MEC&F Expert Engineers : 11/01/14

Saturday, November 1, 2014

WAYS OF TRANSFERRING THE PROFESSIONAL OR CONTRACTOR LIABILITY TO THIRD PARTIES

WAYS OF TRANSFERRING THE PROFESSIONAL OR CONTRACTOR LIABILITY TO THIRD PARTIES

What is a construction defect?

Construction-defect litigation has spread across the U.S. More and more court jurisdictions are finding coverage for defect claims in the completed operations coverage of CGL policies or E&O policies of architects, engineers, or contractors.

A construction defect is generally speaking, a deficiency in the design or construction of a building or structure resulting from a failure to design in accordance with federal, state or local building codes or failure to use applicable environmental safety codes or failure to construct in a reasonably workmanlike manner, or failure to adhere to building plans/design and/or in accordance with a buyer's reasonable expectation or failure of a building component.

The most dangerous defects have the capacity to fail, resulting in physical injury or damage to people or property. However, many defects present no increased risk of injury or damage to other property but nevertheless cause harm to the property owner in the form of loss of use, diminution in value, and extra expenses incurred while defects are corrected. This latter type of defect is often referred to as a passive defect.

Many states have more specifically defined the term "construction defect" for purposes of applying statutes that dictate processes for remedying and litigating construction defect claims. These statutory definitions vary by state. Nevada, for example, uses the term constructional defects and defines it as follows:

“Constructional defect” means a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance and includes, without limitation, the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance:

Which is done in violation of law, including, without limitation, in violation of local codes or ordinances;

Which proximately causes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed;

Which is not completed in a good and workmanlike manner in accordance with the generally accepted standard of care in the industry for that type of design, construction, manufacture, repair or landscaping; or

Which presents an unreasonable risk of injury to a person or property.

In California, for any home or condo completed or closed escrow after January 1, 2003, SB 800 (Civil Code Section 895 et seq.) clarified the types of defects that the builders are responsible to fix. This statute takes the guesswork out of defining a defect and clearly identifies by statute all categories of defects for which the developer is responsible.

Prior to 2003, Courts recognized two primary categories of defects for which damages are recoverable by the homeowner or homeowner association.

Defects in design, workmanship and materials: These include, water seepage through roofs windows and sliding glass doors; siding and stucco deficiencies; slab leaks or cracks; faulty drainage; improper landscaping and irrigation; termite infestation; improper materials; structural failure or collapse; defective mechanical and plumbing; faulty electrical wiring; inadequate environmental controls; improper security measures and devices; insufficient insulation and poor sound protection; and inadequate firewall protection.

Landslide and earth settlement problems: Examples are expansive soils; underground water or streams; landslides; settlement; earth movement; improper compaction; inadequate grading; and drainage.

Structural failures and earth movement conditions can be catastrophic in nature and present both personal injury and substantial property damage exposure. Landslide and settlement conditions may result in collapse of buildings; cracks in slabs, walls, foundations, and ceilings; disturbance of public or private utilities; and sometimes a complete undermining of the structures.

For architects and other design professionals, one of the most devastating professional and business risks is from litigation alleging negligence in performing professional services. These alleged negligent acts, errors, or omissions may cause damage to owners, contractors, or other third parties, and the architect’s firm may be found liable for these damages.

WAYS OF TRANSFERRING THE PROFESSIONAL OR CONTRACTOR LIABILITY TO THIRD PARTIES

The most common way of transferring the construction defect liability from the design professional or contractor to a third party is through the purchase of insurance products. Under these contractual agreements, a third party (the insurer) agrees to carry the risk of your malpractice or construction defect and you agree to pay him a certain premium.

While a commercial general liability (CGL) policy provides coverage for liability for bodily injury and property damage caused by an accident, it excludes coverage for liability for professional services. This is an occurrence-based policy.

On the other hand, Errors and Omissions (E&O) insurance, also commonly referred to as “professional liability insurance” or “malpractice insurance,” provides liability coverage, typically including both defense and indemnity protection, for the design professional. Typically engineers and architects are covered by E&O policies, but specialty carriers issue E&O policies for other types and categories of professionals as well.

E&O insurance provides protection to third parties, usually clients of the particular professional insured by the E&O policy (but sometimes also intended third party beneficiaries of the professional’s contracted-for services) resulting from the negligent performance of professional services. Intentional misconduct by the professional typically is excluded from E&O coverage under most policies, and indemnity for willful torts might otherwise be barred as a matter of public policy under California Insurance Code section 533, as well as other state’s statutes. Economic and other intangible losses are covered by typical E&O policies, whereas losses due to property damage or bodily injury usually are excluded from coverage—as the latter categories of losses are insured under comprehensive general liability (CGL) policies.

E&O insurance almost always is “claims made” or “claims made and reported” coverage, which means that the insurance carrier is obligated (under typical E&O policies) to defend and indemnify the insured from liability only for covered claims made—and (in the case of claims made and reported coverage) actually reported—during the applicable policy period. See Slater v. Lawyers’ Mut. Ins. Co. (1991) 227 Cal.App.3d 1415, 1423 (claims made and reported policy); Chamberlin v. Smith (1977) 72 Cal.App.3d 835, 845 (claims made policy).

An insured may still be covered under a “claims made” policy despite giving tardy notice of the claim to the insurer, unless the insurer can show that it was substantially prejudiced due to the late notice (Pacific Employers Insurance Co. v. Superior Court (1990) 221 Cal.App.3d 1348, 1359). On the other hand, the so-called “notice-prejudice rule” is inapplicable in the case of “claims made and reported” policies because the timely reporting requirement is an express policy condition to coverage. The California Insurance Code requires special warnings in “claims made” policies so that professionals are made aware of that limitation. See California Insurance Code § 11580.01(b).

Most E&O policies have so-called “burning” limits, meaning that defense costs, including attorneys’ fees, reduce the policy limits and, accordingly, the amount of money available for indemnity payments for settlement or to satisfy a judgment. By a “rider” or “endorsement,” however, a professional may be able to purchase defense coverage that is separate from and in addition to the applicable policy limit for indemnity coverage.

To be covered by a typical E&O policy, the claim against the professional must arise out of the professional service provided by the professional to others, typically the professional’s client. See Blumberg v. Guarantee Ins. Co. (1987) 192 Cal. App. 3d 1286, 1290. Most E&O policies issued today, however, contain specific policy definitions and exclusions that contain the scope of activities that constitute “professional services” within the policy’s scope of coverage.

Most E&O policies issued today, like most Director’s and Officer’s (D&O) liability policies issued today, contain various conduct exclusions and claim exclusion that preclude coverage for intentional torts and claims arising from fraud or criminal acts, illicit personal profits, to recover attorneys’ fees paid by the client, for copyright or trademark infringement, for securities violations, or for illegal discrimination. Most E&O policies also contain “insured v. insured” exclusions precluding coverage for claims between two or more insureds under the same E&O policy, as well as excluding coverage for breach of contract claims (apart from breach of the applicable professional services contract used by the insured).

Particular professions also generate policy exclusions in E&O policies designed specifically for that profession. An architect professional liability policy typically will have exclusions tailored to the architectural profession that are not contained in attorney, engineer, or physician professional liability insurance policies.

There is a fundamental difference between a claims made and reported policy and an occurrence policy. Under a claims-made and reported policy, only claims made to an insured and reported to the insured's insurance carrier during the policy period and any extended reporting period has liability coverage. In addition, the allegedly wrongful act must have taken place during the policy period or during the "prior acts" coverage period provided for in the policy. Under a CGL or other occurrence policy, there is liability coverage for bodily injury or property damage caused by an accident that results in harm to the claimant during the policy period, regardless of when the claim is made against the insured, reported to the carrier or when the allegedly wrongful act took place. (Helfand v. National Union Fire Ins. Co., 10 Cal.App.4th 869, 888 (1992).)

The important characteristic of a claims-made-and-reported policy is that the insurance carrier's exposure ends when the policy term and any extended reporting period end, thereby providing certainty as to the insurance carrier's potential liability. If a claim is reported to an insurance carrier after the policy has expired and after any extended reporting period, the carrier can deny coverage whether or not it is prejudiced.

There are two ways insureds can protect themselves in advance: First, they can and should purchase prior acts coverage to be protected in case of a claim from work done before the policy goes into effect. Second, they can obtain coverage permitting them to report claims after the policy has expired, called an extended reporting period (ERP). Some policies include a 30 or 60 day ERP as part of the basic coverage. For an additional premium, an insured usually can purchase optional coverage allowing an ERP for up to a few years.

Also, if a professional retires, he or she has no future coverage unless the professional purchases "tail coverage." Because retirement does not end one's exposure to malpractice claims, a professional should consider such coverage, especially if the business closes with the professional's retirement.

Many policies require that the insured consent to settle. But the carriers protect themselves with a "hammer clause." If the insured has an opportunity to settle but refuses, the carrier's liability, including defense expenses, is capped at the settlement amount.

A significant recent change in the professional market has evolved the insurance coverage to extend beyond purely third-party liability. Previously, first-party protective coverage was not readily available in the market. Over the past few years, the market has significantly expanded to the point where now almost all the major carriers offer it, either through new products or updates of their existing liability forms.

Whereas basic professional liability coverage responds only after a claim has been made by a third party, the addition of protective coverage provides the contractor with first-party coverage excess to professional liability insurance carried by subcontractors. For example, if design errors lead to additional costs incurred to bring a project to completion on time and the limits of the design professional's policy are not high enough to cover the increase, protective coverage will pay the contractor for the difference.

Closely related to the expansion of protective coverage is the growth of rectification or mitigation coverage, which provides primary insurance subject to a self-insured retention. As the name implies, rectification or mitigation coverage covers costs to remedy design errors discovered during construction that would lead to a liability claim if left uncorrected.

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WHAT THE HOLD HARMLESS AGREEMENT MEANS IN CONSTRUCTION CONTRACTS

Hold harmless agreements have become standard parts of construction contracts. In a hold harmless agreement (also known as an indemnity agreement), one party (the indemnitor) agrees to pay for damages assessed against another party (the indemnitee) for its liability for injuries or property damage arising out of the project. There are three basic forms of hold harmless agreements and they have different implications for a contractor's liability insurance.

Broad Form: The indemnitor assumes all liability for accidents arising out of the project, regardless of who was at fault. Under this form, a subcontractor pays for its own sole negligence, its joint negligence with a general contractor for an accident, and the sole negligence of the general contractor. Therefore, an electrical contractor is liable if an employee injures another sub's employee with a dropped tool; if an employee leaves materials in a walkway at the GC's direction, causing another sub's employee to trip and injure himself; and if the scaffolding, set up by the GC for the electrician to use, collapses on top of another sub's employee. Many states prohibit this form of agreement unless the indemnitor finances the assumed liability with an insurance policy.

Intermediate Form: The indemnitor assumes all liability for accidents arising out of the project except for those where the indemnitee is solely negligent. Under this form, the subcontractor pays for all accidents in which it is at least one percent liable. In the above examples, the sub would not assume liability for the incident involving the scaffolding, but it would assume liability for the dropped tool and the materials left in the walkway.

Limited Form: The indemnitor assumes liability for accidents arising out of the project, but only to the extent of its own liability. Under this form, in an accident where each party was 50 percent liable, the sub would owe 50 percent of the judgment amount to the GC. In the case of the materials left in the walkway, if the jury held each party 50 percent liable and the award was $100,000, the GC would pay the $100,000 and the sub would owe the GC $50,000.

The ISO Commercial General Liability Coverage Form excludes coverage for injuries or damage for which the insured is obligated to pay damages because it assumed liability in a contract or agreement. However, the form makes an exception for liability assumed in 'insured contracts,' including parts of contracts where the insured assumes the tort liability of another party to pay for injuries or damages to a third party. This exception gives a subcontractor insurance coverage for liability it assumes in a hold harmless agreement, if the injury or damage occurs after the contract's execution. The policy will cover the GC's attorney fees if the hold harmless agreement requires the sub to pay for them.

Another way for a sub to insure assumed liability is to add the GC as an additional insured under the CGL policy. However, it is important to understand that ISO changed its additional insured endorsements in 2004 so that they do not cover an additional insured for its sole negligence. This could be a problem if the contract contains a broad form hold harmless agreement. In the above examples, the additional insured endorsement would not cover the GC for the scaffolding accident even with the broad form agreement in place. To recover, the GC would have to make a claim for damages under the insured contract coverage.

Contractors should work closely with their contract engineer to ensure that they understand the terms of hold harmless agreements. They should also consult their insurance agents to determine how their liability insurance will apply to the agreements. The time to identify and eliminate coverage gaps is before the job starts and an accident occurs.

examination of THE additional insured status under the CGL, umbrella and excess insurance policies

http://metroforensics.blogspot.com/2014/10/examination-of-additional-insured.html

In this blog we presented an examination of additional insured status under the CGL, umbrella and excess, automobile, commercial property, and workers compensation insurance policies. Thousands of times a day, sophisticated companies around the globe negotiate commercial contracts. Virtually all of those contracts contain indemnification agreements of one kind or another. The majority also include “additional insured” provisions — requirements that one party be covered under the other's insurance policies.

A Deepwater Horizon-related coverage dispute highlights the need for corporations to square their commercial contracts with their insurance policies. We discuss the interplay between indemnification agreements and “additional insured” provisions and the importance of retaining contract engineer to help navigate some very significant pitfalls.

The topic of additional insured status is a challenging one. Many misconceptions result when adding contracting parties to one another's insurance policies as additional insureds. There is also the tug-of-war between insurers and indemnitors who want to limit the scope of additional insured coverage under their policies and the indemnitees who want to maximize coverage under the policies of the indemnitors. Added to this, the interaction of additional insured status with indemnity clauses, insurance requirements, and other contract provisions is unique and complex. These complications have resulted in numerous coverage disputes and, consequently, a number of revisions to standard insurance policy forms and additional insured endorsements. Litigation continues unabated, however, and the controversy and confusion surrounding additional insured status under primary and umbrella liability policies, indemnity agreements, and certificates of insurance persists.

What is an additional insured?

Many construction agreements call for one company to name another company as an “additional insured”. Before this occurs, each party should have a general idea of what this means.

In most situations, the insurance at issue is the Commercial General Liability (CGL) policy of the lower tier party. A common scenario is a prime contractor asking a subcontractor to name the prime contractor (and perhaps the owner or others) as an additional names insured on the subcontractor's CGL policy. This request is sometimes found within the terms and conditions of a proposed subcontract.

Before agreeing to this, both parties should have a basic understanding of what it means. In general, naming a company as an additional insured on your CGL policy enables that company to make a claim directly against your policy.

In today’s world of defective construction claims, prime contractors (and their insurance carriers) are becoming more insistent on obtaining a certificate of insurance where the prime contractor is a named additional insured. Then, if there is an allegation of defective construction by a subcontractor, the prime contractor can make a claim directly against that subcontractor’s CGL insurance. This can be particularly important if the subcontractor is no longer in business.

Notwithstanding the great importance of indemnification and “additional insured” provisions, companies all too often include them without performing the proper due diligence. Specifically, contracting parties fail to analyze and understand the insurance policies that stand behind their commercial agreements. This occurs with high frequency and understandably so because there may be numerous policies effective and only one person in the organization may know anything about their limits and coverages. Importantly, that person is probably the CFO or a lawyer who may not know much about the day to day operations or not familiar with the scope of work of the particular commercial agreement being negotiated. Most of the time, the insurance person inside the organization will ask few questions and s/he may get some answers; but this does mean that he either asked the right question or that he received the correct answer. Quite often we get what is called information exchanged “falling through the cracks”.

Although this concern has always been top of mind for insurance coverage counsel, two recent events have thrust the indemnity vs. insurance issue into a broader spotlight: the latest Deepwater Horizon coverage battle, and the insurance industry's promulgation of new policy language. Taken together, these two events underscore how negotiating indemnity provisions without a comprehensive understanding of the related insurance policies can lead to disastrous results.

The Deepwater Horizon catastrophe in April 2010 left a devastating mark on people, businesses and the environment around the Gulf of Mexico. Now, its ever-expanding ripples are about to hit the world of insurance policy interpretation. A coverage dispute pending before the Texas Supreme Court involving BP P.L.C., Transocean Ltd. and their various subsidiaries, affiliates and insurers will have a significant impact on countless insurance policies across the country.

It is a common practice among commercial entities to indemnify one another for losses arising out of their joint business operations. And it is equally common for such entities to add themselves as “additional insureds” under the other's general liability insurance policies. The question is: When a loss occurs, is the scope of recovery determined by the indemnity agreement or the insurance policy? This is the issue that the Texas Supreme Court is being asked to decide.

The scenario is simple: Company A hires Company B to perform services on its behalf. Company A insists that it be named as an “additional insured” on all of Company B's insurance policies. In their services contract, Company A agrees to indemnify Company B for any losses or claims attributable to Company A's negligence or fault.

In the Deepwater Horizon disaster, Company A was BP and Company B was Transocean, the owner of the Deepwater Horizon rig. BP engaged Transocean pursuant to a drilling contract, which required Transocean to maintain certain minimum insurance coverages and to name BP as an “additional insured.” The drilling contract also stated that BP would indemnify Transocean for any pollution- or contamination-related liabilities deriving from below the surface of the water. Transocean would indemnify BP for any pollution- or contamination-related liabilities above the water's surface.

On April 20, 2010, the Deepwater Horizon exploded and sank. After the explosion, it became apparent that oil was leaking from the former drilling operation. The rest is well-documented history.

Over the past several years, as the liability issues have been winding their way through the courts, so too have the overriding insurance disputes. And now, in one of the Deepwater Horizon disaster's highest-profile coverage battles, BP is seeking coverage under Transocean's commercial general liability policies.

From the outset, BP has asserted that, as an “additional insured,” it is entitled to full coverage under Transocean's policies. Transocean's insurers have disagreed and denied coverage. The insurers cite the drilling contract as evidence that Transocean is only responsible for pollution claims arising from incidents above the surface of the water. According to the insurers, the drilling contract limits BP's entitlement to “additional insured” coverage under Transocean's policy. In their view, BP is an “additional insured” only for above-the-surface incidents.

The foregoing disagreement frames the key legal question: Can the scope of an insurance policy be altered by a separate commercial contract?

This issue was first posed to the U.S. District Court for the Eastern District of Louisiana, where the Deepwater Horizon multidistrict litigation is venued. The District Court found that the drilling contract limited the insurance coverage and held that BP could not avail itself of Transocean's policy.

BP appealed the issue to the 5th U.S. Circuit Court of Appeals. In March 2013, the appeals court reversed the District Court's decision. The 5th Circuit concluded that the policy language should govern in situations where the insurance provision in the parties' contract is “separate and independent” from the indemnification provision in the parties' contract.

According to the court, to be separate and independent, the insurance provision must be a discrete requirement that is distinct from, and in addition to, any requirements under the indemnity provision. Applying that definition to the facts at bar, the 5th Circuit found that the BP/Transocean indemnity provision was “separate and independent” and, therefore, that BP was entitled to additional insured coverage under the Transocean policy.

After reviewing the March 2013 opinion, Transocean's carriers requested a rehearing. And, in August 2013, the 5th Circuit withdrew its initial decision. Citing the significance of the issue, the fact that Texas law governed the dispute and the lack of state law on point, the 5th Circuit certified two questions to the Texas Supreme Court:

• Whether the language of the insurance policy alone determines the extent of BP's coverage as an additional insured if, and so long as, the additional insured and indemnity provisions of the drilling contract are “separate and independent”; and

• Whether the doctrine of contra proferentem (where ambiguous terms are construed against their drafter — here, Transocean's insurers) applies in cases involving highly sophisticated parties.

As of this writing, the issues are fully briefed before the Texas Supreme Court. Oral argument took place on Sept. 16, 2014. The case name number is In Re Deepwater Horizon, 13-0670, 2014.

BP contracted with Transocean to provide "additional insured" protection covering Transocean's operations above the water line, while BP engaged in drilling below the water line. That narrow limitation was contained in the business contracts between the entities, while the insurance contracts themselves (arguably, at least) did not mirror the same limitation.

The first major issue is about construing the various contracts. BP contends that only the insurance policy language matters in deciding whether it is an "additional insured," citing cases such as EVANSTON INSURANCE COMPANY v. ATOFINA PETROCHEMICALS, INC., No. 03-0647. The insurers contend that the extent of coverage they agreed to provide to BP was limited to the scope of Transocean's agreement to provide that coverage, and thus excludes the claims here.

The second major issue might have broader implications. BP contends that if there is any ambiguity about whether it is covered, the policy should be construed against the insurer and in favor of the insured. The insurers contend that the doctrine does not apply in this sophisticated commercial context. They argue that Transocean agreed to indemnify and add as an additional insured for all liabilities assumed by Transocean under the terms of the contract. Transocean argued that it assumed many liabilities but not subsea pollution – that pollution was assumed by BP only.

We believe that the Transocean insurers will win this argument.