Lessons Learned from a Plant Explosion

Ensuing Litigation Involving Builders Risk Insurance

Litigation ensued in July 2011, which involved the builders risk insurance program. The case discussed here is Ace Am. Ins. Co. v. Keystone Constr. & Maintenance Servs., Inc., No. 3:11cv1136 (SRU), 2012 U.S. Dist. LEXIS 138991 (D.CT. Sept. 27, 2012). This was a subrogation action brought by Kleen's insurers against specified subcontractors: Bluewater Energy Solutions, Inc.; Keystone Construction and Maintenance Services, Inc.; Sprague Energy Corp.; WorleyParsons Group, Inc.; and Siemens Energy, Inc (collectively, "subcontractors"). The natural gas supplier and transporter were also named as defendants. The court ruled on several motions, some of which involved the builders risk insurance.

There were two major issues involving the builders risk: whether the subcontractors were insured under the builders risk policy and whether Kleen waived its right to subrogation. As part of examining the first issue, the court focused on whether (1) the subcontractors were additional insureds; (2) the "doctrine of waste" precluded subrogation; and (3) the terms of builders risk coverage applied to this situation.

Were the Subcontractors Additional Insureds?

Under Connecticut law, the "antisubrogation rule" prevents an insurer from subrogating against its own insured. The court then turned to the builders risk policy to determine whether subcontractors were insureds under that policy.

The policy provided that:

To the extent required by any contract or subcontract for the Insured Project, and then only as their respective interests may appear, all owners, all contractors and subcontractors of every tier, tenants of the INSURED PROJECT, and any other individual or entity specified in such contract or subcontract, are additional insureds hereunder. (Emphasis added.)

Due to the presence of the clause "To the extent required by any contract or subcontract," it was necessary for the court to examine the applicable contracts to determine whether subcontractors qualified as insureds.

The subcontractors argued that the following clause in the Kleen/O&G construction contract showed that Kleen was required to maintain insurance for the subcontractors and that they were covered by the builders risk policy:

Owner shall purchase and maintain ... property insurance written on a builder's risk "all risk" or equivalent form on a completed value basis ... This insurance shall name the Owner as the First Named Insured, and also insure the interests of the Contractor, and Contractor's subcontractor and subcontractors in the facility. (Emphasis added.)

They interpreted the requirement to "insure the interests of" to mean that subcontractors were to be included as additional insureds under the builders risk policy. Another argument presented was that the language of the construction contract was very broad. The builders risk insurance requirements in the contract required insurance on the entire value of the facility on a replacement cost basis.

The insurers argued that (1) "insuring the interests" of the subcontractors is not the same as being an "additional insured" and (2) if Kleen wanted the subcontractors to be additional insureds, it could have specified so in the contract. The insurers concluded that the phrase "insuring the interests" must have a different meaning than being an "additional insured."

The insurers attempted to bolster their arguments by citing an additional provision in the contract, which provided:

A loss insured by the Builder's Risk Property insurance described herein shall be adjusted by Owner as fiduciary and made payable to Contractor as fiduciary for the insureds, as their interests may appear, or as required by the Financing Parties.

The insurers interpreted this to mean that subcontractors were not "additional insureds" and were not entitled to make direct claims but may receive insurance proceeds if their claims included damage to their interests.

The court found for the subcontractors. While it acknowledged that different sections of the construction contract and builders risk insurance policy used the phrase "additional insureds," and others did not, the combined meaning of the two was clear. The contract required the owner to buy a policy that protected the interests of contractors and subcontractors. The insurance policy was structured to do this by recognizing such parties as "additional insureds." The judge concluded:

When a policy says that, to the extent required by the contract, a party is an additional insured, and the contract insures that party's interest, the combination of these terms seems to me to suggest, if not to compel, the conclusion that the party is an additional insured. I see no more reasonable construction.

Did the Doctrine of Waste Preclude Subrogation?

Equitable waste is defined as using a right, such as occupancy on a property, to cause damage, not by accident, but by willful malicious behavior.¹ An example of equitable waste would be to allow a landlord's insurer to subrogate against a tenant following damage to real property.² Presumably, the tenant's rent includes allowance for the cost of the landlord's property insurance. The alternative would be for every tenant to carry insurance on the entire building, which would be a form of economic waste.

In this case, a subcontractor argued that it would be wasteful for every contractor and subcontractor to carry insurance equal to the value of the entire power plant construction project. The insurers argued that the contractor and subcontractors already maintained liability insurance and the doctrine of equitable waste did not apply. While the court sided with the subcontractors in principle, it ruled that the doctrine of equitable waste did not preclude this subrogation action by itself. The court concluded that subrogation actions are encouraged, and the appellate courts in Connecticut have not extended the doctrine of equitable waste this far.

Did the Builders Risk Coverage Apply to This Situation?

The insurers argued that they should be permitted to sue the subcontractors, even if the court determined that the builders risk policy covered the contractors. They reasoned that the insuring agreement limited coverage to the respective interests of each contractor and subcontractor. As such, coverage did not apply to a subcontractor for damage to property other than its own tools, equipment, and work it performed. Therefore, coverage would not apply to damage to the work performed by others.

The court disagreed. It determined that the "as their interests may appear" language was ambiguous and that the subcontractors were fully covered by the builders risk policy.

Did Kleen Waive Its Right to Subrogation?

The subcontractors argued that they should be dismissed from all claims because Kleen waived its right of subrogation in the Kleen/O&G contract:

Owner and Contractor waive all rights against each other and any of their subcontractors, sub-subcontractors, agents and employees, each of the other, for damages caused by fire or other causes of loss to the extent covered by Builder's Risk Property insurance obtained pursuant to Section 12.3 or other property insurance applicable to the Work, except such rights as they have to proceeds of such insurance held by Owner as fiduciary.... A waiver of such rights shall be effective as to a person or entity even though that person or entity would otherwise have a duty of indemnification contractual or otherwise, did not pay the insurance premium directly or indirectly, and whether or not the person or entity had an insurable interest in the property damaged.

The builders risk policy specified that the insurers had no rights of subrogation against (1) additional insureds, and (2) any other person or entity against which the insured had waived its rights of subrogation in writing before the time of the loss. The insurers argued that the waiver was against public policy with respect to claims of recklessness and strict liability (the insurers alleged such claims in the original complaint).

The court concluded that prohibitions against waivers of subrogation due to recklessness and strict liability exist to ensure compensation of tort victims. The court refused to strike the waivers between Kleen, O&G, and the subcontractors and dismissed the recklessness and strict liability claims against all subcontractors. It reasoned that Kleen had been paid for its loss, the insurers agreed to insure the construction of the power plant, and both the construction contract and the builders risk policy did not contain exclusions for reckless or ultrahazardous conduct.

Lessons Learned

Those who design and implement builders risk insurance programs can learn from court cases. After all, if the parties cannot come to an agreement on a claim, the courts will do that for them. Here are a few concepts that are reinforced by this case.

The construction contract was unclear as to how the contractor and subcontractors were to be protected by the builders risk policy. The contract required Kleen to "... insure the interests of ... " the contractor and contractor's subcontractor and subcontractors in the facility. The phrase "insure the interests of" has been, and will be, interpreted differently by insureds, insurers, and courts alike. The construction contract should clearly state which parties are to be insureds (e.g., owner, contractor, and subcontractors of all tiers). This removes uncertainty. In other words, say what you mean, and mean what you say. The builders risk policy should then be structured to incorporate the requirements.

The insuring agreement in the builders risk policy contained a phrase that is a source of ongoing disputes: "... to the extent required by any contract or subcontract...." Including this phrase in the insuring agreement forces the claims adjuster (and courts) to review the contract documents to determine the scope of the builders risk policy. It is far better for the builders risk policy to mention the contract requirements, where appropriate, rather than having the policy incorporate the contract provisions by reference. Also, if the intent under a builders risk policy is to insure the contractor and subcontractors of all tiers, it is better to specify this in the policy. If one relies on the contract documents in determining coverage, it is much more likely for a coverage gap to occur.

The insuring agreement contains another phrase that continues to be litigated with some regularity, "... as their respective interests may appear...." This phrase has opened the door to many subrogation actions. As with this case, insurers sometimes attempt to show that, while contractors and subcontractors may be protected by the policy for insured damage to their work, this does not extend to the damage to the work of others. Underwriters often use this phrase because they feel this is a way to prevent a party from collecting more than that to which it is entitled. However, since a builders risk policy is a contract of indemnity, protected parties are prevented from collecting any amount greater than the loss they are able to prove. The phrase is unnecessary and should be retired.

Conclusion

Clarity in the construction documents is very important. It is equally important that the builders risk policy, at a minimum, satisfy the builders risk-related insurance requirements set forth in such documents. Phrases such as "insuring the interests," "to the extent required by any contract or subcontract," and "as their interests may appear" add confusion, not clarity. These phrases should be avoided where possible.

¹ The Law Dictionary (last visited November 22, 2012).

² Wasko v. Manella, 269 Conn. 527, 849 A.2d 777 (2004).

Builders Risk: Lessons Learned from a Plant Explosion