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What Is Subrogation ... and Why Is My Contract Waiving It?

December 2000

Do you really understand the waiver of subrogation provision contained in most form agreements used in the industry, why it is there, and how it helps you manage the risk of your business? This article will help clear up some of the confusion.

by Kenneth A. Slavens
Brown & James, P.C.

Any time you sign a contract for professional services, you should understand the consequences of each clause in the agreement. This may sound like simple common sense, but do you really understand the waiver of subrogation provision contained in most form agreements used in the industry, why it is there, and how it helps you manage the risk of your business? This article will help clear up some of the confusion.

Common Waiver Clause

The most commonly used "family" of form documents is that promulgated by the American Institute of Architects (AIA). The AIA B141–1997, Article 1.3.7.4 contains the following clause:

To the extent damages are covered by property insurance during construction, the Owner and the Architect waive all rights against each other and against the contractors, consultants, agents and employees of the other for damages, except such rights as they may have to the proceeds of such insurance as set forth in the edition of AIA Document A201, General Conditions of the Contract for Construction, current as of the date of this Agreement. The Owner or Architect, as appropriate, shall require of the contractors, consultants, agents and employees of any of them similar waivers in favor of the other parties enumerated herein.

What Is Subrogation?

Subrogation means, in a legal sense, one party has the right to "step into the shoes" of another party for the purposes of bringing a claim for damages. Not all types of claims may be subrogated. The most common type that can be subrogated is property damage claims.

For example, if you are involved in an auto accident where no one is injured, but the vehicles are damaged, and you are completely free of fault, your insurer will pay to have your vehicle damage repaired. If your insurer pays for the "property damage" to your vehicle, in most states, your insurer then becomes "subrogated" to your rights for that property damage. In other words, your insurer can "step into your shoes" and make a claim against the other driver in your auto accident that caused the damage to your vehicle for which your insurer had to pay the repair cost. In fact, if the other driver does not voluntarily pay for the damage, your insurer may even bring a lawsuit against the other driver, and by "stepping into your shoes," your insurer may bring that claim in your name—just as if you were bringing the suit yourself. In most states, the suit would be brought in your name or your company name.

A waiver of subrogation clause is placed in the professional services contract to minimize lawsuits and claims among the parties. The result is that the risk of loss is agreed among the parties to lie with the insurers, and the cost of the insurance coverage is contractually allocated among the parties as they may agree. The risk, once assigned to the insurers by the parties, is determined to stop there, without allowing the insurer to seek redress from the party "at fault."

In our auto accident example, if you and the other driver had an enforceable "waiver of subrogation" agreement at the time of your accident, even though the insurer for the totally innocent party—you—is obligated to pay for the loss, that insurer would not be allowed to seek damages from the party "at fault"—the other driver. The reason being that the parties had agreed to waive the right of subrogation, and the insurer's rights can be no greater than the insured's rights.

In the professional services setting, the clause usually provides that the owner and design professional waive all rights against each other and against others for damages covered by any property insurance in place during construction. To insure the effectiveness of the waiver of subrogation clause, the owner and design professional generally require the same type of waivers from the contractors, other consultants, and agents. Most form contract documents assign the responsibility for procuring the applicable insurance, for demonstrating the coverage is in place (e.g., certificates of insurance), and for the cost.

These clauses are intended to minimize the potential for lawsuits, cross-suits, and counter-suits arising from property loss that may occur during the project. An effective waiver will prevent the various insurers involved from suing the parties to the construction contracts. One reason to use the available form contracts is that the entire network of the waiver of subrogation provisions has already been thought through, drafted, is in place ready to use, and has been tested in the courts to a greater or lesser extent. The clause quoted above from AIA B141, the Standard Form of Agreement Between Owner and Architect, has a sister provision in the AIA Owner and Contractor Agreements and general conditions.

Subrogation in the Real World

Does the clause have real world application or does it only exist in the tangled netherworld of insurance? Not too long ago in Missouri, an owner had purchased a building to be used as an office and warehouse. After property damage was encountered, the owner's insurer encountered the effects of a waiver of subrogation clause. See generally, Butler v Mitchell-Hugeback, Inc. et al., 895 SW2d 15 (Mo 1995).

The owner had contracted with an architect, engineer, and a contractor to retrofit an existing building. The owner and the architect had entered into the AIA B141, 1987 edition, agreement. The owner and construction contractor had also used the AIA standard form agreement, which incorporated the General Conditions for Construction, A201, 1987 edition.

During the retrofit process, a portion of the roof collapsed which resulted from insufficient steel reinforcing bars being placed in the hollow core of certain pilasters, from the reinforcing steel that was installed being improperly spliced, and from certain girders being improperly cut during construction. The owner's property insurer paid the owner for the loss. The owner's insurer in turn claimed that it was entitled to be "subrogated" to the rights the owner would have otherwise had against the parties responsible for the collapse. In other words, the insurer wanted to "step into the shoes" of the building owner and pursue damages against the parties it believed were "at fault" for the collapse.

Suit was filed against the architect, among others. The owner alleged that the architect had breached its contract with the owner and also was negligent in its provision of professional services. The owner had found in the post-collapse investigation that the roof had failed due to the defects mentioned above and some other defects in the original construction, which should have been corrected.

At the trial court level, the court ruled that the owner had "waived" its claims against the architect and granted the architect judgment in its favor before the lawsuit went to trial. The owner appealed.

On appeal, the Missouri Supreme Court was called on to determine what the parties had really intended and agreed to by the use of the form agreements. The court said as follows.

In order to determine the intent of the parties, it is often necessary to consider not only the contract between the parties, but "subsidiary agreements, the relationship of the parties, the subject matter of the contract, the facts and circumstances surrounding the execution of the contract, the practical construction the parties themselves have placed on the contract by their acts and deeds, and other external circumstances that cast light on the intent of the parties.

In light of this guiding principle, the court concluded that all the contract documents of the owner/architect, owner/contractor, and the general conditions must be read together to capture what was intended by the parties.

In reliance on the provisions of the contract documents, the Missouri Supreme Court found that the owner had waived its rights against the architect for damages covered by property insurance. Since the insurer "steps into the shoes" of the owner, the insurer can have no greater rights than the owner, and, as a result, the insurer had no rights against the architect for the damages. The court went on to confirm its finding by noting that its interpretation of the contract documents finding the waiver of subrogation was strengthened by the contract clauses requiring the contractor to purchase and maintain insurance for damages.

Conclusion

A waiver of subrogation may allow you to avoid becoming engaged in the complexities of lawsuits and insurance claims, while managing the risk and associated expenses. The Mitchell-Hugeback case helps to demonstrate the importance of keeping the "family" of documents in place. As the Missouri Supreme Court noted, the agreements had to be read together. No one could predict the result if part of the "family" is missing or if the clauses are edited without attention to the ripple effect throughout the "family."


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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