Additional Insured Endorsements: Watch Your Language!

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1 Additional Insured Endorsements: Watch Your Language! By Jill B. Berkeley, Insurance Policyholder Practice Group Chair Risk - 4th Quarter 2010 Reprinted with permission The use of Additional Insured Endorsements (AIE) is standard in the construction industry. The form of AIEs and the contractual provisions requiring AIEs, however, is anything but standard. In fact, the fight against using an AIE as a risk-shifting tactic has created a major insurance litigation battlefield. One of the ways insurers are fighting against providing additional insureds coverage is to modify standard ISO language. New non-standard language is being used and litigated all over the country in an effort to narrow the coverage provided to additional insureds. In the litigation arena, the insurers of owners and general contractors are suing the insurers of general contractors and subcontractors with a vengeance. They are using insurance concepts relating to duty to defend, estoppel, bad faith, targeted tender, horizontal exhaustion, conflict of interest, and equitable contribution in the finger-pointing struggle to find any other insurer s policy applicable. To the extent that policyholders take an interest in which insurer is defending and indemnifying them, these concepts and a few new forms of AIEs bear watching. Targeted Tender When the policyholder has the opportunity to trigger coverage under an AIE, it may effectively shield its own policy and procure insurance without incurring any obligation for deductibles or higher premiums. Typically, the policyholder should be able to use targeted tender to obtain full reimbursement of all defense and indemnity costs. Once an insurer accepts coverage under an AIE, the acknowledging insurer may want to chase other insurers to split the defense and indemnity obligations under the principle of equitable contribution. In a recent Illinois case, American States Insurance Company v. CFM Construction Company, 398 Ill. App. 3d 994, 923 N.E. 2d 299, 337 Ill. Dec. 740 (2d dist. 2010), the court reiterated the principles for applying equitable contribution. When an insurer has paid the entire loss, the doctrine of equitable contribution allows it to be reimbursed by other insurers that are also liable for the loss. Cincinnati Insurance Co. v. American Hardware Manufacturers Ass n, 387 Ill.App.3d 85, 114, 898 N.E. 2d 216, 325 Ill. Dec. 483 (1st dist. 2008). The doctrine of equitable contribution arises from a right, which is independent from the rights of the insured, to recover from a coobligor who shares the same liability as the party seeking contribution. Argonaut Insurance Co. v. Safway Steel Products, Inc., 355 Ill.App.3d 1, 10-11, 822 N.E. 2d 79, 290 Ill. Dec. 797 (2004). The purpose of the doctrine is to provide a remedy when one insurer has paid a debt that is equally owed by another insurer. Chicago Hospital Risk Pooling Program v. Illinois State Medical Inter- Insurance Exchange, 325 Ill.App.3d 970, 981, 758 N.E. 2d 353, 259 Ill. Dec. 230 (1st dist. 2001). The fact that one insurer undertakes the burden of a full settlement payment does not mean the insurer is a volunteer. Chicago Hospital Risk, 325 Ill.App.3d at 981. Equitable contribution applies to multiple, concurrent insurance situations and is only available where the concurrent policies insure the same entities, the same interests, and the same risks. Home Insurance Co. v. Cincinnati Insurance Co., 213 Ill.2d 307, 316, 821 N.E. 2d 269, 290 Ill. Dec. 218 (2004). Although the principle of equitable contribution is recognized in most jurisdictions, under Illinois law, the insurer may not exercise that right without the insured s explicit approval. For policyholders or their insurers that wish to protect the right to target tender, the policyholder must take precautions to confirm the Neal, Gerber & Eisenberg LLP Two North LaSalle Street Chicago, IL

2 2 insurance specifications in its contractual agreements provide additional insured coverage on a primary and non-contributing basis. It must review additional insured endorsements to confirm that they meet the requirements in the insurance specifications provisions of their contracts, and do not attempt to limit Illinois principles of targeted tender. Finally, the policyholder should review its own policies to be sure that they reflect an appropriate other insurance clause. A recent case illustrates the situation in which the policyholder did not recognize that the AIE had nonstandard language and the insurance specifications in its contract were missing the magic words, on a primary and non-contributory basis. The policyholder was not able to shield its own insurance policy and trigger coverage under an AIE on a primary basis. In River Village I, LLC v. Central Ins. Cos., 919 N.E.2d 426, 396 Ill.App.3d 480, 335 Ill.Dec. 707 (1st dist. 5th div. 2009), River Village was the general contractor on a construction project, and hired First Choice Drywall ( First Choice ) as a subcontractor at the project site. Roche, an employee of First Choice, was injured at the project site and brought suit against River Village and others. The contract between River Village and First Choice required First Choice to name River Village as an additional insured on its insurance policy for defense and indemnification purposes, but did not specify what type of insurance (i.e., primary or excess) First Choice was required to obtain for River Village. Instead, the contract only stated that First Choice was to indemnify and hold harmless River Village for any and all claims, and pay for and maintain such insurance as agreed to by the parties. River Village had its own primary policy issued by Harleysville Lake States Insurance Company ( Harleysville ). Pursuant to the contract, First Choice added River Village as an additional insured to its CGL policy issued by Central Insurance Companies ( Central ). As part of the Blanket Additional Insured provision, Central s policy contained an other insurance clause that stated in part: b. 2) This insurance is excess over: Any other valid and collectible insurance available to the additional insured whether primary, excess, contingent or on any other basis unless a contract specifically requires that this insurance be either primary or primary and noncontributing. (emphasis added). River Village exercised its rights as an additional insured and tendered its defense to First Choice s insurer, Central, noting that it was instructing its insurer, Harleysville, not to respond to Roche s suit or provide coverage unless and until Central s policy was exhausted. Central did not respond. River Village brought a declaratory judgment and breach of contract action against Central, claiming that Central owed it a defense in the Roche litigation. Central responded by denying River Village s tender, filing an answer, and bringing its own counterclaim for declaratory judgment against River Village. As part of its counterclaim, Central argued that its policy was excess to River Village s primary policy with Harleysville. The trial court found that the contract between River Village and First Choice intended to cover River Village as an additional insured, and the bodily injury exclusion in Central s policy did not apply. However, the trial court granted Central s motion for summary judgment and denied River Village and Harleysville s motion, finding that the cases cited by River Village and Harleysville regarding the targeted tender doctrine did not apply. Instead, the trial court noted that it was undisputed that the contract between River Village and First Choice was completely silent regarding the type of insurance (i.e., excess or primary) First Choice had to provide. Therefore, the unambiguous language of the other insurance provision of Central s policy establishing that primary coverage would be triggered only if required by written contract rendered Central s policy excess to Harleysville s policy. On appeal, River Village and Harleysville argued that the targeted tender to Central prohibited any consideration of the other insurance provision in Central s policy. The Illinois Appellate Court agreed that under Illinois law, the targeted tender doctrine allows an insured who is covered by multiple and concurrent insurance policies to select or target which insurer it wants to defend and indemnify regarding a specific claim.

3 3 The court then commented that insurers developed modified other insurance provisions in response to the targeted tender doctrine, and that such provisions attempt to render otherwise primary insurance as excess over any other collectible insurance. The court discussed the cases cited by River Village and Harleysville, in which Illinois courts held that when an insured maintained concurrent primary insurance policies among multiple insurers, the presence of an other insurance excess provision in one insurer s policy did not, in and of itself, overcome the insured s right of targeted tender. The court noted, however, that in those cases the common and determinative element was that the insurance policies at issue were all primary policies. In other words, all the insurers stood in the same position with respect to the potential duty of defense and indemnification owed to the insured. On the other hand, when the insured was covered by multiple insurers providing different types of coverage, Illinois courts reached a different result. Examining those other cases, the appellate court quoted the Illinois Supreme Court s opinion in Kajima Constr. Servs., Inc. v. St. Paul Fire and Marine Ins. Co., 879 N.E.2d 305, 314, 227 Ill.2d 102, 316 Ill. Dec. 238 (Ill. 2007): [W]e find that the better rule is that * * * targeted tender can be applied to circumstances where concurrent primary insurance coverage exists for additional insureds, but to the extent that defense and indemnity costs exceed the primary limits of the targeted insurer, the deselected insurer or insurers primary policy must answer for the loss before the insured can seek coverage under an excess policy. The appellate court also cited its own decision in State Auto Mut. Ins. Co. v. Habitat Constr. Co., 875 N.E.2d 1159, 377 Ill. App. 3d 281, 314 Ill. Dec. 872 (1st dist. 2007), where the court reiterated Kajima s holding that an insured cannot selectively tender a defense to an excess insurer while primary coverage remains unexhausted. In State Auto, the appellate court held that an insured could not target tender its defense to an insurer whose policy contained an other insurance excess provision if primary insurance remained unexhausted. The court then examined the other insurance provision of Central s policy, which stated that its coverage was excess over over any other valid and collectible insurance available to the additional insured whether primary, excess, contingent or on any other basis unless a contract specifically requires that this insurance be either primary or primary and noncontributing (emphasis added). The court found that this language was clear and unambiguous. There was no question that Harleysville s policy comprised other valid and collectible insurance available to River Village. It was undisputed that the contract between River Village and First Choice was completely silent regarding the type of insurance (primary or excess) First Choice was to obtain for River Village. Without a contract specifically requiring the insurance procured by First Choice to be primary, the court concluded that Central s policy was excess to Harleysville s primary policy. As a result, the court held that the targeted tender doctrine used in the cases cited by River Village and Harleysville, which all involved concurrent primary insurers, was inapplicable because Central and Harleysville provided different types of concurrent insurance to River Village. Relying on Kajima and State Auto, the appellate court found that Central s policy required River Village to first exhaust the primary insurance it held with Harleysville before it could trigger the excess coverage it held with Central. Because the Roche litigation was completely satisfied within the limits of the Harleysville policy, the Central policy was not triggered, and the targeted tender doctrine did not apply. Accordingly, the Illinois Appellate Court affirmed the rulings of the trial court. Changing the Additional Insured Coverage Grant In a typical AIE, the additional insured is granted coverage for its liability arising out of the activities of the named insured. If the damage arises out of the named insured s operations, coverage will generally be afforded. Lafarge Midwest, Inc. v. Frankenmuth Mut. Ins. Co., No , 2005 WL (Mich. App. Aug. 11, 2005); Home Depot U.S.A., Inc. v. Nat l Fire Ins. Co. of Hartford, No. 3:06-CV-0073-D, 2007 WL (N.D. Tex. Sept. 10, 2007). In order to determine whether the insurer has a duty to defend under an AIE, i.e., whether liability arose out of the named insured s work, courts will look at the allegations in the complaint against the additional insured. Regal Homes, Inc. v. CNA Ins., 217 Ariz. 159, 171 P.3d 610 (Ariz. App. 2007). In many states, the arising out of standard is a but for analysis, and the courts should find coverage for the additional insured when the question is close. Premcor Refining Group, Inc v. Matrix Industrial Contractors, Inc. v. Catalyst Handling Service

4 4 Co., LLC, No. 07C JOH, 2009 WL (Del. Super. Mar. 19, 2009). In Pekin Insurance Co. v. Roszak/ADC, LLC, 931 N.E.2d 799 (Ill. App. 1st dist. 6th div. June 25, 2010), the court upheld language in the AIE that narrowed coverage to vicarious liability only. Roszak, a general contractor, was named as an additional insured on a policy Pekin had issued to Rockford Ornamental Iron, a subcontractor hired by Roszak. The additional insured endorsement contained the following language: Such person or organization is an additional insured only with respect to liability incurred solely as a result of some act or omission of the named insured and not for its own independent negligence or statutory violation. After an injured construction worker filed suit against Roszak alleging negligence and premises liability, Roszak tendered its defense to Pekin. The complaint in the underlying suit alleged that the injury was a direct result of Roszak s negligence when plaintiff was struck by a load of structural steel. The complaint did not state the relationship between Roszak and Rockford. However, the court assumed that Roszak hired Rockford and Rockford hired Arena Erectors, the plaintiff s employer. Pekin sought a declaratory judgment that it was under no duty to defend Roszak because the complaint did not allege the plaintiff was injured solely as a result of Rockford s acts. The trial court disagreed, finding a duty to defend as the complaint left open the possibility of Roszak s vicarious liability for Rockford s acts, a theory that would provide Roszak with coverage under the Pekin policy. The appellate court reversed, holding that direct allegations of negligence against an additional insured did not fall within the coverage granted by the Pekin policy. The court emphasized that the theory of liability giving rise to the duty to defend must be supported by the complaint and a theory cannot be supported by the complaint if the complaint does not allege facts supporting the elements of that theory. The court looked to the complaint and found that it did not allege facts supporting the elements of vicarious liability. Nothing in the complaint alleged an agency relationship between Roszak and Rockford or indicated that Roszak retained sufficient control over Rockford s work to be vicariously liable for Rockford s acts. Since the complaint alleged direct liability against Roszak and Pekin s policy expressly excluded coverage of an additional insured for the additional insured s own negligence, the court concluded that Pekin had no duty to defend Roszak. The court looked for some allegations that Roszak retained control over the work of Rockford in order to trigger the possibility that Roszak was liable due to the conduct of Rockford. The plaintiff, however, had not included any such allegations. And, why should it? The plaintiff did not need to allege Roszak retained control over the subcontractor in order to prove liability. Under Section 414 of the Restatement (Second) of Torts, a general contractor can be liable in the absence of control, if it is exercising supervisory control. Although the court admitted that the allegations appeared to describe the general duties of a supervisor, it did not go so far as to allege retained control. The court concluded that, Essentially, the instant case involves one theory of liability arising out of section 414 of the Restatement and the additional insured endorsement provides coverage for the other. Pekin was similarly successful in upholding its modified AIE in Pekin Ins. Co. v. United Parcel Services, Inc., 381 Ill. App.3d 98, 885 N.E.2d 386, 319 Ill.Dec. 115 (1st dist. 6th div. 2008). Pekin s success streak, however, came to a screeching halt in the recent case of Pekin Ins. Co. v. Pulte, Ill. App. 3d, N.E. 2d (1st dist. 3d div. 8/25/10). Pekin denied coverage to the additional insured on the basis that the underlying complaint did not allege that the Additional Insured was solely liable for the Named Insured s acts or omissions. The AIE provided coverage if the Additional Insured were solely liable as a result of some act of the Named Insured. The Additional Insured argued that because it was alleged to have owned, controlled or been in charge of the work, it was possible for it to be vicariously liable for the work of the Named Insured. Pekin argued that the underlying complaint had to allege that the Additional Insured was solely liable based on the work of the Named Insured. The court held that Pekin s argument was overreaching. Although the court agreed the Named Insured could be held liable for its own conduct, that did not preclude the possibility that it could be held vicariously liable. The court believed that there were enough facts in the record from which it could draw a reasonable inference that the Additional Insured would be vicariously liable, including plaintiff s answer to Requests to Admit and the

5 5 Named Insured s answers to the counterclaim filed by the Additional Insured. The court was also swayed by a provision in the contract between the Additional Insured and the Named Insured, in which the Named Insured promised to indemnify the Additional Insured unless such claims have been found to have been specifically determined to be the sole negligence of the Additional Insured. The duty to indemnify existed even if the Additional Insured is the only named party and the allegations of the complaint allege that the Additional Insured s conduct is the sole cause of the claimant s injury. The full provision read as follows: Subcontractor hereby agrees to save, indemnify, and keep harmless Pulte and its agents and employees against all liability, claims, judgments, suits or demands for damages to persons or property arising out of, resulting from, or relating to Contractor s performance of the work under this Agreement ( Claims ) unless such claims have been specifically determined by the trier of fact to be the sole negligence of Pulte. Contractor s duty to indemnify Pulte shall arise at the time written notice of a Claim is provided to Pulte regardless of whether claimant has filed suit on the Claim. Contractor s duty to indemnify Pulte shall arise even if Pulte is the only party sued by claimant and/or claimant alleges that Pulte s negligence was the sole cause of claimant s damages. Changing the Employee Exclusion One last twist that bears discussion is the case in which the insurer denied coverage to the Additional Insured on the basis of the Employer s Liability Exclusion. In James McHugh Construction Co. v. Zurich Am Ins. Co., 401 Ill. App. 3d 127, 927 N.E.2d 247, 339 Ill. Dec. 706 (1st dist. 2d div. 2010). McHugh, the general contractor, hired JMS Electric, Inc. to design and build an electrical system on a construction project, and Stevenson Crane Service for the use of a crane. Pursuant to both subcontract agreements, the subcontractors added McHugh as an additional insured under their separate general liability policies with Zurich. During the construction, two McHugh employees were injured. The employees sued JMS and Crane. They both filed third-party complaints for contribution against McHugh alleging McHugh s negligence contributed to its employees injuries. McHugh tendered its defense in both cases to Zurich. Zurich denied coverage because the policy excluded coverage for bodily injury to an employee of the insured arising out of and in the course of employment by the insured. McHugh argued it was an insured under the policy, but was not the insured under the exclusion because only the subcontractor was the insured. Otherwise, McHugh argued, the term the insured in the exclusion was ambiguous. The trial court disagreed and found no duty to defend. The Illinois appellate court affirmed. The parties agreed that an insured referred to both the named insured and any additional insureds. It made no sense to interpret the insured differently from an insured. The obvious meaning of the insured was the insured seeking coverage. Interpreting the insured to mean the insured seeking coverage meant that both the named insured and the additional insured were equally subject to the exclusion. In previous cases interpreting the same exclusion in the context of third party complaints, the courts acknowledged the applicability of the separability clause, which provides that the coverage of the policy will apply separately to each insured. In contrast to the McHugh court s conclusion that coverage for the additional insured should be limited to the same extent as the named insured s, most other courts have recognized the coverage grant is not the same. Conclusion General contractors and owners who hope to use AIEs to provide primary coverage as a risk-shifting devise need to exercise extreme caution in drafting contracts and reviewing insurance policy forms. Caveat emptor is the rule, even if the additional insured is not be the buyer. If the contract has been negotiated to use additional insured status as a means of shielding the Additional Insured s own insurance, then the Additional Insured must be diligent in lining up the appropriate contract provisions, acceptable additional insured endorsements, and conforming other insurance provisions in its own policy. If the opposition against AIEs is successful in preventing the use of additional insured status, then owners and general contractors will have to make adjustments in contract price and subcontract fees.