In recent years, aggressive policyholders’ counsel have included claims for extracontractual liability arising out of vendors hired by property insurance companies as a way to maximize recoveries for their clients. The additional bad faith risk emerges from the typical first-party property insurance claim scenarios where either (1) the insured loss was repaired by an insurer-approved contractor or preferred vendor that the policyholder retains; or (2) when the insurer takes full control of the repair process and hires and supervises the work. When repairs go wrong, property insurers may find themselves faced with a lawsuit seeking compensation for the bad repair that extends beyond breach of the insurance contract.
In situations where the post-loss repair was ineffective or faulty, some policyholders have sought property insurance company extracontractual liability on the basis that the insurer became the “employer” of the vendor that did the repair work and, consequently, the insurer was the principal responsible for the vendor’s defective workmanship. Fortunately for property insurers, at least in situations where the policyholder has selected his own contractor, courts are reluctant to find liability against insurers on that basis because the vendors are deemed independent contractors and not employees or agents whose negligent or wrongful acts can be imputed to the insurance companies. In these situations, courts typically find that an insurance company does not have a duty to supervise independent contractors selected to perform repair work for policyholders’ losses.
Problems arise for insurance companies when they provide a preferred vendor list to policyholders. In these situations, an insurer should be careful to include a disclaimer as to the extent of the insurance company’s responsibilities with regard to the repair. The disclaimer should make clear that the insurer is only providing a list of recommendations, but the ultimate decision remains with the policyholder as to which vendor to hire (whether the vendor is on the list or not).
Additionally, it is important the disclaimer note that it is the policyholder’s obligation to supervise and monitor the work of the independent contractor. Courts are more likely to reject extracontractual liability arising from approved vendors’ negligence claims when a plainly worded disclaimer has been provided to the policyholder.
An important distinction exists when the insurer offers to guarantee the work of a preferred vendor in contrast to the situation when the insurer simply provides its policyholder with a list of recommended vendors. When the insurer guarantees the repair work, the guarantee creates a new contract between the policyholder and the insurance company. Most courts will apply basic contract principles to this new contractual arrangement and are likely to determine that the guarantee is a warranty and not an insurance contract. In these situations, there is typically no extracontractual exposure for the insurer for a vendor’s defective work.
When an insurer undertakes the repairs itself, it subjects itself to greater risk of a bad faith claim. Courts frequently look to the extent of the insurer’s control over the vendor’s work to determine vicarious liability. An insurer that avoids supervisory responsibility for a vendor’s work will have a greater opportunity to defend itself against extracontractual exposure arising from a vendor’s defective work. Although a disclaimer may be helpful in this situation, the fact that the insurance company exercised more direct control over the vendor’s faulty workmanship increases the risk of bad faith liability. Not surprisingly, an insurer is exposed most to extracontractual liability when it hires a vendor that it knows is unqualified. In these situations, claims of negligence, bad faith, intentional infliction of emotional distress, fraud, and conspiracy are common.
Few courts have had the occasion to consider how an insurer’s fiduciary duty is implicated when determining liability for a contractor’s negligence. In one case, the policyholder claimed that his insurer breached its fiduciary duty because a contractor hired by the insurer overcharged for the work done and consequently depleted the policyholder’s policy limits. In another fiduciary liability case, the policyholder argued that the insurer was negligent for using an incompetent claims professional and otherwise failed to inspect properly the insured’s losses. These cases illustrate the broader challenges that first-party insurers face when a claim response requires a competent repair solution.
To minimize the risk of extracontractual exposure for defective vendor repair work, property insurers should, at a minimum:
- Include a disclaimer with the issuance of any preferred vendor list.
- Implement quality control verification for all vendors identified on preferred lists.
- Make clear that repair guarantees or warranties are not separate insurance contracts.
Finally, property insurers should consider adopting carefully worded exclusionary language designed to prevent against ancillary claims arising out of faulty work performed by preferred vendors. An example of this protection is an exclusion barring coverage for ensuing losses related to faulty repair of a covered loss. While an exclusion of this type of will not prevent policyholders from pursuing extracontractual claims, the contractual intent to avoid insurer responsibility for faulty vendor work may become more apparent to courts that interpret claims for extracontractual liability arising out of vendors hired by insurers where the disputed policies include the exclusion.