DTCI: Court interprets waiver of subrogation clause

July 29, 2015

By William E. Kelley

kelley-william-mug Kelley

A waiver of subrogation clause is a typical — but often overlooked — contract provision in design and construction contracts, especially for parties using standard form contracts, such as the American Institute of Architects (AIA) forms. In general, the term “subrogation” refers to situations where an insurance company pays for damages covered under its policy, and then seeks to recoup some or all of those damages from other entities that may have caused or contributed to the loss. For example, the insurance company for a property owner pays for damages caused by a broken water line and then seeks to recoup those damages from contractors who may have caused or contributed to the water leak through their construction activities. The insurance company stands in the shoes of its insured and may pursue any claims that the insured may have in relation to the damages. The corollary to this concept is that the insurer also has no greater rights than the insured would have. Therefore, if the insured has already waived certain claims by contract or other agreement, then the insurance company cannot pursue those waived claims.

The waiver of subrogation clause refers to a contractual provision whereby the parties agree to mutually waive legal rights of recovery arising from certain classes of claims covered by property insurance. So, in the water leak example, the waiver might apply to bar the insurance company from recovering from the contractor, architect or engineer, even if the broken water line was partially caused or complicated by design or construction defects. In that instance, the owner’s insurance company would pay for the damages, and the contractor might have no liability to the owner or insurance company for any amounts paid under the insurance policy.

There have been many cases involving this contract language, and Indiana courts have split in their interpretation of that clause. The major issue? Interpreting the scope of the waiver. Or, in other words, which claims have been waived and which claims are still available for the insurance company to pursue through subrogation. Several court decisions from across the country (Indiana included) have been divided into two camps on the issue of the scope of the waiver.

In the first camp, some courts have interpreted the waiver of subrogation to hinge on a “work vs. non-work” analysis. Under that analysis, the waiver would apply to damages to the contractor’s work, but it would not be applicable to damages to property outside the scope of the contractor’s work. In the second camp, other courts have interpreted the waiver of subrogation to hinge on the “any insurance” analysis. Under this approach, if the damages at issue are covered by “any insurance,” namely property insurance maintained by the owner for the project, then subrogation claims for those damages are waived. The insurance company, standing in the shoes of the owner, has no right to pursue a subrogation claim against the protected parties.

The Indiana Supreme Court has now definitively weighed in on interpretation of the AIA contractual waiver of subrogation clause to provide some clarity on this issue. In Board of Commissioners of the County of Jefferson v. Teton Corp., 30 N.E.3d 711 (Ind. 2015), issued on May 13, 2015, the Indiana Supreme Court analyzed the waiver of subrogation clause in the AIA A101-1987 “Standard Form of Agreement between the Owner and the Contractor” and A201-1987 “General Conditions of the Contract for Construction.” After discussing the two interpretations of this type of clause, the Supreme Court formally adopted the “any insurance” approach.

The case involved a fire that occurred during renovations to the Jefferson County courthouse. The Indiana Supreme Court noted that the owner relied upon an existing “all risk” property insurance policy that covered not only the existing property at the courthouse, but also the ongoing construction operations. The parties apparently agreed that all damages at issue in the fire were covered and were paid by the property insurance company for Jefferson County under the “all risk” insurance policy. Nonetheless, the owner and its insurance company argued that the waiver of subrogation applied only to damages to the contractor’s work, since the construction contract required the owner to purchase builder’s risk insurance only for the construction work at issue.

The Indiana Supreme Court noted that the waiver of subrogation language was broader than that used for coverage for the “work” on the project. Instead, the language applied both to damages covered under the required builder’s risk policy and also to damages covered under any other property insurance policy maintained by the owner. Even though the owner had broader insurance coverage than required under the contract, the waiver still applied to all covered damages, since the waiver language specially applied to damages “to the extent covered by property insurance obtained pursuant to this Paragraph 11.2 or other property insurance applicable to the Work ” The Supreme Court was careful to note that this language clearly applied only to property insurance maintained by the owner and was not so broad to include damages covered under the liability insurance policies that the parties agreed to maintain for the project.

The lesson to be learned from this case is that contractors, owners and design professionals should give attention to risk-shifting strategies for construction projects and cooperate to ensure that the contract language reflects those agreed strategies. Parties on a construction project can cover risks by agreeing that one party will assume the risk and defend others for any claims that may arise (e.g., defense and indemnity clauses). Alternatively, parties can agree to cover certain classes of risk through the purchase of specific insurance products, which effectively shifts the risk to the insurance companies involved. Where parties have agreed to cover certain risks through insurance, and further where the parties agree to waive claims against each other for claims covered by that insurance, the Indiana Supreme Court’s decision makes clear that Indiana law favors enforcement of those waivers.

The policy behind this decision appears to be that Indiana law supports avoidance of protracted litigation for claims where parties have already agreed to waive certain classes of claims and to instead cover the risk through the procurement of property insurance. Under the “any insurance” analysis, the inquiry simply becomes whether the damages at issue were covered by any applicable property insurance policies, without having to resort to what could be a fact-intensive analysis of whether the damages at issue involve damage to the “work” or to areas of “non-work.”•

Mr. Kelley is a partner in Drewry Simmons Vornehm in Indianapolis and is a member of the Defense Trial Counsel of Indiana. The opinions expressed in this article are those of the author.