Many disputes arise and litigation results over additional insured status.
Extrinsic contracts, such as between the policyholder and its customers, can
complicate matters, as is seen in these cases. To avoid litigation, drafting
the extrinsic contract harmoniously is essential. Additionally, the additional
insured should ensure that its additional insured coverage conforms to the
insurance clause of the extrinsic contract.
In most cases, the reason that a commercial general liability (CGL) insurer
issues an additional insured endorsement is that its policyholder has entered
into a contract with a customer of the policyholder, and that contract requires
the policyholder to name the customer as an additional insured. (Such contracts
will be called "extrinsic contracts" in this article.) The
endorsement is then issued to satisfy that obligation.
The same extrinsic contract invariably also requires the policyholder to
indemnify its customer for bodily injury and property damage arising out of
whatever work the policyholder is doing (construction, property management,
commercial leasing, product distribution, as the case may be). The contractual
liability coverage of the CGL policy insures the policyholder's obligations
under an indemnity clause in an extrinsic contract.
Although the insurer may issue the additional insured endorsement to satisfy
its policyholder's obligation to provide insurance to the
policyholder's customer, the insurer is not a party to the extrinsic
contract between the policyholder and its customer. Accordingly, that contract
neither broadens nor narrows the coverage the additional insured endorsement
provides, right? Generally, that is correct. An example of this general rule
can be seen in pairs of cases decided by the Illinois Appellate Court and the
California Court of Appeal.
Illinois and California Appellate Cases
In the Illinois cases, the court rejected attempts by the insurer to limit
its additional insured coverage to what the extrinsic contract required, when
the additional insured endorsement provided more coverage. In J.A. Jones Constr. Co. v Hartford Fire Ins. Co., 645 NE2d
980 (Ill App 1995), the court held that the additional insured was entitled to
coverage for his own negligence, even though his contract with the policyholder
entitled him only to coverage arising out of the policyholder's negligence,
because the additional insured endorsement provided coverage for the additional
insured's own negligence. In Mobil Oil Co. v
Maryland Cas. Co., 681 NE2d 552 (Ill App 1997), the court held that the
additional insured was entitled to the full limits of the policy, even though
its contract with the policyholder required much lower limits.
On the other hand, in the California cases, the court held that the
insurer's obligations would not be broadened by the indemnity agreement in
its policyholder's extrinsic contract. In Travelers
Cas. & Surety Co. v American Equity Ins. Co., 93 Cal App 4th 1142
(2001), the court held that a building owner's insurer, on whose policy an
apartment manager was an additional insured, owed only pro rata coverage in
accordance with its other insurance clause, and not sole primary coverage. The
apartment manager argued that the indemnity clause in its contract with the
building owner evidenced a clear intent to shift the entire loss to the
building owner's insurer, but the court held that the indemnity agreement
was irrelevant to the insurer's obligations, absent a judgment against the
building owner on that agreement.
In Reliance Natl. Indem. Co. v General Star Indem.
Co., 72 Cal App 4th 1063 (1999), the court held that an excess insurer
that provided additional insured coverage to its policyholder's customer
did not have to pay reimbursement to the additional insured's own primary
insurer, despite the indemnity agreement requiring the excess insurer's
named insured to indemnify the additional insured for the entire loss.
An
exception to this general rule applies when the additional insured has a
judgment for indemnity against the named insured. In such a case, the
policy's contractual liability coverage will apply to the named
insured's obligation to indemnify the additional insured. Since the
contractual liability coverage belongs to the named insured, but the additional
insured coverage belongs to the additional insured, the policy's other
insurance clause does not apply. This is because an "other insurance"
clause apportions coverage between policies covering the same insured. Cases
applying this exception include Rossmoor Sanitation,
Inc. v Pylon, Inc., 13 Cal 2d 622 (1975), and J. Walters Constr. Co.,
Gilman Paper Co., 620 S2d 219 (Fla App 1993).
Most reported cases in this area involved endorsements that did not
specifically or generically refer to the policyholder's obligations under
an extrinsic contract, other than a blanket endorsement's identification of
the additional insured as one entitled by an extrinsic contract to such status.
Some cases, however, have involved endorsements that specifically or
generically conditioned coverage on the requirements of an extrinsic contract,
such as where the additional insured endorsement provided for excess coverage
unless an extrinsic contract required primary coverage. See, e.g., Bieda v Carson, Pirie Scott & Co., 663 NE2d 102 (Ill App
1996). That case involved a generic reference to an extrinsic contract. An
example of a specific reference to an extrinsic contract is Truck Ins. Exch. v Liberty Mutual Ins. Co., 428 NE2d 1183
(Ill App 1981).
Four recent cases add to the body of case law on the important question of
how additional insured coverage is impacted by requirements in an extrinsic
contract:
- An
Eighth Circuit case held that the indemnity agreement between a product
manufacturer and the retailer required the manufacturer's primary and
excess policies to pay the entire loss on behalf of the retailer (an
additional insured on those policies), even though the manufacturer's
excess policy provided that its coverage did not incept until exhaustion of
all applicable primary policies.
- A
Fifth Circuit case held that the indemnity agreement between a general
contractor and a subcontractor required that the subcontractor's CGL
policy pay the entire loss on behalf of the general contractor (an
additional insured on the subcontractor's policy), even though the
other insurance clauses of the two policies both provided for sharing with
other primary policies.
- A
California appellate case held that the scope of coverage for the
additional insured would be commensurate with the scope of the indemnity
agreement, and not as broad as the additional insured endorsement provided.
- A
New York high court case held that the additional insured would be
entitled to primary coverage under an endorsement providing that coverage
for the additional insured is excess unless a contract requires primary
coverage. The high court held that additional insured coverage, by its very
nature, is primary, that contracts requiring additional insured coverage
necessarily require primary coverage, and that no special words are needed
for this purpose.
The Eighth Circuit Case
In Wal-Mart Stores, Inc. v RLI Ins. Co., 292
F3d 583 (8th Cir 2002), Jasmine, a minor, was severely burned in a fire
allegedly caused by a halogen lamp purchased at Wal-Mart and manufactured by
Cheyenne. Jasmine's parents, on her behalf, filed suit against Wal-Mart and
Cheyenne. Her suit was eventually settled for $11 million.
Wal-Mart and Cheyenne had entered into a vendor agreement under which
Wal-Mart agreed to sell halogen lamps manufactured by Cheyenne. The agreement
contained an indemnity clause, which obligated Cheyenne to indemnify Wal-Mart
for any liability resulting from its sale of Cheyenne's lamps. The
agreement also required Cheyenne to obtain CGL insurance with limits of $2
million.
Cheyenne had a primary CGL policy with St. Paul, with limits of $1 million.
Cheyenne also had a $10 million excess policy with RLI. RLI's policy
contained an excess "other insurance" clause. Wal-Mart was an
additional insured on both of these policies. Wal-Mart had its own primary CGL
policy with National Union, with limits of $10 million. The National Union
policy also contained an excess "other insurance" clause.
All parties agreed that St. Paul owed the first $1 million of the settlement
paid on Wal-Mart's behalf. They disagreed, however, as to who owed the next
$10 million—Cheyenne's excess insurer, RLI, or Wal-Mart's insurer,
National Union. RLI paid the remaining $10 million, and sought reimbursement
from National Union in a declaratory judgment action. The district court,
applying Arkansas law, found that a comparison of the other insurance clauses
required the conclusion that RLI's policy was excess over National
Union's. The court therefore entered judgment for RLI. National Union and
Wal-Mart appealed.
On appeal, the court found it unnecessary to resolve the competing other
insurance clauses. The court held that the indemnity clause of the vendor's
agreement controlled. The court said that the indemnity agreement reflected a
clear intent that Wal-Mart be fully indemnified by Cheyenne for any losses
caused by its products, and that to allow RLI to obtain reimbursement from
Wal-Mart or its insurer would frustrate that intent. The court rejected
RLI's contention that its true excess policy should not be triggered before
exhaustion of National Union's primary policy with an excess other
insurance clause. The court also rejected RLI's contention that because
Cheyenne had not been found liable to indemnify Wal-Mart, the indemnity
agreement should not control.
Lastly, the court opined that to allow RLI to obtain recovery from National
Union would result in a "circuity of litigation," resulting in RLI
ultimately owing the debt anyway. This is so, said the court, because if
National Union had to reimburse RLI, then National Union, as Wal-Mart's
subrogee, would assert Wal-Mart's right to be indemnified by Cheyenne.
Cheyenne's obligation to indemnify Wal-Mart, in turn, would be covered by
RLI, thus leaving the loss where it began.
The court reversed the judgment in favor of RLI. The court opined that
Travelers Cas. & Surety Co. v American Equity. Ins.
Co., 93 Cal App 4th 1142 (2001), and Reliance
Natl. Indem. Co. v General Star Indem. Co., 72 Cal App 4th 1063 (1999),
were inconsistent with Rossmoor Sanitation, Inc. v
Pylon, Inc., 13 Cal 2d 622, 532 P2d 97 (Cal 1975), and so declined to
follow those more recent appellate cases.
But the court overlooked what distinguishes Rossmoor from the appellate cases: the presence or absence
of a judgment for indemnity, or some other determination that indemnity was
owed. This key distinction was explained very well by the court in Travelers Cas. & Surety Co. v American Equity. Ins.
Co.
The Fifth Circuit Case
In American Indemnity Lloyds v Travelers Property
Casualty Ins. Co., 2003 WL 21437012 (5th Cir 2003), Alas was injured on
a prison construction project while employed by Elite Masonry, a subcontractor.
Alas sued Caddell Construction, the general contractor, for his injuries. The
subcontract between Caddell and Elite contained separate clauses for
indemnification and insurance. The indemnification clause required Elite to
indemnify Caddell for any bodily injury claims or suits arising out of
Elite's work, including those caused by Caddell's negligence, except
for those losses caused by Caddell's sole negligence. The insurance clause
required Elite to make Caddell an additional insured on its CGL policy.
American Indemnity Lloyds (AIL) issued a CGL policy to Elite, containing a
blanket additional insured endorsement. Caddell was the named insured on a CGL
policy issued by Travelers. Both the Travelers and AIL policies contained the
ISO CG 00 01 coverage form, pre-1998 version, which provided for sharing with
other primary policies. Travelers initially defended Caddell in the Alas
lawsuit, but AIL subsequently assumed Caddell's defense under the blanket
additional insured endorsement to the AIL policy.
AIL advised Travelers, however, that it deemed the two policies'
coverage to be concurrent, and that AIL would seek contribution from Travelers
for any sums AIL paid to defend and indemnify Caddell. AIL then settled the
Alas suit for $625,000, after having incurred $230,000 in defense costs. AIL
demanded half these sums from Travelers, and when Travelers refused, AIL filed
a declaratory judgment action in federal court in Texas.
AIL's position was that its right to contribution was based on the other
insurance clauses of the two policies, which, when compared, provided for
concurrent coverage. Travelers' position was that the indemnity agreement
controlled, not the other insurance clauses.
The insurers stipulated to all relevant facts, and that Travelers was
subrogated to whatever indemnity rights Caddell had under its subcontract with
Elite. They also stipulated that AIL's policy covered Elite's indemnity
obligations, if any, to Caddell, and that there was no judicial determination
of fault or negligence in the Alas suit. Travelers contended that because the
court in the Alas suit had not determined that Caddell was solely negligent,
the lone exception to Elite's obligation to indemnify Caddell therefore did
not apply, and thus, that Elite owed indemnity to Caddell for Alas's suit.
Since the insurers had stipulated that Travelers was subrogated to
Caddell's indemnity rights, and that AIL insured Elite's obligation to
pay indemnity to Caddell, AIL was therefore barred from suing Travelers for
contribution, Travelers contended.
The district court agreed with Travelers' contentions, and entered
summary judgment in Travelers' favor. AIL appealed.
On appeal, the court acknowledged that, as AIL contended, the general rule
is that where two liability policies issued by different insurers provide
coverage to the same insured, and both contain an other insurance clause that
provides for sharing with other primary policies, the two insurers share the
loss, and if one paid it and the other did not, the paying insurer may recover
contribution from the non-paying insurer. However, said the court, there is an
exception to this general rule where the insurer seeking contribution insures
the obligation of its named insured to indemnify the additional insured for the
loss in question. In this case, then, since AIL's policy insured
Elite's indemnity obligation under its subcontract with Caddell, AIL was
not allowed to seek contribution form Travelers. As an example of this
exception, the court cited the
Wal-Mart case.
To support the court's reliance on this "indemnity exception,"
the court discussed with approval the "circuity of litigation"
rationale of the
Wal-Mart case. The court reasoned that to
allow AIL to obtain contribution from Travelers would only result in Travelers,
as Caddell's subrogee, asserting Caddell's right to be indemnified by
Elite, and AIL, which insured Elite's obligation to indemnify Caddell,
paying the ultimate loss.
Finally, the court addressed AIL's contention, supported by Travelers Cas. & Surety Co. v American Equity Ins. Co.,
93 Cal App 4th 1142 (2001), that the indemnity agreement did not control
because there had been no determination of liability in the Alas suit, and thus
no determination that Elite owed indemnity to Caddell. The court said that AIL
could have sought such a determination in the federal declaratory litigation.
The court also noted that Texas law, unlike California law, does not require a
finding that the indemnity obligation was actually owed for the indemnity
agreement to control allocation of coverage.
The court reasoned that because the indemnity agreement applied unless the
exception was established, i.e., that Caddell was solely negligent, the lack of
a judicial determination that Caddell was or was not solely negligent failed to
establish the exception. Therefore, indemnity was owed, and the indemnity
agreement determined the allocation between the two insurers, not their other
insurance clauses. The court affirmed the judgment in favor of
Travelers.
The California Appellate Case
In St. Paul Fire & Marine Ins. Co. v American
Dynasty Surplus Lines Ins. Co., 101 Cal App 4th 1038 (2002), Casados was
injured while doing electrical work for his employer, Sasco Electric, at a rail
yard in California. ARB was the general contractor, and Sasco was ARB's
subcontractor. Although Casados was doing Sasco's work under the
subcontract, his injury was not caused in any way by that work. Rather, ARB was
pressure testing a pipe connected to a fuel tank in a completely different area
when the pipe exploded, causing metal fragments to strike Casados and injure
him. Casados filed suit for his injuries against ARB and the railroad,
ATSF.
The subcontract required Sasco to name ARB an additional insured on its CGL
policy, and to indemnify ARB from any bodily injury claims or suits arising out
of Sasco's work, provided that such claims or suits arose from Sasco's
acts or omissions. American Dynasty issued a CGL policy to Sasco. The policy
included an additional insured endorsement on a CG 20 10-type form that
provided coverage to ARB for "liability arising out of [Sasco's]
ongoing operations performed for [ARB]." ARB had its own CGL policy with
St. Paul.
St. Paul provided a defense to ATSF and to ARB, and tendered their defense
to American Dynasty. American Dynasty declined the tender, and St. Paul paid a
total of $113,000 in defending and settling the Casados suit. St. Paul then
filed an action for declaratory relief, seeking reimbursement from American
Dynasty. It was undisputed that no act or omission of Sasco caused the injury
to Casados. The trial court entered judgment for St. Paul for the amounts it
paid to defend and settle the Casados suit. American Dynasty appealed.
On appeal, the court found that the language in the additional insured
endorsement ("arising out of [Sasco's] ongoing operations") was
ambiguous, because it could reasonably be construed as "embracing either
(1) any liability arising while Sasco was on [the construction site] doing work
under the subcontract or (2) liability restricted to that arising, at least in
part, from Sasco's actual performance of such work." Instead of
resolving that ambiguity against the insurer and in favor of additional insured
coverage, however, the court found that it was necessary to construe the
endorsement along with the subcontract. Since the subcontract required
indemnity only for liability arising from the subcontractor's acts or
omissions, concluded the court, the additional insured endorsement could not be
read to provide broader coverage.
This decision is difficult to justify. First, the court construed what it
found to be an ambiguous policy term in favor of the insurer that drafted it.
Second, the court, in looking to the subcontract, ignored the additional
insured requirement, which required coverage for the subcontractor's
ongoing operations, and instead focused on the indemnity clause, with its more
restrictive obligation. But if it was proper to look to the subcontract at all
to determine the scope of coverage, surely, the portion of the subcontract that
prescribed the scope of additional insured coverage is more specific, and more
relevant, than the indemnity clause. Additionally—all other things being
equal—when confronted with two clauses providing different types of coverage, a
court is supposed to choose the clause that results in broader coverage. Third,
the court overlooked the fundamental differences between private-contract
indemnity and commercial liability insurance. To import the narrow construction
against indemnification for one's own negligence that applies to an
indemnity clause into a discussion of additional insured coverage is
unprecedented and unwarranted.
I am not the only commentator to criticize this decision. See also John K.
DiMungo and Paul E.B. Glad, California Insurance
Law Handbook, § 106 (2003 ed.). Those authors said the following.
The analysis of the St. Paul court does a
disservice to principals seeking protection from the risks associated with
hiring an independent contractor. Principals can never be sure that their
indemnity clauses will be found enforceable. * * * [I]nsurance is
most needed when the indemnity obligation fails; yet the effect of
the St. Paul decision is to limit insurance to
indemnifiable claims. This despite the fact the general contractor in St.
Paul presumably paid in the subcontract price the premium for the additional
insured endorsement.
The New York High Court Case
In Pecker Iron Works of New York, Inc. v Travelers
Ins. Co., 786 NE2d 863 (NY 2003), an employee of Upfront Enterprises was
injured at a construction site. Upfront was a second-tier subcontractor of
Pecker Iron Works, which in turn was a subcontractor of the general contractor.
The Upfront employee brought suit for his injuries against the owner and
general contractor, who then impleaded Pecker.
Upfront's subcontract required it to furnish additional insured coverage
to Pecker. Upfront's CGL policy with Travelers contained a blanket
additional insured endorsement, which provided that its coverage was excess
unless the contract requiring the coverage required primary insurance. Pecker
tendered its defense to Travelers under the additional insured endorsement, and
when Travelers declined the tender, Pecker commenced an action for declaratory
relief.
The trial court entered judgment for Travelers, finding that the subcontract
did not specify primary coverage, and concluding that the additional insured
coverage was therefore excess of Pecker's own coverage. Pecker appealed,
and the appellate court reversed. The appellate court held that the subcontract
did not provide for excess coverage, and therefore had to be construed as
requiring primary coverage. Travelers appealed to New York's highest
court.
On appeal, the high court noted that it was undisputed that the Travelers
policy provided Upfront (the named insured) with primary coverage. The court
then observed that the term "additional insured" has a
well-understood meaning, i.e., "an entity enjoying the same protection as
the named insured." The court ended by noting that the obvious purpose of
the additional insured requirement in the subcontract was to provide that
Upfront's insurer—not Pecker's—would provide the primary insurance for
a loss involving an Upfront employee.
The high court affirmed the appellate court judgment in favor of Pecker.
This decision is clearly correct, although the reasoning is somewhat
overwrought. It is not true that additional insureds enjoy the same protection
as named insureds, although this overstatement did not taint the reasoning of
the court. The court simply noted the obvious fact that the parties to the
extrinsic contract could only have intended primary additional insured
coverage, since coverage applying only in excess of the additional
insured's own primary insurance is illogical.
These "elastic" excess clauses are in common use by some of the
major property and casualty insurers, including Travelers, CNA, and St. Paul.
Pecker Iron Works goes one step further than the
decision of the Illinois Appellate Court in Bieda v
Carson, Pirie Scott & Co., 663 NE2d 102 (Ill App 1996). The
Bieda court held that the extrinsic
contract's requirement that the insurance cover "any and all
claims" against the additional insured necessarily meant primary coverage.
But the extrinsic contract in Pecker Iron Works
did not contain that "any and all claims" language. Armed with this
new decision, additional insureds can now forcefully argue that no special
language is needed in the extrinsic contract for their coverage to be primary,
because it makes no sense to construe the contract any other way.
Conclusion
The wall of separation between extrinsic contracts and insurance policies is
beginning to come down. In the two federal cases, the wall was breached so that
the additional insured could insulate its own primary coverage from any
obligation to share with, respectively, the named insured's primary policy,
and the named insured's excess policy. It is interesting that these two
federal cases, decided under Arkansas and Texas law, respectively, recognized
that California law does not allow the wall to be breached absent a judicial
determination of the indemnity obligation. This is probably the majority
view.
Should it be necessary that the indemnity obligation be judicially
determined before it controls the allocation between the insurers? These two
federal cases say no, but California cases continue to say yes. Will the
circuity of litigation rationale catch on? That rationale is very
insightful and practical, but it assumes the enforceability of the indemnity
obligation. Anti-indemnity statutes and the facts of the particular losses may
leave the indemnity obligation unenforceable. What happens then?
These issues are going to have to be decided in a coherent way, because
there isn't a construction contract signed these days that doesn't
require both indemnification and the procurement of additional insured
coverage. The interplay between the two does not always produce the desired
result, as these decisions show. The vast majority of states continue to adhere
to the simple rule that an insurance policy's coverage will not be
determined by provisions of an extrinsic contract to which the insurer is not a
party, unless the policy so provides.
But looking to the subcontract can be justified in general terms. It is
black letter contract law that a contract should be construed with due regard
for the context and purpose of the contract. In the case of additional insured
coverage, the context and purpose can be discerned largely from the provisions
of the extrinsic contract, which required the procurement of additional insured
coverage to begin with.
The one conclusion that can be drawn from these recent cases is that
drafting the extrinsic contract harmoniously is essential to good risk transfer
planning. The indemnity and insurance obligations should be consistent with
each other, because you never know when a court may look to the indemnity
agreement to determine the scope or allocation of the additional insured
coverage, whether the policy endorsement incorporates the indemnity clause or
not. A court may even do this when the result is inconsistent with the
insurance clause, as the California court did, although this decision was so
patently wrong it's hard to imagine any courts outside California will
follow it.
Additionally, the additional insured, to the extent he is able, should exert
all efforts to see that the additional insured coverage conforms to the
insurance clause of the extrinsic contract. Failure to take these steps can
lead to costly and unsuccessful coverage litigation.