Two popular means of risk transfer in construction agreements are often confused and can lead to disputes in interpretation when legal issues arise. The first method is the procurement of “additional insured” status on your contractual partner’s insurance. Second is the obtainment of insurance coverage for the contractual indemnifications set forth in your contract.
While the mere frequency of their use might suggest that these methods have become an easy and efficient way to effectively achieve risk transfer, experience shows that almost the opposite is true. As with all risk transfer devices, it is imperative to understand the parties’ intentions and to know what language best communicates these intentions. Before embarking on any risk analysis, one must understand that additional insured status and contractual indemnity are distinct concepts.
An additional insured is one who becomes a party to another’s liability insurance policy. As an additional insured, a party has direct and independent rights against another’s insurance company as an insured. The scope and breadth of coverage will be determined by the language of the insurance policy and the “additional insured endorsement.” On the other hand, contractual indemnity is created by a clause contained in most commercial agreements, particularly in the construction industry. The scope and breadth of the obligations created between the parties will be determined by the wording of the indemnification clause. Accordingly, a party’s obligation to indemnify another is completely independent of an insurance policy or additional insured endorsement.
Additional Insured Endorsements
For many years, insurers have viewed issues involving additional insureds with tunnel-vision due to the long-held industry belief that additional insured coverage applies only to any vicarious liability that might be imposed on it for the liability of the named insured. Indeed, that perception led to the practice of most large insurers providing additional insured coverage at no extra premium and to the industry’s often sloppy communication and recording practices regarding the issuance of additional insured endorsements.
The issue that most frequently arises under additional insured endorsements, particularly in the construction industry, is the scope of coverage and whether the additional insured is entitled to coverage for claims arising from their own negligence. Although case law in differing states has established opposite boundaries on the issue, courts analyzing the standard ISO Additional Insured Endorsement (CG 20 10) have generally concluded that the additional insured need show only a broad causal relationship to obtain coverage—for example, where the endorsement provides, “The ‘persons insured’ provision is amended to include as an insured the person or organization named below but only with respect to liability arising out of the operations performed by the named insured.”
Courts have determined that as long as there is some causal connection between the named insured’s work and the loss in question, the additional insured is entitled to coverage for claims arising out of their own negligence. Where the injured party is an employee of the named insured, most courts have found that the mere employment relationship is sufficient to satisfy the causal nexus and conclude that the injury arose out of the named insured’s work “for” the additional insured regardless of the cause of the injury. Courts have therefore employed this liberal construction of the phrase “arising out of” in the context of insuring agreements to require only “but for” causal connection in such agreements.
Perhaps in response to this broad interpretation, newer versions of the CG 20 10 form utilize language making additional insured coverage subject to bodily injury or property damage being caused, in whole or in part, by the acts or omissions of the named insured in its performance of ongoing or completed operations for the additional insured. Courts interpreting these additional insured endorsements have concluded that the insurer does not owe a duty to defend the additional insured when the complaint fails to allege that the injuries were, in fact, caused in whole or in part by the named insured’s negligence. Courts addressing this issue have found that the phrase can be given a definite meaning and legal effect, stating:
The focus of the definition of additional insured coverage in the “whole or in part” sentence is on whether plaintiffs allege a theory in the operative pleading in the underlying lawsuit under which [the additional insured] could be held liable for conduct by [the named insured] that “caused” injury to a third party in any way. The sentence does not address the conduct of the other wrongdoer or wrongdoers, whether they be the additional insured or not.
Based on consideration of cases and their drafting history, the courts have generally determined that these additional insured endorsements must demonstrate that the named insured’s acts or omissions were a proximate cause of the alleged injuries in order to trigger additional insured coverage.
Despite differing standards of causation, where such causation is demonstrated, most courts have concluded that an additional insured has all the rights under the named insured’s policy as the named insured. New amendments to CG 20 10 in 2013 are intended to limit the scope to only that which is required in the underlying contract. Whether the courts will enforce these new terms remains to be seen. Regardless, additional insured coverage remains considerably broader than that provided by an “insured contract” as discussed below.
Contractual Indemnity and Insured Contracts
Simply stated, “indemnity” is a fancy word for protection. When one agrees to indemnify someone else for a particular risk, that person (the indemnitor) is agreeing to protect the other (the indemnitee) from financial harm or loss should a future event, usually involving bodily injury or property damage, take place. As such, an indemnity agreement reflects nothing more than an agreement between two persons or entities as to which one should bear the financial risk should an incident or category of incidents occur.
Where the controversy begins is when parties seek to obtain financial protection from others (or shift the financial risk and responsibility to others) for harm resulting from their own wrongdoing or tortious conduct. Where the courts have a public policy concern that people may do things carelessly due to immunity from financial responsibility for the harm they might cause, contractual indemnity agreements are viewed with a measure of judicial disfavor.
Consequently, they are generally subject to strict construction, with any ambiguities construed against the party seeking indemnity, and to be effective must be expressed in clear and explicit terms. That rule of specificity is particularly applicable where the indemnitee is seeking protection for claims arising from his own negligence. In that instance, the contractual indemnity provision must state explicitly that it includes claims arising from his own negligence, and words of general import alone (such as “any and all claims”), no matter how broad, will not suffice. Many jurisdictions alternatively have statutory limitations on indemnification provisions that seek to pass on one party’s negligence to another.
In jurisdictions permitting indemnity agreements, being specific with the language of a contractual indemnity provision is crucial in situations where the injury for which indemnity is sought is to an employee of the contractor or subcontractor. In other words, if an owner and general contractor are sued for injuries by an employee of a subcontractor and they are seeking indemnity, it is important that the contractual indemnity provision explicitly state that it is to include injuries to such employees.
Courts have reasoned that an employer’s immunity from common law liability, particularly since the employer was presumably already paying the injured employee workers’ compensation, is a protection so fundamental and valuable that the courts should not infer or assume that the employer has agreed to give up that protection unless the agreement explicitly provides for it.
Of course, there are exceptions to practically every rule. For example, although most courts employ strict construction of the language of contractual indemnity provisions for public policy reasons, there also are cases that recognize indemnity clauses to be a commercially acceptable risk shifting mechanism, which is usually accounted for in the contract bid price and protected against by insurance.
Standard commercial general liability (CGL) policies anticipate that these indemnification agreements will be covered by the policy, assuming certain conditions are met. The “insured contract” coverage is itself an exception to the broader exclusions in the standard CGL for contractual liability and employer’s liability. As such, where the policy presumptively excludes coverage for the insured’s contractual liabilities, it provides an exception for indemnification agreements. The conditions can be different from policy to policy but generally require that the indemnification agreement be part of a written contract that is executed prior to the date of the injury at issue. Further, the indemnification provision must seek to transfer tort liability. An insured cannot seek coverage for its duty to indemnify another party for purely contractual obligations. As such, a bodily injury claim, which arises from tort, will be acceptable, whereas an agreement to pay specified damages in the event of a contractual default would not be covered.
A particularly thorny issue arises when an indemnity clause in a contract may not be enforceable in the jurisdiction in which the contract is litigated. Does the mere existence of the indemnification provision trigger insured contract status, or must the indemnification provision be legally enforceable in order to be insured? Must the enforceability of the indemnification clause be litigated prior to a proper tender as an insured contract? This issue is frequently encountered, particularly in jurisdictions that do not regulate indemnity agreements by statute. However, it is rarely litigated, and those courts facing the issue have not ruled with any consistency.
Distinguishing Additional Insured Status from Insured Contract
This takes us full circle to the issue of distinguishing additional insured status from insured contract. If the contract at issue requires the named insured to name the putative additional insured, then the additional insured is presumptively an insured on the policy. The named insured’s carrier presumably would bear the burden of showing that the causality requirement has been met to trigger the endorsement. This is significantly broader coverage than the putative additional insured tendering its right to contractual indemnity to another party’s CGL insurer and expecting that the terms of the indemnification clause are both enforceable and insured.
There also are distinctions as to the rights of a putative additional insured to defense coverage. If there is additional insured coverage in the contract and a causal link, then the additional insured is entitled to a full “dollar one” defense in the underlying action, generally outside of the policy indemnity limits. If, however, a party seeks to be defended pursuant to an insured contract, it must demonstrate that the terms of the contract provide for that defense, and often, the defense obligations are not ripe until fault has been established in the underlying action. Further, an insurer’s agreement to pick up the defense of another party pursuant to an insured contract may have additional conditions, such as the requirement that the indemnitor and the indemnitee defense can be consolidated.
Additional insured endorsements raise a host of other issues, such as whether the injury was during ongoing or completed operations and whether the additional insured is entitled to have the named insured’s CGL assume a primary position over the additional insured’s CGL policy. Indemnification and insured contract analyses are similarly complex and unpredictable from jurisdiction to jurisdiction.
However, some broad conclusions can be made to begin the process of sorting out the priorities and availability of coverage in these risk transfers. First, additional insured coverage is generally broader than insured contract coverage. If your contract provides for this status, particularly on a primary basis, then you may not need to proceed to make a tender of an indemnity provision. Second, insured contract status is very dependent on the terms of the indemnification provision in the contract at issue and also is subject to any number of complex conditions.
Determining the appropriate means of risk transfer in construction agreements begins with reviewing available options. A proper analysis will begin with (1) a complete copy of both the named insured’s and the additional insured’s CGL policies, preferably certified, with all endorsements; (2) a complete copy of any contracts between the parties; and (3) a complete copy of all pleadings among the parties to the litigation that give rise to the risk transfer. With these materials in hand, you should be in a position to begin the process of sorting out the obligations of the parties and insurers effectively to achieve risk transfer.