KOTECKI WAIVER COVERAGE?

KOTECKI WAIVER COVERAGE? West Bend Mutual Insurance Company v. Mulligan Masonry Co., Inc. By: Thomas F. Lucas McKenna, Storer, Rowe, White & Farrug Chicago Introduction In West Bend Mutual v. Mulligan Masonry Co., Inc., 337 Ill. App. 3d 698, 786 N.E.2d 1078 (March 24, 2003), the Second District Appellate Court considered whether an insured s Kotecki waiver 1 triggered the insured contract exception to the Employer s Liability and Contractual Liability exclusions of a Comprehensive General Liability (CGL) Policy. This was the Second District s second opportunity to address this issue. Michael Nicholas, Inc. v. Royal Insurance Co., 321 Ill. App. 3d 909, 748 N.E.2d 786 (2nd Dist. 2001), appeal denied 196 Ill. 2d 545, considered identical policy language in a case involving an identical fact pattern. Both cases reached the same conclusion, that an insured/employer s contractual agreement to waive the Kotecki cap triggers the insured contract exception. As a result, when an insured s employee, injured on the job, sues the party to whom the insured has given a Kotecki waiver, and that party in turn brings a third-party action against the insured/employer seeking indemnity or contribution, the insurer cannot rely on the Employer s Liability or Contractual Liability exclusions to deny coverage. The West Bend opinion generated a dissent by Justice McLaren, who noted that the conclusion reached by the majority, as well as the holding in Michael Nicholas Inc., was in conflict with the Fifth District s opinion in Hankins v. Pekin Insurance Co., 713 N.E.2d 1244, 305 Ill. App. 3d 1088 (5th Dist. 1999). An examination of the insured contract exception considered by both the Second and Fifth Districts indicates that an insured/employer s contractual Kotecki waiver would not come within its terms. This is because an insured/employer assumes its own liability when it waives the Kotecki cap, not the liability of another party. Therefore, the conflict that now exists between the Second District and the Fifth District on this issue should be resolved in favor of the Fifth District s Hankins opinion and Justice McLaren s dissenting opinion in West Bend. The Factual Background of West Bend and Michael Nicholas, Inc. West Bend and Michael Nicholas, Inc. present a familiar fact pattern. In West Bend, Mulligan Masonry contracted with R.C. Wegman Construction Co. to perform masonry work on a construction project. One of the provisions of the contract required Mulligan to indemnify Wegman from any loss caused, in whole or in part, by any negligent act or omission of Mulligan. A Mulligan employee was injured on the project and brought suit against Wegman. Wegman, in turn, brought a third-party complaint against Mulligan seeking indemnity and contribution. The third- Page 1 of 6

party complaint included allegations that Mulligan had waived the limitation of contribution liability available to Mulligan pursuant to the Workers Compensation Act and Kotecki. Mulligan tendered the third-party complaint to West Bend, its CGL carrier, for defense. West Bend denied coverage based upon the Contractual Liability and Employer s Liability exclusions of its policy. Both exclusions contained an insured contract exception and the Second District, following its opinion in Michael Nicholas, Inc., ruled that these exclusions could not be relied upon by West Bend because of the insured contract exception. The factual setting of Michael Nicholas, Inc. was identical to that of West Bend. Michael Nicholas, Inc. ( Nicholas ) was a subcontractor of Kimball Hill on a subdivision development project. By contract, Nicholas agreed to indemnify Kimball Hill from all loss caused in whole or in part by Nicholas negligent act or omission. A Nicholas employee was injured during the course of construction and sued Kimball Hill, which then brought a third-party action against Nicholas seeking indemnity and contribution. Nicholas tendered the defense of the third-party action to Royal Insurance Co. ( Royal ), its CGL insurer, which denied coverage based upon the Employer s Liability and Contractual Liability exclusions. In the subsequent declaratory judgment brought by Nicholas, the trial court agreed with Royal s coverage position; however, the Second District reversed. The Employer s Liability and Contractual Liability Exclusions The policy provisions considered in West Bend and Michael Nicholas, Inc., like the factual settings, were identical. Both the West Bend and Royal policies contained Employer s Liability and Contractual Liability exclusions. The Employer s Liability exclusion of the Royal policy excluded: 2 Bodily injury to: (1) An employee of the insured arising out of and in the course of employment by the insured; or (2) The spouse, child, parent, brother or sister of that employee as a consequence of (1) above. This exclusion applies: (1) Whether the insured may be liable as an employer or in any other capacity; and (2) To any obligation to share damages with or repay someone else who must pay damages because of the injury. The Contractual Liability exclusions of both policies excluded: Bodily injury or property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. The Employer s Liability and Contractual Liability exclusions of both policies contained an exception that provided that the exclusions would not apply to liability assumed by the Insured under an insured contract, which was defined in pertinent part as that part of any other contract or agreement pertaining to your business... under which you assume the tort liability of another party to pay for bodily injury... to a third person. Page 2 of 6

The Second District Finds Kotecki Waiver Coverage In West Bend, the Second District concluded that, by contractually waiving the Kotecki limitation, Mulligan assumed Wegman s entire liability to Mulligan s employee. Therefore, the Mulligan- Wegman subcontract agreement, which included the Kotecki waiver, was an insured contract and West Bend could not rely on the policy exclusions to deny coverage. The court reasoned that, when Mulligan agreed to waive the Kotecki cap, the potential existed for Mulligan to pay Wegman s entire liability to the injured employee; therefore, applying the terms of the insured contract exception, Mulligan had contractually assumed Wegman s liability and the policy exclusions would not apply. It was important to the court s analysis in West Bend (and Michael Nicholas, Inc.) that the insured was a construction contractor. Since indemnification clauses in construction contracts are void by statute (see the Construction Contract Indemnification for Negligence Act, 740 ILCS 35/1 et. seq.), the court viewed any interpretation of the insured contract provision that did not include a Kotecki waiver within its purview would result in the policy providing illusory coverage. In Michael Nicholas, Inc., the court expressed this concern as follows:... it is difficult to envision any situation where the exception would apply in plaintiff s line of work because if plaintiff ever agreed to indemnify another party for its own negligence, the contract would be unenforceable. 321 Ill. App. 3d at 915. In West Bend, counsel for the insurer responded to this concern by noting that the insured contract exception would apply in the situation where the insured entered into a lease for office space which required the insured to indemnify the lessor against the lessor s own negligence. However, the West Bend majority was unphased by the insurer s ability to address the illusory coverage issue and noted: As was the case in Michael Nicholas, the parties must have anticipated that most of defendant s contracts would involve construction. Thus, adopting plaintiff s interpretation would defeat defendant s reasonable expectations of coverage in those situations. 786 N.E.2d at 1085. In Michael Nicholas, Inc., the court described the liability being assumed by an insured who waives Kotecki as, That portion of Kimball Hill s liability to Bauer (which was assumed by [Nicholas] pursuant to its Kotecki waiver) that is attributable to [Nicholas ] negligence is in fact imposed on Kimball Hill by law, i.e., joint and several liability. 321 Ill. App. 3d at 914. The West Bend court agreed with this analysis, noting: If [Mulligan s] Kotecki cap is lower than the amount of Weeks s damages that is attributable to [Mulligan s ] negligence, then under principles of joint and several liability, Wegman can be held liable in tort for the difference. Relying on the indemnification clause, Wegman attempted to recover that amount. If [Mulligan] has waived its Kotecki cap, then it has assumed tort liability that otherwise would have been imposed upon Wegman. 786 N.E.2d at 1084-85. The final issue addressed in West Bend was the insurer s argument that the result in Michael Nicholas interferes with the dovetailing coverage schemes of the CGL and the workers compensation/employer liability (WC/EL) policies. 786 N.E.2d at 1085. West Bend argued that the Employer s Liability exclusion in the CGL policy evidenced an intent that coverage for losses attributable to injuries suffered by an insured s employees was to be found in the Workers Compensation/Employer s Liability policy. However, the Second District rejected this argument, in large part because the Fourth District in Christy-Foltz, Inc. v. Safety Mutual Casualty Corp., 309 Ill. App. 3d 686, 722 N.E.2d 1206 (4th Dist. 2000), found that an employer s Kotecki waiver triggers the exclusion of an Employer s Liability policy barring coverage for liability assumed under contract. Page 3 of 6

In the Second District s view, rather than confounding the insurance company s coverage schemes, an interpretation of the insured contract exception of the CGL policy that finds coverage for a Kotecki waiver complimented the insured s Workers Compensation/Employer s Liability coverage. The Fifth District s View: Hankins v. Pekin Insurance Co. A dissent in West Bend by Justice McLaren noted that the majority, while following the precedent set in Michael Nicholas, deviated from the Fifth District opinion in Hankins v. Pekin Insurance Co., 305 Ill. App. 3d 1088, 713 N.E.2d 1244 (5th Dist. 1999). 786 N.E.2d at 1086-87. The contract under consideration in Hankins was not a construction contract as in West Bend and Michael Nicholas, Inc. However, the coverage issue was the same, namely whether a hold harmless provision of a contract was an insured contract thereby avoiding a Contractual Liability exclusion. In Hankins, the insured (Hankins) operated a shipping terminal and entered into a contract with Rudolf Express to provide terminal facilities. A hold harmless provision of the contract required Hankins to indemnify and hold Rudolf harmless from all loss caused in whole or in part by [Hankins ] negligent act or omission. A Hankins employee was injured while unloading a Rudolf truck and sued Rudolf, claiming negligence. Rudolf filed a third-party complaint against Hankins, seeking indemnity and contribution. Hankins sought coverage for the third-party action from Pekin, which denied coverage based upon the Contractual Liability exclusion. In the declaratory judgment action filed by Hankins, the trial court ruled that the insured contract exception applied and, therefore, Pekin was required to provide coverage to Hankins for the thirdparty action. The Fifth District reversed, concluding that, by its terms, the insured contract provision only applied when the insured was assuming the liability of someone else and that the hold harmless provision of the Hankins-Rudolf contract did not qualify because Hankins was not assuming Rudolf s liability but instead was assuming its own liability. The court in Hankins did not specifically discuss whether the hold harmless given by the insured constituted a Kotecki waiver. Nevertheless, Justice McLaren, the dissenter in West Bend, found the Hankins analysis persuasive. Justice McLaren construed the indemnity provision of the Mulligan-Wegman contract to require Mulligan to indemnify Wegman for all loss caused by Mulligan s fault. Since the dissent did not read the clause as requiring Mulligan to indemnify Wegman for Wegman s fault, the insured contract exception did not apply. Furthermore, the dissent did not read the Kotecki waiver provision as requiring Mulligan to assume Wegman s liability because Justice McLaren viewed a Kotecki waiver as affecting the amount of contribution payable by the insured, without altering the insured s pro rata share of responsibility for the underlying accident. In other words, by waiving the Kotecki cap, the insured agrees to give up the right to limit its contribution liability; it does not agree to assume the liability of another party. The West Bend Dissent is the Better Reasoned Opinion The flaw in the Second District s analysis in West Bend and Michael Nicholas, Inc. is illuminated in Justice McLaren s dissenting opinion in West Bend. The West Bend majority, like the court in Michael Nicholas, Inc., found that the liability being assumed by an insured waiving Kotecki was based on joint and several liability principles. However, Justice McLaren characterized the court s joint and several liability discussion as a red herring, and stated: [T]he analysis contained in Michael Nicholas characterizes aspects of tort liability that are preexisting and imposed by operation of law, as being assumed under the terms of the Page 4 of 6

indemnification contract in question. The major deficiency with both the majority and Michael Nicholas decisions is that they ignore the distinction between those matters that are imposed by law and those that have been assumed through the indemnification contract. The joint and several liability analysis in Michael Nicholas presumes that the insured assumed the joint and several liability of all the joint and several tortfeasors. There is no such language in the indemnification contract... 786 N.E.2d at 1087. Justice McLaren also rejected the notion that a Kotecki waiver could amount to an assumption of liability, noting: The waiver of the Kotecki cap is a waiver of a right to a credit or offset that is provided by law and would reduce the amount due from the insured. 786 N.E.2d at 1089. Following Hankins, Justice McLaren interpreted a Kotecki waiver as an agreement by the employer/indemnitor to indemnify the nonemployer/indemnitee for the employer/indemnitor s own negligence. Id. The validity of Justice McLaren s analysis on the question of whose liability is being assumed when an employer contractually waives the Kotecki cap is borne out by Braye v. Archer-Daniels- Midland Co., 175 Ill. 2d 201, 676 N.E.2d 1295 (1997), the case which recognized the employer s right to waive Kotecki. In Braye, the court stated: ADM simply maintains that if an employer determines it advantageous to promise to assume liability for its own negligence, it may not avoid its contractual agreement if it later perceives the promise to be detrimental. According to ADM, neither the Workers Compensation Act nor our decision in Kotecki prohibits an employer from entering into an agreement prior to the commencement of litigation to assume full liability for damages commensurate with its relative degree of fault. We agree. (Emphasis provided.) 175 Ill. 2d at 209. As Braye makes clear, an insured waiving Kotecki is assuming its own liability, not the liability of the party to whom it has given the waiver. The Fifth District s conclusion in Hankins is founded on the court s distinction between an agreement whereby an insured assumes another s liability and one in which the insured assumes its own liability. The Second District s failure in West Bend and Michael Nicholas, Inc., to recognize this fundamental difference led to the court finding an ambiguity in the insured contract definition where none exists. Conclusion The Employer s Liability and Contractual Liability exclusions are standard provisions of most CGL policies. Likewise, these exclusions normally contain an insured contract exception under which the Employer s Liability and Contractual Liability exclusions will not apply when the insured, as part of its business, enters into a contract that requires the insured to assume the tort liability of another party. A split now exists between the Fifth District (Hankins) and the Second District (West Bend and Michael Nicholas, Inc.) on the issue of whether an insured s Kotecki waiver amounts to an assumption of another party s liability so as to trigger the insured contract exception. Applying Hankins, the Fifth District would conclude that, by waiving Kotecki, the insured is merely assuming its own liability, not that of another party; thus, the insured contract exception does not apply. However, the Second District concluded that a Kotecki waiver results in the insured potentially assuming all of another joint tort-feasor s liability, thus triggering the insured contract exception. As shown herein, the Second District s opinions misconstrue the effect of a Kotecki waiver on an insured/employer s contribution liability. By waiving Kotecki, the insured assumes its own liability, Page 5 of 6

not that of a third-party. This is made clear by an examination of Braye v. Archer-Daniels-Midland Co., the case that recognized an employer s right to waive Kotecki. Thus, the conflict over whether a Kotecki waiver triggers the insured contract exception should be resolved in favor of the Fifth District s Hankins opinion rather than the result reached by the Second District in West Bend and Michael Nicholas, Inc. Endnotes 1 In Kotecki v. Cyclops Welding Corp., 146 Ill. 2d 155, 585 N.E.2d 1023 (1991), the Illinois Supreme Court ruled that an employer s contribution liability is limited to the amount the employer paid in worker s compensation. In Braye v. Archer-Daniels-Midland Co., 175 Ill. 2d 201, 676 N.E.2d 1295 (1997), the court held that an employer could contractually waive the Kotecki limitation. 2 The Employer s Liability exclusion of the West Bend policy, though worded differently, was identical in effect. ABOUT THE AUTHOR: Thomas F. Lucas is a partner in the Chicago office of McKenna, Storer where he concentrates his practice in insurance coverage and the defense of insureds and self-insureds. He received his B.S. from the University of Illinois and his J.D. from Loyola University. He is a member of the IDC and DRI. Page 6 of 6