc., 268 Wis. 2d 16, 673 N.W.2d 65, 81 (2004) ("the contractually-assumed liability exclusion applies where the insured has contractually assumed the liability of a third party, as in an indemnification or hold harmless agreement; it does not operate to exclude coverage for any and all liabilities to which the insured is exposed under the terms of the contracts it makes generally")

• Dreis & Krump Mfg. Co. v. Phoenix Ins. Co., 548 F.2d 681, 684 (7th Cir. 1977) (coverage for "liability assumed [] under any written contract … mean[s] a specific written agreement between the insured and some third party whereby the insured agrees to 'indemnify' the third party")

38 CGL Exclusion for "Liability Assumed in a Contract" – Majority Rule • Aetna Cas. & Sur. Co. v. Spancrete of Illinois, Inc., 726 F. Supp. 204, 207 (N.D. Ill. 1989) (coverage for liability assumed by contract "only affords coverage for liability assumed by a contractual provision, not liability arising out of a breach of a contractual provision") (emphasis in original)

• Weger v. United Fire and Cas. Co., 796 P.2d 72, 74 (Colo. Ct. App. 1990) ("'liability assumed by contract' refers to a particular type of contract—a hold harmless or indemnification agreement—and not to the liability that results from breach of contract")

• Aetna Cas. & Sur. Co. v. Cotter, 26 Mass. App. Ct. 56, 522 N.E.2d 1013, 1014 (1988) ("The 'liability assumed' [language] has been taken to refer to 'liability incurred when one promises to indemnify or hold harmless another'")

• Olympic, Inc. v. Providence Wash. Ins. Co. of Alaska, 648 P.2d 1008, 1011 (Alaska 1982) (" 'Liability assumed by the insured under any contract' refers to liability incurred when one promises to indemnify or hold harmless another, and does not refer to the liability that results from breach of contract")

39 CGL Exclusion for "Liability Assumed in a Contract" – Majority Rule • Haugan v. Home Indem. Co., 86 S.D. 406, 197 N.W.2d 18, 23 (1972) ("[B]reach of an implied warranty is not a contractual assumption of liability. The coverage under this section of the policies applies only to an assumption of another's liability. This contemplates an express contractual assumption of another's potential liability by an agreement to indemnify or hold another harmless for an obligation not otherwise imposed by law.")

• Musgrove v. Southland Corp., 898 F.2d 1041, 1044, (5th Cir. 1990) ("The assumption by contract of the liability of another is distinct conceptually from the breach of one's contract with another…. The blanket contractual coverage in the St. Paul policy entitled [the insured] to recover losses for liability assumed, but not for liability incurred by virtue of its contractual breach")

• Toombs NJ Inc. v. Aetna Cas. & Sur. Co., 404 Pa. Super. 471, 591 A.2d 304, 308 (1991) (coverage for liability assumed by contract does not create coverage for breach of contract claims)

40 The Majority Rule – A Contractual Promise to Procure Insurance Is Not "Liability Assumed in a Contract"

• Olympic, Inc. v. Providence Washington Ins. Co. of Alaska, 648 P.2d 1008, 1010–11 (Alaska 1982).

• Aetna Cas. & Sur. Co. v. Spancrete of Illinois, Inc., 726 F. Supp. 204, 206-07 (N.D. Ill. 1989)

41 Some Courts: CGL Contractual Liability Exclusion Applies to Any Contract Breach • Gilbert Texas Const., L.P. v. Underwriters at Lloyd's London, 327 S.W.3d 118, 128-33 (Tex. 2010) (exclusion barred coverage for any contractual liability assumed by the insured, even a construction contractor's commitment to protect adjoining property from harm during the course of a construction project)

• TGA Development, Inc. v. Northern Ins. Co. of New York, 62 F.3d 1089, 1091–92 (8th Cir. 1995) (exclusion for injury "for which the insured has assumed liability in a contract" applies to any breach of contract claim)

• State Farm Fire and Cas. Co. v. Tillerson, 334 Ill. App. 3d 404, 268 Ill. Dec. 63, 777 N.E.2d 986, 991-92 (5th Dist. 2002)(exclusion applied to breach of contract and warranty claims)

• CIM Ins. Corp. v. Midpac Auto Center, Inc., 108 F. Supp. 2d 1092, 1100 (D. Haw. 2000) (exclusion encompasses "any claim that is dependent upon the existence of an underlying contract")

• Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 13 (Tex. 2007) (Liability insurance policies are not limited to affording coverage for tort claims. They "make[] no distinction between tort and contract damages …. [A]ny preconceived notion that [a liability] policy is only for tort liability must yield to the policy's actual language"

42 Some Courts Have Recharacterized Tort Claims as Contract Breaches • Allstate Ins. Co. v. Hansten, 765 F. Supp. 614, 616-17 (N.D. Cal. 1991) – "Here, the two remaining causes of action in the Wedekind complaint, the fifth and the tenth, sound in tort (negligence and negligent infliction of emotional distress). Yet, the factual predicate of both of these causes of action is the contract between the Hanstens and the Wedekinds. The fifth cause of action (negligence) alleges that the Hanstens failed to exercise ordinary care as a builder. Although this claim does not refer to the Hanstens' contractual duties, the alleged harm could not have been realized without the contract to sell the house. Without the contract, the Hanstens would have had no duty of care towards the Wedekinds. Therefore, the duty alleged to have been breached was a contractual duty, and the policy does not cover such losses. Similarly, the tenth cause of action (negligent infliction of emotional distress) relies on a duty created by the contract. The Wedekind Complaint alleges that the Hanstens should have known that their misrepresentations and their failure to exercise due care in the construction would have caused the Wedekinds to suffer severe emotional distress. Again, the Hanstens had that duty as a result of the contract to sell to the Wedekinds. Without the contract, the Hanstens could not have inflicted emotional distress on the Wedekinds through misrepresentation or negligent construction."

43 Some Courts Have Recharacterized Tort Claims as Contract Breaches • Cincinnati Ins. Co. v. Metropolitan Properties, Inc., 806 F.2d 1541 (11th Cir. 1986) – "We do not agree with the appellant's proposed application. As fleshed out in oral argument, appellant contends that any damages incurred by the insured through some 'negligent' action is coverable. For example, appellant admitted that if Metropolitan forgot to pay its bills, this would be negligent conduct and Cincinnati might be liable if causation were proved. Appellant is interpreting 'negligent' in general terms synonymous with careless or slack. We agree with the appellee that the word 'negligent' as used in the policy should be interpreted in legal terms. Generally, the traditional elements of negligence [include] a legal duty requiring the actor to conform to a certain standard of conduct, for the protection of others against unreasonable risks…. Appellee is correct in arguing that if appellant has breached any duty, it is one created by contract, not by law."

44 Some Courts Have Recharacterized Tort Claims as Contract Breaches • National Union Fire Ins. Co. of Pittsburgh, Pa. v. Pep Boys-Manny, Moe & Jack, 304 A.D.2d 218, 759 N.Y.S.2d 42, 46 (1st Dep't 2003) ("if the 'gist' of the underlying claim sounds in contract, it does not trigger coverage, even if negligence concepts were employed in the underlying Complaint")

• Freestone v. New England Log Homes, Inc., 2003 Pa. Super 24, 819 A.2d 550, 553 (2003) ("gist" of action was for breach of contract; "the negligence alleged … is actually the failure to live up to a contract." "[P]laintiffs [are precluded] from recasting ordinary breach of contract claims into tort claims." Accordingly, coverage held not to exist for insured that had sold a defective home to the plaintiffs even though the defects had accidentally resulted in damage to the contents of the home)

• Blake Industries, Inc. v. General Agents Ins. Co. of America, 2000 WL 1031054 (Tenn. Ct. App. July 27, 2000) (underlying claims against insured "were grounded in contract and arose out of [the insured's] attempt to fulfill its agreement to install a water softener system.... To hold otherwise would make the insurer a guarantor of the insured's performance")

• Allstate Ins. Co. v. Morgan, 806 F. Supp. 1460, 1464 (N.D. Cal. 1992)("But for that contract, there could be no claim for negligence. Because the factual predicate of the claim is contractual in nature, there is no coverage under the policy notwithstanding the allegations of a tort claim in the complaint")

45 Other Courts Have Respected A Complaint's Allegation of Negligence • Trinity Homes LLC v. Ohio Cas. Ins. Co., 864 F. Supp. 2d 744 (S.D. Ind. 2012) – Homes built by insured experienced water damage – Homeowner class action asserted a negligence claim against the builder of the homes – The economic loss rule precluded class members from recovering under a tort theory, so any liability flowing to the insured had to arise on the basis of its home sales contracts – Court found coverage, reasoning that the negligence claim based damages on a potential liability beyond the alleged breach of contract, and the economic loss doctrine did not apply to insurance coverage disputes

Some Courts Take a Strict and Narrow View of the Term "Insured Contract" • Colony Nat. Ins. Co. v. Manitex, L.L.C., 461 F. App'x 401 (5th Cir. 2012) – Insured bought cranes from seller. Under the purchase agreement between the seller and the purchaser, the insured assumed the seller's potential liability for loss – The seller, in turn, had separately contracted with the crane manufacturer to assume its potential liability for loss – Court found that purchase agreement was not an "insured contract" for purposes of the purchaser's CGL coverage because seller's liability arose strictly from its contract with the manufacturer and, therefore, was not an assumption of tort liability

47 Some Courts Take a Strict and Narrow View of the Term "Insured Contract" • Virginia Sur. Co., Inc. v. Northern Ins. Co. of New York, 224 Ill. 2d 550, 866 N.E.2d 149 (2007) – Subcontractor agreement with general contractor contained standard indemnity clause – "To the fullest extent permitted by law, the Subcontractor WAIVES ANY RIGHT OF CONTRIBUTION AGAINST AND shall indemnify and hold harmless the Owner, Contractor, Architect, Architect's consultants, and agents and employees of any of them from and against claims, damages, losses, and expenses, including but not limited to attorneys fees, arising out of or resulting from performance of the Subcontractor's Work under this Subcontract, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death or to injury to or destruction of tangible property (other than the Work itself) including loss of use therefrom, WHICH IS caused in whole or in part by negligent acts or omissions of the Subcontractor. …" 886 N.E.2d at 151 (emphasis in original).

48 Some Courts Have Taken a Strict and Narrow View of the Term "Insured Contract" • Virginia Sur. Co., Inc. v. Northern Ins. Co. of New York, 224 Ill. 2d 550, 866 N.E.2d 149 (2007) (cont.) – The Subcontractor's employee was injured on the job • Employee's recovery from its employer, the subcontractor, was limited by workers compensation law • Employee sought full recovery from general contractor, who in turn invoked the indemnity provided by the subcontractor • The subcontractor tendered the indemnity claim to its CGL carrier – The Illinois Supreme Court finds no coverage: • Reasons that there is no "insured contract" because the subcontractor did not agree to "indemnify" the general contractor but rather simply agreed to waive its liability cap under the Illinois workers compensation statute • Note that this case involved a construction contract, and the Court's reasoning is strongly driven by the fact that the Illinois anti-indemnity act therefore barred the subcontractor from indemnifying the general contractor for its own negligence

49 THANK YOU!

David M. Kroeger [email protected]

CGL Contractual Liability Coverage: Interplay with Contractual Indemnification and Additional Insured Provisions

The Legal Publishing Group of Strafford Publications Tuesday, April 19, 2016

David Taubenfeld

3 Very Different Ways to Transfer Risks

1. Contractual Indemnification 2. Additional Insured Requirements

3. Contractual Liability Coverage

• Party 2 will reimburse Party 1 if Party 1 has to defend itself or pay a settlement or judgment within the

scope of the indemnity • No insurance company involved

53 © 2013 Haynes and Boone, LLP Contractual Indemnification Example • A manufacturer (Party 1) contracts with a supplier (Party 2) • The contract requires Party 2 to indemnify Party 1 for third-party claims arising out of Party 2’s work • A third party—such as a student visiting the plant— suffers injury, then sues Party 1 • Party 1 seeks indemnification from Party 2

54 © 2013 Haynes and Boone, LLP How do parties gain coverage for contractual indemnification obligations? 2 Ways • One party’s obligation to indemnify another party will not necessarily trigger coverage under the indemnitor’s policy • Parties secure coverage to support indemnity obligations in two ways: 1. Contractual Liability Coverage 2. Additional Insured provisions

• Service contracts often require one party to add the other party to its insurance policies as an Additional

Insured • If an accident occurs, the party named as an Additional Insured can seek coverage under the other party’s policies

Additional Insured Requirement Overview

• Party 2 must make sure that Party 1 becomes an insured under Party 2’s insurance contract

• Accomplished by adding an endorsement to Party 2’s policies • Watch out, because these endorsements come in many, many forms with varying scope and effect

57 © 2013 Haynes and Boone, LLP What Do Additional Insured Provisions Look Like? Example “A. Section II. Who is An Insured is amended to include as an additional insured the person(s) or organization(s) shown in the Schedule, but only with respect to liability for “bodily injury,” “property damage” or “personal and advertising injury” caused, in whole or in part, by: 1. Your acts or omissions; or 2. The acts or omissions of those acting on your behalf; in the performance of your ongoing operations for the additional insured(s) at the location(s) designated above.”

How Much Coverage Do Additional Insured Clauses Provide? Scope • Additional Insured provisions normally cover liabilities “arising out of” the Named Insured’s operations

• Can provide more coverage than Contractual Liability Coverage • Amount of coverage provided depends on the precise language of the Additional Insured provision

• Party 1 wants to make sure that it is both an Additional Insured under Party 2’s polices and that Party 2 has Contractual Liability Coverage

• Naked indemnities are only as good as the entity standing behind them • Many business entities do not want to fight directly with their integral business partners • Additional Insured status allows Party 1 to go directly to Party 2’s insurance companies • Contractual Liability Coverage ensures that there is money behind the indemnity obligation

Cost-Benefit Analysis Pros & Cons of Each

• From Party 1’s perspective, there are benefits and detriments to both Additional Insured provisions & Contractual Liability Coverage • As an Additional Insured, Party 1 should receive a defense in addition to access to Policy Limits, and will have a direct relationship with the insurer • Of course, Additional Insurance coverage will be subject to deductibles and policy terms and conditions, and Party 1 will lose the ability to control its defense and to control settlement of claims

Cost-Benefit Analysis Pros & Cons of Each

• Contractual Liability Coverage for Party 2 helps Party 1, because it allows Party 1 to take advantage of Party 2’s indemnity without directly

impacting Party 2, and regardless of Party 2’s financial status • The Contractual Indemnity will not be subject to deductibles nor to policy terms and conditions, and Party 1 will retain control of its defense and settlement • Contractual Liability Coverage is more limited than Additional Insured coverage because Party 1 will not get security beyond the absolute limits of Party 2’s policies

• These three risk transfer devices really interact in areas where an Anti-Indemnity Statute applies

• Anti-Indemnity Legislation renders certain kinds of indemnity clauses void and unenforceable as against public policy • Anti-Indemnity Statutes limit or prevent parties from seeking indemnification for their own negligence • 44 states now have Anti-Indemnity Laws on the books.

• In the past, Additional Insured provisions provided a loophole—a way for parties to get around Anti-Indemnity Legislation and receive

coverage for their own negligence • To close this loophole, several states enacted laws that render Additional Insured provisions unenforceable to the extent that

they would provide coverage prohibited by Anti-Indemnity Legislation —i.e., for a party’s own negligence

• These states include: • Arizona, California, Colorado, Kansas, Louisiana, Minnesota, Montana, New

Mexico, Oklahoma, Oregon, Texas, and Utah • Even in these states, however, Contractual Liability Coverage may save the day by providing coverage for Party 2’s indemnity obligations to Party 1

In re Deepwater Horizon

Background

• Offshore drilling rig in Gulf of Mexico • Transocean owned rig, maintained: • CGL insurance policy • Four layers of excess coverage • Transocean entered into a Drilling Contract with BP to produce oil • Contract required Transocean to name BP as an additional insured on its policies • In the Drilling Contract, Transocean agreed to indemnify BP for above- surface pollution, while BP agreed to indemnify Transocean for subsurface pollution

• Explosion destroyed rig • BP sought full coverage under Transocean’s policies as an

additional insured • Transocean and its insurers argued that BP could only receive coverage as an additional insured under Transocean’s policies to the extent determined by the Drilling Contract—i.e., for above-surface pollution only. See In re Deepwater Horizon, 470 S.W.3d 452, 455 (Tex. 2015).

Insurance Issues:

• 5th Circuit certified questions of insurance policy interpretation to the Supreme Court of Texas

• Can an insurance policy incorporate by reference limits on additional-insured coverage found in an external document—such as a drilling contract?

• If so, did Transocean’s insurance policies incorporate the Drilling Contract’s limitations on BP’s additional-insured coverage?

• Insurance policies can incorporate limitations on additional-insured coverage found in

external documents, such as drilling contracts

• Transocean’s policies incorporated the limitations on BP’s additional- insured coverage found in the Drilling Contract

• Because Transocean only agreed to indemnify BP for above-surface pollution in the Drilling Contract, Transocean’s policies did not provide coverage for BP for subsurface pollution

• A policy’s language determines its scope of coverage for additional insureds • The policy must ‘clearly manifest’ an intent to include an external contract as part of the policy

72 © 2013 Haynes and Boone, LLP Questions that Remain After In re Deepwater Horizon What kind of policy language will incorporate by reference limits on additional-insured coverage found in an external document?

• In re Deepwater Horizon decision: unclear • Supreme Court of Texas found two provisions that incorporated the Drilling Contract: • Additional Insured provision • Definition of “Insured”

Policy language that incorporated the Drilling Contract’s limitation on additional-insured coverage:

• Additional Insured Provision • “Underwriters agree where required by written contract […]

additional insureds are automatically included hereunder […]” (emphasis added) • Definition of “Insured” • “[A]ny person or entity to whom the ‘Insured’ is obliged by any oral or written ‘Insured Contract’… to provide insurance such as is afforded by this Policy;” (emphasis added)

Other Policy Language that Incorporated a Separate Contract Policy language:

• A separate contract can be incorporated into an insurance

policy by an explicit reference clearly indicating the parties’ intention to include that contract as part of their agreement.

Policy language: • An insurance company’s policy with a truck leasing company incorporated by reference the leasing company’s rental agreements with its customers

• The policy’s definition of “Who Is An Insured” included “both lessees and rentees of covered autos as insureds, but only to the extent and for the limits of liability agreed to under contractual agreement with the named insured.” Urrutia v. Decker, 992 S.W.2d 440, 441 (Tex. 1999)(emphasis added).

• Evanston Ins. Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d

660, 675 (Tex. 2008). • Refinery owner entered into a service contract for maintenance • Contract required maintenance company to indemnify the refinery owner and carry CGL and umbrella insurance • Maintenance company employee drowned; refinery owner sued the maintenance company’s umbrella insurer, demanding coverage

Case: • Maintenance company’s policy with umbrella insurer had a “Who Is An Insured” provision that read: • “A person or organization for whom you have agreed to provide

insurance as is afforded by this policy; but that person or organization is an insured only with respect to operations performed by you or on your behalf, or facilities owned or used by you.” • Court ruled that the refinery owner was entitled to full coverage as a direct insured; Court did not look at the underlying contract to determine the scope of additional-insured coverage

David Taubenfeld [email protected]