Builders Risk Insurance: When Coverage Interpretation Relies on Nonpolicy Documents

Steven Coombs | July 1, 2012

Under what circumstances are contract documents referenced in determining coverage under a builders risk policy?

With most builders risk claims, the adjuster will review the circumstances of a loss, the terms and conditions of the insurance policy, and the proof of loss provided by the insured. The claim will be adjusted and the insured paid an appropriate amount. In some cases, however, the process becomes more complicated because coverage cannot be determined without first referencing documents apart from the policy. This is not necessarily a problem if things are structured properly. In other cases, there may be conflicting terms or ambiguity, leading to an unanticipated and unintended result.

Why and How Contract Documents Are Referenced

Not all builders risk policies reference contract documents,¹ but most do. The reason for this is to provide clarity. For instance, a construction contract will generally include a listing of the contract documents, the identity of key parties, a detailed description of the work to be performed, project descriptions, timelines, insurance requirements, subrogation provisions, and defined terms. Insurers include such references in their preprinted policy forms (e.g., subrogation clause). In addition, insureds, their insurance brokers, or underwriters may find it useful to reference specific provisions contained in the contract documents (e.g., in describing an insured project) as part of a builders risk policy. The thought process is that the builders risk policy should work hand-in-hand with the contract documents.

Such references may be very specific or are inferred. These are found in a variety of places within a builders risk policy. These may appear in preprinted insurer policies and endorsements or in manuscripted wordings. The following includes several areas where references to contract documents appear in policies. The list is not exhaustive. To further illustrate, each area is followed by one for more actual wordings taken from policies (emphasis is added as appropriate).

Naming of Insureds

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, any other individual or entity specified in such contract or subcontract, are recognized as....
The following persons or organizations are included as a Named Insured when you have agreed in a written contract or written agreement, executed prior to a loss, to name such persons or organizations as a Named Insured, but only to the extent of their financial interest in the Covered Property: (1) Owner(s) of Covered Property; (2) Contractors; and (3) Sub Contractors and Sub-Sub Contractors.
Named Insured: [Name of Insured], its divisions, subsidiaries or affiliated corporations or companies, or companies or corporations associated through ownership or management, or any other entity for which the insured has agreed to provide insurance.

Policy Term

... Such coverage shall apply only for such periods commencing directly with work at the Insured Project and continuing in full force and effect until the earlier of the final acceptance of the owner....
In the event an owner places insurance on any portion of the work which has been declared and accepted as Substantially Complete ... coverage hereunder as respects the portion of the work shall cease as of the Substantial Completion Date as stated in Certificate of Substantial Completion....

Note: Since "final acceptance" and "substantially complete" are generally not defined terms in builders risk policies, the contract documents would most likely be relied on.

Project Description

Work the Insured is contractually obligated to perform in accordance with the contract documents....
Insured Project: All the contracts for the construction, erection and testing of the [Project Name]....

Covered Property

Covered property includes property of every kind and description that you own or are liable for that is intended to become a permanent part of the building or structure described in the Declarations.
Permanent Works. All materials, supplies, equipment, machinery, and other property of a similar nature, being property of the insured or of others for which the Insured may be contractually responsible....

Note: The phrases "or are liable" or "contractually responsible" will usually require a review of the contract documents to determine the scope of responsibilities.

Excluded Property

This policy does not insure land and land values and the value of cut, fill and backfill materials existing at the project site prior to project commencement; however, to the extent included in the contract bid documents and declared for premium purposes, the value of fill and backfill materials for use in the completion of the project is not excluded.

Other Exclusions

Damages for breach of contract, late or noncompletion of orders, or for any penalties of any nature.
Error, omission, or deficiency in design, plans, specifications, engineering or surveying.
Liquidated Damages. If the construction contract for the "project" contains a clause that requires payments to you because of a delay in the completion of the "project" beyond the "planned completion date," we will subtract the amount due from others....

Additional Coverages

Construction Contract Penalty. If your construction contract contains a clause that requires you to pay a penalty as a direct result of a Covered Cause of Loss to "Builders Risk," we will pay up to [$ Amount] during each separate 12 month period of this policy for all such expenses.

Definitions

"Completion date" means the later of the original scheduled completion date in the construction contract or the date the structure would have been completed if a loss hadn't occurred.
"Contractor" means a Contractor of any tier who performs operations at the Project under contract with the Owner and Construction Manager....

Conditions

Subrogation. The Company will have no rights of subrogation against (1) any person or entity, which is an Additional Insured; (2) any other person or entity, against which the Insured has waived its rights of subrogation in writing before the time of loss.
Valuation for Property under Construction. The cost to repair or replace the lost or damaged property, valued as of the time and place of loss, with material of like kind and quality, less betterment, including contractor's reasonable profit and overhead in the same proportion as that included in the original contract documents.

Recent Case Illustrates How Conflicts Can Arise

A recent case provides an illustration of the problems that can arise when a builders risk policy is structured in such a way as to require a review of the contract documents to ascertain coverage. In WH Holdings, LLC v. Ace Am. Ins. Co., No. 10–31091 (U.S. Ct. App. June 6, 2012), the sole issue was whether the construction contract obligated WH Holdings, LLC, or Gootee Construction to purchase builders risk insurance on renovation work at a hotel in New Orleans. The district court determined that WH Holdings was obligated under the construction contract to provide the insurance. WH Holdings appealed this decision, and the appeals court found the contract provisions to be ambiguous and remanded the case to the district court for considering course of conduct evidence and other forms of extrinsic evidence.

The facts of the case are fairly straightforward. WH Holdings ("Owner") owned the Ritz Carlton Hotel Complex in New Orleans. The Owner hired Gootee Construction Company ("Contractor") to perform renovation work on an existing structure of the Ritz. Hurricane Katrina caused damage in excess of $1.6 million to the façade and exterior insulation finishing system. The Contractor secured a builders risk insurance policy from Ace American Insurance Company ("ACE"). Rather than naming the specific parties to be insured, the ACE policy contained a broad form named insured endorsement, which provided coverage to any party of interest that the insured (Contractor) was responsible to insure. As such, a determination of whether the owner qualified as an insured under the ACE policy hinged on the terms of the contract documents. This is where things turn a little murky.

The construction contract between the Owner and Contractor incorporated General Conditions (AIA Document A201–1997), which was amended in several areas by the parties. (It may be helpful for the reader to download and print a complimentary copy of a comparison of AIA A201–1997 to AIA A201–2007.) Subsection 11.4 is the section of AIA A201 that addresses property insurance on the work to be performed. The standard provision calls for the Owner to secure the property insurance (builders risk policy). In this case, however, the parties amended this section (Part 11.4.1) to require the Contractor to secure and maintain this insurance, in lieu of the Owner.

If this were the end of the story, all would have concluded that the policy provided coverage to the Owner. However, the Contractor's Liability Insurance part (Subsection 11.1) was amended to include the following:

g. Builders Risk Insurance Limits

Full Replacement Cost Value on the Work being installed as described in the Construction Contract. The policy shall name as an [sic] named insured the Owner and any other entity required by the Contract between the Owner and the Contractor. This policy shall waive subrogation against Owner and any other Owner related entity whether or not required by the Contract between the Contractor and the Owner. This coverage will be placed by the Contractor on an "All Risk" replacement cost basis for the full value of the construction unless the construction is an addition or renovation to an existing structure. If this construction is an addition or renovation than [sic] the Owner shall be responsible for providing this coverage and will add the Contractor and its subcontractors and sub-subcontractors as additional insureds(s) and waive subrogation against the Contractor and its subcontractors and sub-subcontractors as regards any structures being built or renovated and already existing at the site [emphasis added].

Based on 11.1.5(g), the district court concluded that the Owner was responsible for procuring the builders risk policy. The appeals court recognized that the Contract contained conflicting provisions and found the contract to be ambiguous.

Tips for Practitioners

Other than by sheer luck, a builders risk policy cannot be properly structured without a review and understanding of the contract documents. Practitioners would be well advised to adhere to the following.

Obtain and review the contract documents to understand the insurance requirements and other provisions. This review is not limited to the construction contract, as other documents may contain additional requirements.
If the provisions therein are not clear or are in conflict, seek clarification from the stakeholders.
Understand the sections of preprinted builders risk policy forms that reference one or more of the contract documents.
When crafting manuscript clauses for the builder risk policy, be certain these changes clarify coverage and are unambiguous.
Changing one section of an existing contract, such as the ones offered by the American Institute of Architects, may also require other sections to be amended as well.

Conclusion

While most builders risk claims are adjusted within the confines of the four corners of a builders risk policy, there are situations where coverage cannot be determined without a review of nonpolicy documents. Following a review of the contract documents, professionals have an opportunity to add value by providing appropriate counsel to their clients.

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Footnotes

¹ Contract documents are usually enumerated in the construction contract and attachments thereto.