Why insurers aren't paying, and you are

I HAVE WRITTEN many columns about indemnity and insurance issues, but I have to write another one because courts, legislatures, insurers and attorneys just can't seem to leave it alone. They keep changing the rules, and you are the ones who have to make sense of it all and live with it. Indemnification, the legal principle that allows one party, who has paid for something that the other one has done

I HAVE WRITTEN many columns about indemnity and insurance issues, but I have to write another one because courts, legislatures, insurers and attorneys just can't seem to leave it alone. They keep changing the rules, and you are the ones who have to make sense of it all and live with it.

Indemnification, the legal principle that allows one party, who has paid for something that the other one has done wrong, to require that other party to cover the loss, is a serious issue in construction. On any given day, something can go wrong and a burst pipe can damage a homeowner's oriental rug, or an improperly installed handrail can send a shopper tumbling down a flight of steps. It is important for the person for whom the work is done to be able to turn to the person who did the work for relief (which means money) in such situations. In most commercial situations, the contract requires that this indemnification obligation be backed up by liability insurance.

What has been changing is that attorneys keep making these two contractual obligations tougher and tougher, which is what their clients want them to do. Indemnification clauses have gone from fair to a little overreaching to the absurd. Many clauses are now written that require the contractor to pick up the entire tab where there is fault on both sides, and a fair number go so far as to require the contractor to pay all damages even if it is entirely the customer's fault.

The other prong of the problem — insurance coverage — is as much of a challenge. Insurers are smart folks. They understand very well what makes them money and what costs them money, and they act pretty quickly to change the way they operate in response.

Some insurers are simply refusing (or making economically unavailable) coverage for some of the claims that lead to the biggest indemnity suits (such as condominium owners' claims of decreased property values or illness due to mold or silica).

Insurers understand what costs them money.

Insurers are fighting back against the recent trend in contracts to require the contractor to include as indemnified parties more and more people. It is not unusual to see contracts that require the contractor to indemnify the owner, the architect (and its sub-consultants), tenants, lenders and anyone else the lawyers can think to throw in. What this has led to is a skyrocketing cost of defense for the insurer, even though the cost of the claim itself hasn't changed. In response, insurers are issuing "additional insured endorsements" that refuse to cover anyone that is not actually in the "chain of privity" (owner to contractor; contractor to subcontractor; subcontractor to vendor).

Insurers are also restricting the scope of what they will cover. They are careful about the language in the additional insured endorsement — no matter what the contract seems to require, the insurance policy is not going to provide "primary" coverage for what the customer supposedly has done wrong. It will only cover the customer to the extent it is blamed for what the insured did wrong.

The extent of coverage is further limited through the "your work" exclusion, which is intended to prevent an insurance policy from being used as a surety bond. It says, generally, that the insurance policy will not cover claims that ask to be reimbursed because your work itself was bad — repairing defective work is the job of a surety. The insurance policy will cover claims of accidental damage (what the policies refer to as "occurrences") as a result of failed work. In older policies the your work exclusion only avoided coverage for claims that the work of the insured itself was bad, but it would cover claims that the work of the insured's subs was bad. Newer policies are written to limit the coverage to damage from only the insured's work.

Insurers have very effective and well-paid lobbyists. A wave of legislation has been enacted in the last few years to outlaw clauses that ask a contractor to pay for anything more than what he is responsible for, and there is more every year.

The problem with all these changes is that there is now a giant disconnect between what the contracts are requiring and what the contractors can provide in insurance to cover indemnity agreements. Since most of these contracts are presented on a take-it-or-leave-it basis (particularly on public work), a contractor who wants the work has no choice but to accept the terms even if he can't meet them (probably hoping that no one will ask for a copy of the actual policy to know the difference).

The best advice I can give contractors on the subject is:

  • Get your insurance adviser to read the indemnification and insurance clauses of your contracts carefully and let you know if you can comply with them. If you can comply for an extra charge, make that an option to your customer.
  • Ask your attorney if the contract's requirements are really enforceable in your state — there is a very good chance that they are not.
  • Work with your trade associations to bring your problems to the attention of your state insurance commissioner and legislators — there may still be time this year to get some relief.
TAGS: Law