In this article, Kent Holland discusses a Fourth Circuit case that demonstrates the importance of waivers of subrogation as part of the risk allocation strategy.
When an insured design-builder signs a contract with its client agreeing to a "waiver of subrogation, it gives up the right of its insurer to seek recovery for a third party (including the client) for the amount it paid to the policyholder for a loss caused by that third party. Many insurance policies state that the insured may waive subrogation provided it is done as part of the contract between the insured and its client and is done at the outset of the job and not after a claim or loss has arisen. The "waiver of subrogation" means that by giving up its right of recovery, the insurer accepts the fact that the policyholder and the parties with whom it has contracted have allocated the risk of the insured event to the insurer.
In American Home Insurance Company, et al. v Monsanto Enviro-Chem Systems, Inc., 2001 U.S. App. LEXIS 17406 (4th Cir 2001), the Home Insurance Company filed suit against Monsanto Enviro-Chem Systems ("Enviro-Chem") to recover a loss that it paid under a property insurance policy on behalf of its insured, PCS Phosphate Company ("PCS"). Enviro-Chem had designed and built a chemical plant for PCS in 1985. In 1997 an implosion occurred at the plant, causing millions of dollars of damages to plant. American Home paid $5.6 million to PCS for the damage caused by the implosion and sought to recover that amount from Enviro-Chem.
American Home argued that Enviro-Chem knew of the risk that led to the accident and failed to warn PCS of the risk and remedial procedures that could have been implemented to avoid the risk. These allegations were based on the fact that a similar implosion had occurred in 1986 on another chemical plant designed and built by Enviro-Chem. Based on its investigation of the 1986 implosion, Enviro-Chem had recommended certain operational changes to the owner of that plant. In defending itself against American Home's suit, Enviro-Chem argued that the insurance company had waived its right of subrogation. The trial court judge agreed with Enviro-Chem and dismissed the action. This was appealed by American Home.
Fourth Circuit Court of Appeals
On appeal, the Court of Appeals for the Fourth Circuit concluded that American Home had no subrogation rights. The policy in question provided as follows:
Owner [PCS] shall carry Builder's Risk Insurance "all risk" type coverage fully protecting Owner, Enviro-Chem ... against all physical loss or damage or damage to Plant, the Work, or any part thereof .... After such Builder's Risk Insurance shall have terminated, Owner shall maintain insurance covering, or assume the risk of, loss and damage to the Plant and the Work, however caused, and shall provide a waiver of subrogation in favor of Enviro-Chem ... under such insurance.
The lower court concluded that the term "however caused" was sufficiently broad and unambiguous to prevent the insurance company from having the right to assert claims based on negligent failure to warn. The appellate court rejected the insurance company's argument that the term "however caused" was ambiguous. Moreover, the court found that the subrogation clause explicitly applied to any damage to the plant or the work, which covered the entire heat recovery system.
Going a step further than the lower court holding, the appellate court analyzed the other terms and conditions of the contract between PCS and Enviro-Chem to determine whether American Home would have benefited by being able to "step into the shoes" of PCS if the subrogation right had not been waived. What the court found was that the design-build contract contained several clauses that would prevent PCS from recovering against Enviro-Chem for the damages in any event.
These clauses included a:
- Waiver of consequential damages;
- A limitation of liability; and
- A clause stating that once Enviro-Chem completed its work under the agreement it would have no further obligation to PCS for any damage to the plant.
As a result of these terms and conditions, American Home could not have recovered against Enviro-Chem even if American Home had a right of subrogation since there was no contractual basis for a claim against Enviro-Chem.
This case demonstrates the importance of waivers of subrogation as part of the risk allocation strategy. The court considered the plain meaning of the "builder's risk" policy language, finding that the parties intended that insurance be the source of funds for the type of loss that actually occurred. The court also considered the plain meaning of the contract terms and conditions which specifically limited or barred causes of action by the owner against the design-build contractor—again indicating that the insurance would be the sole remedy and that the risk would be on the insurer.