Coverage for Kotecki Waivers: Finally an Answer

Featured Article Coverage for Kotecki Waivers: Finally an Answer By: David B. Mueller Cassidy & Mueller, Peoria and Francis A. Spina Cremer, Kopon, Shaughnessy & Spina, LLC, Chicago INTRODUCTION The ebb and flow of insurance coverages in cases where multiple parties are linked by contractual relationships has been a particularly vexing subject in recent years. The area has two significant foci that have produced a plethora of decisions. The great majority of these decisions are in the area of construction injuries where there are daisy chains of contracts running from the owner to architects, construction managers, general contractors, subcontractors, sub-subcontractors and so forth to the lowest provider of men and materials on the job. The first and best recognized problem involves the so-called targeted tender, where upstream parties in the contractual confluence require those below to include them as additional insureds, and then require the additional insuring carrier to exclusively take on the upstream party s coverage while that party s own coverage is left untouched. The second pregnant topic of dispute concerns coverage for the contribution liability exposure of an employer which exceeds the employer s workers compensation exposure, and there is a contractual waiver of the employer s Kotecki protection (which otherwise limits the employer s contribution liability to the amount it paid in workers compensation benefits). Where a contractual waiver of the Kotecki protection is found the battle lines are drawn between coverage under the employer s CGL policy resulting from an insured contract and coverage under its employer s liability policy where there is an exclusion for liability assumed under a contract. This article concerns the subject of coverage for the Kotecki excess. It describes the evolution of the problem, commencing with recognition of contribution in Illinois and the impact of contribution upon an employer s statutory immunities under the Workers Compensation Act. Thereafter, it proceeds to the decision in Kotecki v. Cyclops Welding Corp., 146 Ill. 2d 155, 585 N.E.2d 1023 (1991), and finally to the coverage implications created where the Kotecki limitation is contractually waived. The trail from beginning to end is a classic study of the common law process by which the courts perceive public policy and incrementally shape the law to fit it. That process has finally run its course on the issue of coverage for an employer s contribution exposure over and above its workers compensation obligation. In Virginia Surety Co., Inc. v. Northern Ins. Co. of New York, No. 102036, 2007 WL 121161 (January 19, 2007) the Illinois Supreme Court determined that coverage, if any, lies under the employer s liability policy. The story and reasoning which led to that result follows. EVOLUTION OF EXPOSURE Before Contribution Page 1 of 8

Before 1977 Illinois did not recognize contribution among joint tortfeasors. John Griffiths & Son Co. v. National Fireproofing Co., 310 Ill. 331, 339, 141 N.E. 739 (1923) and Chicago & I.M. Ry. Co. v. Evans Const. Co., 32 Ill. 2d 600, 603, 208 N.E.2d 573 (1965). Consequently, under the doctrine of joint liability, the jury in a case involving multiple defendants was not permitted to consider comparative fault of each. Instead, a verdict was all or nothing as to each. The plaintiff was then entitled to pick and choose among the liable defendants in satisfying his judgment and the defendants had no recourse vis a vis one another. Thus, the least liable party with the deepest pockets was frequently the target, thereby effectively exonerating the others from the economic consequences of their fault. In some cases, particularly those involving the construction industry, the defendants anticipatorily attempted to apportion the economic consequences of fault by a series of contracts that contained indemnification provisions. Thus, prior to the adoption of the Construction Contract Indemnification for Negligence Act in 1971, the issue of fault apportionment in construction liability cases was commonly adjusted by indemnity provisions that extended progressively downstream from the owner, requiring each lower level to indemnify each level of contractors above it. In that manner the employer of the injured party was customarily obligated to defend and indemnify each of the upstream parties. The burden of that liability was then the subject of contractual liability insurance which was routinely purchased by each contractor and subcontractor on the job. The inequities of contractual indemnification are self-evident. There is no concern for the respective fault of the parties. Instead, the superior contracting party is fully indemnified against the consequences of its own misconduct, thereby militating against the objective of encouraging safe practices on its part. These inequities led the general assembly to adopt the Construction Contract Indemnification for Negligence Act (740 ILCS 35/1), which effectively ended self-indemnification in construction cases. However, as seen infra, contractual indemnity provisions remained in most construction agreements and have been given new but limited vitality in the liability apportionment process. Impact of Contribution In 1977 the Illinois Supreme Court abolished the prohibition against joint tortfeasor contribution. Skinner v. Reed-Prentice Div. Package Machinery Co., 70 Ill. 2d 1, 11-16, 374 N.E.2d 437 (1978). Shortly thereafter the general assembly adopted the Joint Tortfeasor Contribution Act (740 ILCS 100/1 et seq.). Under that statute, fault is apportioned among the parties who are subject to liability in tort arising out of the same injury... to the extent that the fault of each contributed to cause any damages which are awarded. The Act is specifically concerned with ameliorating the adverse economic impact of joint liability. In that regard it provides that where one tortfeasor is obligated to pay more than his pro rata share of the common liability, he is entitled to contribution from the others for the liability properly assignable to those others. (740 ILCS 100/2). In complementary fashion the statute emphasizes that: (1) a party which pays more than its share is entitled to contribution and (2) [n]o tortfeasor is liable to make contribution beyond his own pro rata share of the common liability. These considerations are of signal significance in understanding the impact of Kotecki as it relates to the coverage analysis of the court in Virginia Surety Co., Inc. v. Northern Ins. Co. of New York, supra. The statutory equation between proportionate fault and liability was then extended to employers, despite the employer s statutory immunity from a direct action by the employee under Sections 5(a) and 11 of the Workers Compensation Act. (820 ILCS 305/5(a) and 305/11). Doyle v. Rhodes, 101 Ill. 2d 1, 14, 461 N.E.2d 382, 389 (1984). The effect of Doyle was to effectively vitiate the immunities which were provided to employers under the workers compensation statute. Simply stated, if an employer were liable for contribution commensurate with its causative fault the outcome would be the same as if the employer were subject to a direct action by the injured employee. Page 2 of 8

Recognizing the public policy considerations which led to the adoption of the workers compensation statute, the Illinois Supreme Court in Kotecki capped an employer s contribution exposure at the amount of its workers compensation obligation. Following the Kotecki decision, an employer was able to measure its contribution liability with the yardstick of its workers compensation exposure (less a 25% attorney s fee and pro rata share of the plaintiff/employee s litigation expenses. (820 ILCS 305/5(b)). Given that degree of protection, employers were and are able to effectively gamble upon whether their proportionate share of the common liability will exceed 75% of the lien that they are entitled to recover. LaFever v. Kemlite Co., 185 Ill. 2d 380, 398-404, 706 N.E.2d 441 (1998). As indicated supra, self-indemnification provisions were outlawed in construction contracts in 1971. Also, they are disfavored generally and will not be construed to indemnify a party against its own tortious conduct unless the language expressly calls for that result. Westinghouse Electric Elevator Co. v. LaSalle Monroe Bldg. Corp., 395 Ill. 429, 432, 70 N.E.2d 604 (1947), and Tatar v. Maxon Const. Co., 54 Ill. 2d 64, 66-68, 294 N.E.2d 272 (1973). Nonetheless, those provisions do have the effect of obligating the indemnitor for the full extent of the indemnitor s own negligence or fault. Therefore, while self-indemnification language seldom protects the indemnitee against its own misconduct, the provision nonetheless obligates the indemnitor to the full extent of the indemnitor s causative fault. That reasoning led the Fifth District in Herington v. J.S. Alberici Const. Co., 266 Ill. App. 3d 489, 639 N.E.2d 907 (5th Dist. 1994) and the supreme court in Braye v. Archer-Daniels- Midland Co., 175 Ill. 2d 201, 210-212, 676 N.E.2d 1295 (1997), and Liccardi v. Stolt Terminals, Inc., 178 Ill. 2d 540, 545-550, 687 N.E.2d 968 (1997), to hold that indemnification provisions serve to keep an employer s liability at its full pro rata share. As otherwise expressed, in signing a contract with a standard indemnification clause an employer agrees to waive the assertion of the Kotecki cap as an affirmative defense. The waiving employer s liability therefore remains its pro rata share of the common liability. (740 ILCS 100/2) and Doyle, 100 Ill.2d at 14. This brings us to the liability coverage issue that has vexed the courts since Braye and Liccardi: Is the contractual waiver of Kotecki an insured contract under the employer s CGL policy? Or, is the employer s excess liability covered under the insuring agreement of its employer s liability policy? If the latter, then is it a... liability assumed under a contract within the meaning of the standard exclusion which applies to that coverage? COVERAGE CONSIDERATIONS FOR THE KOTECKI WAIVER The Problem Braye and Liccardi were quickly followed by a series of cases that involved the issue of coverage for the Kotecki excess. Traditionally, an employer s contribution liability was the subject of the Employer s Liability Insurance coverage of its Workers Compensation and Employer s Liability Insurance Policy. The insuring agreement provided coverage up to the policy limits for the employer s contribution exposure. On the other hand, the employer s CGL policy expressly excluded coverage for employer s liability. The following language is typical of that exclusion: 2. EXCLUSION This insurance does not apply to: e. EMPLOYEE INDEMNIFICATION AND EMPLOYER S LIABILITY Bodily Injury to: (1) An employee of the insured arising out of and in the course of: (a) (b) Employment by the insured; or Performing duties related to the conduct of the insured s business; or Page 3 of 8

For this exclusion only, employee does not include a leased worker or a temporary worker. This exclusion does not apply to liability assumed by the insured under an insured contract. Therefore, defense and indemnification of the employer was under its employer s liability policy and there was no coverage under the CGL policy. Kotecki arguably placed a different spin on both coverages. The employer s liability exclusion to the standard CGL policy contains an exception for... liability assumed by the insured under an insured contract. The term insured contract is customarily defined as: That part of any other contract or agreement pertaining to your business (including an indemnification of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for bodily injury or property damage to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement. Conversely, the employer s liability coverage expressly excludes liability assumed under a contract. The decisions in Braye and Liccardi use the employer s contractual agreement to indemnify another as the basis for contribution exposure in excess of the workers compensation limitation which Kotecki affords. Is that provision an insured contract thereby obligating the CGL carrier for the employer s Kotecki liability? In the same vein does the provision amount to a liability assumed under a contract thereby triggering the exclusion under the employer s liability policy? The battle on these questions alternatively waxed and waned through the appellate courts until it was finally resolved by the Illinois Supreme Court in Virginia Surety Co., Inc. v. Northern Ins. Co. of New York, No. 102036, 2007 WL 121161 (January 19, 2007). Two cases from the Second District held that in the context of the indemnification/kotecki waiver provision, the insured contract exception to two CGL policy exclusions was ambiguous, such that the exclusions could not be relied upon to avoid coverage, and thereby obligating the CGL carrier to defend and indemnify the employer against the contribution claims of the other contracting party. Michael Nicholas, Inc. v. Royal Ins. Co. of America, 321 Ill. App. 3d 909, 748 N.E.2d 786 (2nd Dist. 2001), and West Bend Mut. Ins. Co. v. Mulligan Masonry Co., Inc., 337 Ill. App. 3d 698, 786 N.E.2d 1078 (2nd Dist. 2003). The Fifth District reached the opposite result in Hankins v. Pekin Ins. Co., 305 Ill. App. 3d 1088, 713 N.E.2d 1244 (5th Dist. 1999). While not considering the question of CGL coverage, the Fourth District in Christy-Foltz, Inc. v. Safety Mut. Cas. Corp., 309 Ill. App. 3d 686, 722 N.E.2d 1206 (4th Dist. 2000), held that there was no coverage for the liability in excess of the Kotecki cap under the employer s liability insurance policy because of the contractual liability exclusion in that insurance contract. The Second District Michael Nicholas, Inc. v. Royal Ins. Co. and West Bend Mut. Ins. Co. v. Mulligan Masonry Co., Inc. The reasoning in Michael Nicholas and West Bend, supra, borders upon metaphysics and in that regard involves the subtleties and nuances of joint liability. Under Illinois law every tortfeasor whose liability to the plaintiff is 25% or more of the total fault attributable to the plaintiff, the defendant sued by the plaintiff, and any third party defendant except the plaintiff s employer... 735 ILCS 5/2-1117, is jointly liable for the entire amount of the plaintiff s damages. In other words, an injured Page 4 of 8

plaintiff can collect the full amount of his damages from any defendant whose exposure is anything less than 25% of those who are considered in the statutory equation. The right to contribution mitigates the economic outcome but does not affect the joint and entire nature of the obligation. As indicated above, an insured contract as defined in the typical CGL policy is one in which the insured assume(s) the tort liability of another party to pay for bodily injury or property damage to a third party or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement. The Second District in West Bend Mut. Ins. Co. v. Mulligan Masonry Co., Inc., supra, and Michael Nicholas, Inc. v. Royal Ins. Co., supra, held that an indemnification provision that waives the Kotecki limitation is an insured contract within the preceding definition. The rationale of those cases focuses upon the fundamental nature of joint liability. In the first instance the party seeking contribution is liable for the full amount of the plaintiff s damages. Under Kotecki the employer contributor is liable only to the extent of its workers compensation obligation. Consequently, the difference between that obligation and the contributor s pro rata share of the common liability remains that of the party seeking contribution under joint liability principles. Where there is a contractual waiver of the Kotecki limitation, the contributor s exposure increases and the contributee s potential liability is reduced. Therefore, the Second District reasoned that the waiver effect of the indemnification provision was that the insured under the CGL policy assumed all or a portion of the joint tort liability of the other contracting party. Cutting to the chase, the contributor s increased exposure potentially reduces the economic consequences of the contributor s liability to the plaintiff and therefore is considered an assumption of the contributee s liability to the plaintiff. It should be noted that the Michael Nicholas decision was unanimous, while the West Bend decision from the same district drew a reasoned dissent by Justice Robert McLaren, which was later cited with approval by the Illinois Supreme Court in Virginia Surety. The Fifth District Hankins v. Pekin Insurance The Fifth District in Hankins v. Pekin Ins. Co., 305 Ill. App. 3d 1088, 713 N.E.2d 1244 (5th Dist. 1999), was less abstract in reaching the opposite result. While Hankins did not involve the question of coverage for a Kotecki waiver, the pertinent issue was presented on the broader ground of coverage for contractual indemnification. In Hankins, the employee of a trucking terminal sued a cartage company for injuries sustained while unloading a truck. The carrier had an agreement with the terminal operator which required the latter to indemnify the carrier for all damages for bodily injury... caused in whole or in part by CARTAGE OPERATOR s negligent act or omission... The terminal operator sought coverage under its CGL policy on the basis that the preceding provision was an insured contract. Pekin Insurance defended by asserting the policy exclusion for assumption of liability in a contract or agreement. The court distinguished between a true indemnity agreement and what it characterized as a partial indemnity contract. In the former the indemnitor agrees to hold the indemnitee harmless from the indemnitee s own negligence. In that regard the indemnitor assumes the tort liability of the indemnitee and the provision is an insured contract. On the other hand, where the indemnitor agrees only to protect the indemnitee against the consequences of the indemnitor s own negligence, the only liability assumed is that of the indemnitor. The provision in question was therefore not an insured contract and coverage was denied. The Fourth District Christy-Foltz v. Safety Mutual Page 5 of 8

Completing the pre-virginia Surety cycle of cases is Christy-Foltz, Inc. v. Safety Mut. Cas. Corp., 309 Ill. App. 3d 686, 722 N.E.2d 1206 (4th Dist. 2000), which addressed the liability assumed under a contract exclusion in an employer s liability policy. There the insured contractor sought coverage under its employer s liability policy to the full extent of its contribution exposure for injuries sustained by its employee. The insurer asserted the following policy exclusion, which is common to employer s liability coverages: In no event shall the CORPORATION [Safety Mutual] be liable for any [l]oss or [c]laim [e]xpenses voluntarily assumed by the EMPLOYER [Christy-Foltz] under any contract or agreement, express or implied ***. Section (E)(1) of the policy defines the term loss as follows: Loss -shall mean actual payments made by the EMPLOYER [Christy-Foltz] to [e]mployees and their dependents in satisfaction of (a) statutory benefits, (b) settlements of suits and claims, and (c) awards and judgments. The Fourth District held that the insured employer s agreement to waive the Kotecki limitation constituted a voluntary assumption of liability for its pro rata share of the damages proximately caused by its own negligence. Therefore, the increased exposure amounted to a loss that was contractually and voluntarily assumed within the meaning of the exclusion. From the preceding thicket of conflicting reasoning, two things logically emerge: (1) if the contractual exclusion in the employer s liability policy applies then the liability that is contractually assumed should fall within the definition of an insured contract under the CGL policy, and (2) resolution of the issue by the Illinois Supreme Court was badly needed. The recent decision in Virginia Sur. Co., Inc. v. Northern Ins. Co. of New York, No. 102036, 2007 WL 121161 (January 19, 2007), resolves both. The Supreme Court Virginia Surety v. Northern Insurance Virginia Surety came out of the Third District. Factually, it somewhat paralleled Michael Nicholas and West Bend in focusing upon coverage for an employer s liability resulting from a Kotecki waiver pursuant to a partial indemnity contract. However, it was also distinguishable in that unlike the Second District cases, only a single claim for contribution was filed against the employer. The appellate court refused to find that the indemnity provision was an insured contract because the third party complaint did not contain an indemnification count. The Illinois Supreme Court affirmed, but on different grounds. In doing so it analyzed the preceding coverage decisions in the context of an employer s tort liability, the Contribution Act, and its evolutionary underpinnings. Following an in-depth discussion of Hankins, Christy-Foltz, Michael Nicholas and West Bend, the court held that the indemnification provision in the agreement between the subcontracting employer, DeGraf, and the general contractor, Capital, could not be an insured contract under the employer s CGL policy with Northern Insurance Company. In reaching that decision the court specifically found that DeGraf, as the indemnifying party, is required to indemnify Capital only for DeGraf s own negligence. Therefore, the only liability assumed by DeGraf pursuant to the provision was DeGraf s own liability. Dispensing with the metaphysical nuances of joint liability, the court addressed the respective liabilities of DeGraf and Capital under the Contribution Act. While both parties were jointly and severally liable for the Kotecki excess, the contribution statute specifically provides in pertinent part: The right of contribution exists only in favor of a tortfeasor who has been paid more than his pro rata share of the common liability, and his total recovery is limited to the amount paid by him in Page 6 of 8

excess of his pro rata share. No tortfeasor is liable to make contribution beyond his pro rata share of the common liability. (740 ILCS 100/2(b)). In contradistinction to indemnity the court held that both parties were jointly and severally liable for the same injury on a primary basis. As neither was secondarily liable, indemnification concepts did not apply. Thus, the waiver of the Kotecki cap does not shift liability. Rather, the employer chooses to remain liable for its own tort liability by not asserting an affirmative defense. (Emphasis in the original). In other words, by the very nature of the Contribution Act liability, a third party defendant employer can only be assessed with its own pro rata share of liability resulting from its own negligence. In that regard the court further reasoned: Under principles of joint and several liability, the third party does not then become liable for the difference. Instead, it always was jointly and severally liable regardless of the Kotecki cap and it additionally always retained the right to sue in contribution. The distinguishing factor is the employer s use of the affirmative defense of the Workers Compensation Act. Thus, the contribution defendant-employer s liability could only have been its own pro rata share of the common liability that the direct defendant/contribution-plaintiff was liable to pay under joint and several liability principles. So what the employer undertook was never an assumption of the tort liability of another party (i.e. the direct defendant). The bottom line is the determination that a partial indemnification provision serves only as a waiver of the right to assert a liability-limiting defense to a contribution claim. It is not to be considered an assumption of the other contracting party s joint and several liability. As the waiver is not an assumption of liability, the loss assumed by contract exclusion in the standard employer s liability policy would not apply. Conversely, there is no coverage for the Kotecki excess under a CGL policy as the employer s liability exclusion applies since the waiver does not constitute an insured contract such as would allow that exception to negate the exclusion. Finally, to dispel any confusion that might remain, the opinion concludes: Accordingly, we agree with the appellate court that Northern is not under a duty to defend or indemnify DeGraf under the CGL policy. Hence, the circuit court properly granted summary judgment in favor of Northern. To the extent that Michael Nicholas, West Bend, and Christy Foltz would hold otherwise, they are overruled. CONCLUSION The dust has finally cleared. Simply stated, a construction contract s partial indemnification provision leaves coverage where it was under an employer s liability policy before Kotecki. Likewise, the employer s liability exclusion under a CGL policy applies to preclude coverage under that insurance contract. The problem is now one of picking up the pieces. In numerous cases, defenses have been tendered to and assumed by CGL carriers under the reasoning in Michael Nicholas and West Bend. Similarly, coverage has been tendered to and rejected by employer s liability carriers based upon the contractual exclusions in those policies. There is no indication that the decision in Virginia Surety is in any sense to be applied prospectively only, nor would such an application comport with Illinois law. Consequently, an interesting period of readjustment is likely to take place, as CGL carriers that accepted the defense of cases now deemed non-covered by the Illinois Supreme Court decide what steps to take next. ABOUT THE AUTHORS Page 7 of 8

David B. Mueller is a partner in the Peoria firm of Cassidy & Mueller. His practice is concentrated in the area of products liability, construction injury litigation, and insurance coverage. He received his undergraduate degree from the University of Oklahoma and graduated from the University of Michigan Law School in 1966. He is a past co-chair of the Supreme Court Committee to revise the rules of discovery, 1983-1993 and presently serves as an advisory member of the Discovery Rules Committee of the Illinois Judicial Conference. He was member of the Illinois Supreme Court Committee on jury instructions in civil cases and participated in drafting the products liability portions of the 1995 Tort Reform Act. He is the author of a number of articles regarding procedural and substantive aspects of civil litigation and lectures frequently on those subjects. Francis Chip A. Spina is a partner in the Chicago firm of Cremer, Kopon, Shaughnessy & Spina, LLC. Mr. Spina s employment law practice deals with a broad scope of employment issues faced by employers, including federal and state statutory matters, discrimination claims, common law actions, and personnel law issues. Mr. Spina s insurance coverage practice includes representation of insurance carriers in analyzing their policy obligations to their insureds and in litigating coverage disputes arising from many varieties of liability insurance policies. Mr. Spina also has extensive experience at both the trial and appellate levels in general tort litigation. Page 8 of 8