Expert Commentary

Is Additional Insured Coverage Becoming Just an Illusion?

Joe Postel looks at the recent Illinois Appellate Court decision, National Union v R. Olson Constr., and at the judicial confusion over additional insured endorsements that exclude the additional insured's own negligence.


Additional Insured Issues
July 2002

With its April 18th decision in National Union Fire Ins. Co. of Pittsburgh, Pa. v R. Olson Constr. Contractors, Inc., ___ NE2d ___, 2002 WL 689662, the Illinois Appellate Court has fired the latest salvo in a war that has raged for 10 years over whether an additional insured endorsement that excludes the negligence of the additional insured furnishes illusory coverage. This debate, which so far has taken place in the Illinois courts alone, has nationwide significance. That is because the exclusion for the negligence of the additional insured is likely to become the underwriting weapon of choice for insurers with large books of subcontractor business, faced with the ever-expanding number of states with court decisions construing Insurance Services Office, Inc. (ISO), additional insured endorsements broadly in favor of coverage.

So far, with the exception of AIG, the large commercial general liability (CGL) insurers do not use these endorsements. But every time a court finds that these endorsements are not illusory, it gives other insurers an incentive to use them.

National Union v Glenview Park District

The opening shots of this war were fired in 1992, with the Illinois Appellate Court's decision in National Union Fire Ins. Co. of Pittsburgh, Pa. v Glenview Park District, 594 NE2d 1300 (Ill App 1992). The court in that case rejected the contention that the exclusion for the Park District's negligence rendered the coverage illusory. The court's analysis, like that of all of the appellate court decisions in the ensuing 10 years, betrayed a fundamental misunderstanding of the subject. The court reasoned that the exclusion did not negate all coverage. Rather, the court said, it merely required that the negligence of the named insured be established as a condition for the additional insured's coverage. But the court did not explain how establishing the named insured's negligence avoids the exclusion for the additional insured's negligence. It clearly does not.

On appeal to the Illinois Supreme Court, that court held that the exclusion would not apply to the claim brought under the now-repealed Structural Work Act. Under the "defend the entire complaint if any part of it is potentially covered" rule, National Union therefore had to defend the entire complaint (including the negligence claim), making it unnecessary for the court to determine whether the exclusion for the Park District's negligence rendered the coverage illusory. The court vacated the portion of the appellate court judgment holding that the coverage was not illusory. [National Union Fire Ins. Co. of Pittsburgh, Pa. v Glenview Park District, 632 NE2d 1039 (Ill 1994).]

Chief Justice Bilandic, joined by Justice Heiple, dissented from that portion of the majority opinion that found it unnecessary to decide the illusory coverage issue. The chief justice opined that the exclusion in the National Union endorsement for the Park District's negligence rendered the coverage illusory. In response to National Union's argument that the endorsement was not illusory because it covered the Park District for its vicarious liability for the acts or omissions of National Union's named insured (the Park District's contractor), the chief justice said:

The Glenview Park District does not need, nor does it seek, coverage for vicarious liability in connection with the NDS painting contract. NDS is an independent contractor and the Glenview Park District cannot be held vicariously liable for its acts except under a narrow exception. [632 NE2d at 1046, emphasis supplied.]

Said the chief justice, the exclusion for the negligence of the additional insured "deceptively affects the general liability risks that the endorsement purports to assume," and it therefore "violates public policy and should not be enforced." [Id.]

It seemed that the stage had been set for the Illinois Appellate Court to take up the chief justice's challenge and analyze the illusory coverage issue. Either the repeal of the Structural Work Act in 1995, or a case where indemnity was at issue (and not just the duty to defend, as in the Glenview Park District case), would have presented such an opportunity. And yet when it came, in 1998, the appellate court again rejected the assertion that an exclusion for the negligence of the additional insured renders the coverage illusory.

American Country v Kraemer Bros.

In American Country Ins. Co. v Kraemer Bros., Inc., 699 NE2d 1056 (Ill App 1998), the court acknowledged that "if the claim is brought by an employee of the subcontractor, as was done in this case, the negligence cannot be imputed to the general contractor." [699 NE2d at 1062.] In other words, the court accepted the point in the chief justice's dissenting opinion that there can be no vicarious liability for the acts or omissions of an independent contractor. And yet, the court nonetheless rejected the contention that the coverage was illusory, reasoning that:

[T]he imputed negligence coverage in the policy includes claims based on strict liability where the general contractor is held to have a duty that it cannot delegate to someone else. Restatement (Second) of Torts, sections 416-429.

The court's reasoning was flawed, however. In fact, Illinois law imposes strict liability in only two situations:

Illinois has recognized strict liability principally in two instances: (1) when, under certain circumstances, a defendant introduces a product into the community which is unreasonably dangerous to the user, consumer, or to his property (product liability cases); and (2) when a defendant engages in ultrahazardous or abnormally dangerous activity as determined by the courts[.] [Miller v Civil Constructors, Inc., 651 NE2d 239, 242 (Ill App 1995) (citations omitted).]

Ordinary construction projects are obviously not product liability cases. Nor are they ultrahazardous activity as that term is used in section 520 of the Restatement (Second) of Torts. Thus, there is simply no way, contrary to Kraemer Bros., that a general contractor on an ordinary construction project can be held strictly liable for the acts or omissions of its subcontractor.

The Kraemer Bros. court gave two examples of strict liability. The first example, St. Paul Fire & Marine Ins. Co. v Frankart, 358 NE2d 720 (Ill App 1976), involved a question of insurance coverage for a truck, operating under an Interstate Commerce Commission (ICC) permit, that was involved in an injury-causing accident. The court recognized that the general rule of nonliability for acts or omissions of an independent contractor has an exception, contained in section 428 of the Restatement (Second) of Torts, for activity that can be carried on only under a franchise granted by a public authority (such as the ICC). The trucking carrier in that case was held liable for the acts and omissions of its independent contractor driver, because the interstate hauling of cargo for hire could be carried on only with an ICC permit.

The activity in Frankart is simply not analogous to construction activity, however. The Kraemer Bros. court did not even attempt to explain how Frankart establishes that a general contractor can be strictly liable for the acts or omissions of a subcontractor. In fact, a review of the Comments and Illustrations to section 428 of the Restatement shows that it specifically does not apply to construction activity. Thus, the Kraemer Bros. court misapplied Frankart. Frankart in no way supports the conclusion that a general contractor on a construction project can be strictly liable for the acts or omissions of a subcontractor.

The second example of strict liability given by the Kraemer Bros. court was Clark v City of Chicago, 410 NE2d 1025 (Ill App 1980). Clark was a case involving demolition of a building. Demolition is a well-recognized example of ultrahazardous activity that subjects owners and general contractors to strict liability. But no ordinary construction activity, such as that carried on by American Country's named insured (masonry work), has ever been recognized as subjecting anyone to strict liability. Thus, Clark in no way supports the assertion that a general contractor on an ordinary construction project could ever be strictly liable for the acts or omissions of its subcontractor.

Kraemer Bros. simply failed to establish any legal possibility of a general contractor on an ordinary construction project being held strictly liable for a subcontractor's acts or omissions. The opinion failed to take the next logical step after observing that strict liability is possible under Illinois law. The court should next have asked whether any recognized case of strict liability in Illinois bore any resemblance whatsoever to the case before it in particular (ordinary masonry work), or to any ordinary construction activity in general. The answer, obviously, is "No." Had the court asked that question, it could not have avoided the conclusion that the American Country endorsement furnished illusory coverage. Instead, the court simply concluded that because strict liability does exist, the endorsement's coverage was not illusory. That conclusion, however, is a non sequitur.

American Country v Cline

Kraemer Bros. was followed in American Country Ins. Co. v Cline, 722 NE2d 755 (Ill App 1999), which, in addition to following Kraemer Bros., offered three reasons of its own for rejecting the general contractor's contention that the exclusion for the negligence of the additional insured rendered the coverage illusory.

First, said the court, because American Country only charged $150 for issuing a blanket additional insured endorsement, it must have intended to cover "only a narrow class of claims." This is interesting, if for no other reason, because it appears to mark the debut of the opposite of Professor Keaton's doctrine of the "reasonable expectations of the insured." Here, the court ignored what Pepper Construction Co., the general contractor, reasonably expected when it bargained to become an additional insured on its subcontractor's CGL policy, and instead focused on the "reasonable expectations of the insurer."

This perversion of Professor Keaton's doctrine can be answered in three ways. First, no matter how small the premium and how narrow the expectation of coverage, if it covers nothing, it's illusory, and nothing can justify that. Second, American Country already factored in the risk of claims against additional insureds when it calculated the premium for its named insured, because the named insured's claims experience already reflected claims against additional insureds in previous policy periods. The $150 premium reflects administrative costs more than additional risk. Third, it is settled Illinois law that the amount of premium does not determine policy coverage. [American States Ins. Co. v. Liberty Mutual Ins. Co., 683 NE2d 510, 514 (Ill App 1997).]

The court also said that if Pepper wanted additional insured coverage similar to the coverage it already had with its own insurer, it should have paid a like premium to American Country. Needless to say, however, Pepper could not reasonably be expected to arrange for American Country to receive a higher premium than it charged. Moreover, Pepper's own risk management program—whether that program consisted of traditional insurance, self-insurance, or some combination of the two—would have been designed (and priced) with the assumption that Pepper would enjoy industry standard coverage on its subcontractor's policies. And certainly, ISO CG 20 10 coverage is the industry standard that undoubtedly would have been factored in. American Country's additional insured coverage falls far short of that standard, however. Finally, Pepper's reasonable intent to acquire industry standard additional insured coverage would have been factored into the contract price with American Country's named insured.

The court's second reason for rejecting Pepper's illusory coverage contention was the notion that because American Country agreed to provide Pepper with coverage for liability arising out of the subcontractor's work, it should not be expected to provide coverage for liability arising out of Pepper's own work. But the court did not explain how Pepper could be covered for liability arising out of its subcontractor's work without being covered for liability arising out of its own work. How is such a thing even possible? How could any claim against Pepper involve the subcontractor's work without also involving Pepper's work? The court seems to have assumed that the one could be separated from the other (it can't), or that the two were mutually exclusive (they're not). There is no reason that a claim cannot involve both Pepper's work and its subcontractor's; in fact, there can't be a claim against Pepper that involves only the subcontractor's work and not Pepper's. Even if such a thing were a logical possibility, it would be rendered impossible by the definition of "your work" in Pepper's CGL form, which includes the work of subcontractors.

Third, the court noted that American Country had filed its manuscript additional insured endorsement with the Director of the Illinois Department of Insurance, and the Director had not rejected it. The Director's silence, said the court, is "entitled to great weight as against the contention that such a provision is against public policy." But the court overlooked the fact that the Director filed an amicus curiae brief in support of the Glenview Park District in National Union Fire Ins. Co. of Pittsburgh, Pa. v Glenview Park District, supra, 632 NE2d 1039 (Ill 1994). In his brief, the Director urged the Illinois Supreme Court to find that the National Union endorsement, which contained an exclusion identical to American Country's, was against public policy because it furnished illusory coverage. Just why the Director did not reject American Country's identical endorsement is a matter of speculation. "Bureaucratic snafu" is a phrase that readily comes to mind. But in light of the Director's brief in the Glenview Park District case, it seems patently unreasonable to infer consent from the Director's silence.

Great American v West Bend Mut.

Against this seemingly impregnable shield guarding the insurers is Great American Ins. Co. v West Bend Mut. Ins. Co., 723 NE2d 1174 (Ill App 2000). The opinion at first blush appears to furnish a road map around the exclusion for the additional insured's negligence, showing how it is at least possible that there could be coverage despite this exclusion. But close analysis shows that the decision is deeply flawed, because it totally misunderstands the concept of imputed, or vicarious, liability.

The Great American opinion did not explicitly analyze the exclusion for the negligence of the additional insured in the West Bend policy, but the opinion nonetheless should be a part of any analysis of this issue, because of its discussion of "imputed" liability. As we have seen, imputed (or "vicarious") liability is all that an endorsement with such an exclusion could possibly cover. Yet this opinion badly misdefines and misapplies the concept, so that additional insureds that take refuge in its holding are likely to find they have entered a trap from which they are unlikely to emerge.

This is what the Great American court said:

Liability for negligence may be imputed where the person to whom the negligence is imputed had a legal right to control the action of the person actually negligent. Negligence in the conduct of another will not be imputed to a party if he did not authorize such conduct, participate therein, or have the right or power to control it. [723 NE2d at 1177 (quotations and citations omitted).]

Right away, the question begs to be asked: Is it not negligent to authorize unsafe conduct, participate in it, or fail to control it? The answer, obviously, is "Yes." Thus, one who does these things is directly liable, not vicariously liable. His liability is not imputed to him.

It is important to keep in mind that one who is vicariously liable for the acts or omissions of another (or, put another way, one to whom liability is "imputed") is himself totally free of any negligent conduct. Rather, he is liable only because of his relationship to the one who committed the act or omission giving rise to liability to a third party. This is made clear by the definition in Black's Law Dictionary (6th ed.) of vicarious liability:

The imposition of liability on one person for the actionable conduct of another, based solely on a relationship between the two persons. Indirect or imputed legal responsibility for acts of another; for example, the liability of an employer for the acts of an employee, or a principal for torts and contracts of an agent. [Emphasis supplied.]

But if, on the other hand, the person who is liable was guilty of acts or omissions of his own, then his liability is not vicarious; it is direct, i.e., he is liable for his own acts and omissions, not someone else's. This is true even where his acts or omissions are passive, in comparison with the active fault of the one he failed to supervise or control, for example. This was the case with the general contractor in the Great American case. If that general contractor was guilty of authorizing, participating in, or failing to exercise the right or power to control unsafe work methods, then his liability is direct, not vicarious (or imputed), because he himself was negligent, even though that negligence is passive in comparison with the subcontractor's negligence.

That the general contractor's liability for authorizing, participating in, or failing to exercise control over his subcontractor would be direct liability, as opposed to vicarious or imputed, is made clear by a line of cases deciding whether the anti-indemnity statute voids an agreement requiring a subcontractor to indemnify a general contractor for the general contractor's Structural Work Act liability. The statute prohibits agreements in construction contracts that call for one party to indemnify another for the indemnified party's own negligence. In that line of cases, the general contractor (the party seeking indemnification) contended that the statute did not void the agreement, because liability under the Structural Work Act can be imputed, and thus, indemnification for imputed liability is not indemnification for one's own negligence. The courts rejected this contention, however, holding that though passive or merely technical, a general contractor's liability for failing to supervise his subcontractor is not imputed liability; it is direct. See, e.g., Pettie v Williams Bros. Constr., Inc., 589 NE2d 169, 174 (Ill App 1992) ("liability under the Structural Work Act only arises out of actual negligence and not vicariously"); accord, Lavelle v Dominick's Finer Foods, Inc., 592 NE2d 287 (Ill App 1992); Motor Vehicle Cas. Co. v GSF Energy, Inc., 549 NE2d 884 (Ill App 1989); Ryan v E.A.I. Constr. Corp., 511 NE2d 1244 (Ill App 1987); Cox v Lumbermens Mut. Cas. Co., 439 NE2d 126 (Ill App 1982).

In a negligence case, the principle is the same: even liability resulting from the general contractor's merely passive or technical negligence is nonetheless the general contractor's own negligence. In Jandrisits v Village of River Grove, 669 NE2d 1166 (Ill App 1996), the court rejected the indemnitee's contention that cases holding that Structural Work Act liability cannot be imputed are inapplicable to a negligence case. On the contrary, the court held, in a negligence case, one who employs an independent contractor can only be held liable for his own negligence, and therefore, any contract requiring the independent contractor to indemnify would violate the anti-indemnity statute. Because liability for one's own negligence is direct, not vicarious or imputed, it would therefore be excluded from an additional insured endorsement, such as West Bend's, that excludes the additional insured's own negligence.

The Great American court, in taking pains to refute the general contractor's assertion that liability under the Structural Work Act cannot be imputed, gave an example of how such liability can in fact be imputed:

If a corporation employs a foreman to take charge of construction, and the foreman violates the [Structural Work] Act, the corporation is liable, vicariously, for its employee's acts. Corporations, which necessarily act through their agents, are vicariously liable for their employees' violations of the Act, and those violations are imputed to the corporation. [723 NE2d at 1177.]

But that example involves liability being imputed from agent to principal, from employee to employer. In fact, agent-principal and employee-employer relationships are precisely the context in which vicarious liability arises, according to the definition in Black's cited above. But it is clear that the general contractor's relationship with the subcontractor is not agent-principal or employee-employer. Rather, the subcontractor is an independent contractor. And under section 409 of the Restatement (Second) of Torts, one cannot be vicariously liable for the acts or omissions of an independent contractor:

Except as stated in sections 410-429, the employer of an independent contractor is not liable for physical harm caused to another by an act or omission of the contractor or his servants.

Thus, the analysis given by the Great American court does not in any way establish that liability can be imputed from subcontractor to general contractor. The court made a fundamental error in overlooking the distinction between those relationships in which liability can be imputed (agent-principal and employee-employer) and those in which it cannot (general contractor-subcontractor), and in reasoning that liability under the Structural Work Act can be imputed, contrary to the holdings in Pettie v Williams Bros. Constr., Inc., 589 NE2d 169, 174 (Ill App 1992); Lavelle v Dominick's Finer Foods, Inc., 592 NE2d 287 (Ill App 1992); Motor Vehicle Cas. Co. v GSF Energy, Inc., 549 NE2d 884 (Ill App 1989); Ryan v E.A.I. Constr. Corp., 511 NE2d 1244 (Ill App 1987); and Cox v Lumbermens Mut. Cas. Co., 439 NE2d 126 (Ill App 1982).

National Union v R. Olson Constr. Contractors

The opinion in this brand new case, cited above, adds nothing to the discussion not already supplied by earlier cases. It is noteworthy, however, that this opinion does recognize, as Kraemer Bros. did, that a general contractor cannot be vicariously liable for the acts or omissions of a subcontractor. The court said:

There is no indication that Meyer was anything but an independent contractor, so Olson cannot be vicariously liable for the negligent acts of Meyer resulting in harm to Meyer's employee. [Slip op. at 5 (emphasis supplied.)]

Endorsements That Exclude the Additional Insured's Negligence Furnish Illusory Coverage

There is support outside Illinois for the assertion that an exclusion for the negligence of the additional insured renders the coverage illusory. In Bonner County v Panhandle Rodeo Assoc., 620 P2d 1102 (1980), the Idaho Supreme Court refused to enforce an exclusion in an additional insured endorsement for the additional insured's "sole negligence." The court held that to do so would "defeat the very purpose or object of the insurance." [620 P2d at 1106.] See also, Douglas R. Richmond & Darren S. Black, Expanding Liability Coverage: Insured Contracts and Additional Insureds, 44 Drake Law Review 781, 806 (1996) ("an endorsement that provides coverage only for the additional insured's vicarious liability may be illusory and provide no coverage at all").

Numerous other courts have recognized that the purpose of additional insured coverage is to furnish coverage for the additional insured's own, even his sole, negligence. See Marathon Ashland Pipeline LLC v Maryland Cas. Co., 243 F3d 1232, 1240 (10th Cir 2001) ("it is obvious that additional insureds expect more from an endorsement clause than mere protection from vicarious liability"); Shell Oil Co. v National Union Fire Ins. Co. of Pittsburgh, Pa., 44 Cal App 4th at 1643-44, 52 Cal Rptr 2d at 585-86 (Cal App 1996) ("restricting the CGL to indemnifiable claims, and thus excluding from it those involving Shell's sole negligence, would have left Shell unprotected for those claims for which it most needed insurance"); Freund v Utah Power & Light Co., 793 P2d 362 (Utah 1990) ("[o]ne reason, at least, why the licensor wanted to be an additional insured was to have coverage for its own negligence"); Chevron U.S.A., Inc. v Bragg Crane & Rigging Co., supra, 180 Cal App 3d 639, 644, 225 Cal Rptr 742, 745 (Cal App 1986) ("a fundamental purpose of insurance [is] to protect against liability for one's own negligence"). If an exclusion defeats the very purpose of such coverage, it renders that coverage illusory.

Other cases, outside the additional insured context, illustrate that courts will not hesitate to find coverage illusory where there is no tangible scenario in which the coverage would apply. See, e.g., Fidelity & Guaranty Ins. Underwriters, Inc. v Everett I. Brown Co., 25 F3d 484, 490 (7th Cir 1994) (Indiana law) (an insurance provision is considered illusory "if a premium was paid for coverage which would not pay benefits under any reasonably expected set of circumstances").

Indeed, coverage has been found illusory even where there are actual circumstances where coverage might conceivably apply, if the possibility of those circumstances coming into existence is too remote. For example, in the leading Illinois case, Glazewski v Allstate Ins. Co., 466 NE2d 1151 (Ill App 1984), aff'd. in relevant part sub nom. Glazewski v Cornet Ins. Co., 483 NE2d 1263 (Ill 1985), the court held that an insurer was guilty of fraud when it sold underinsured motorist coverage with limits equal to the minimum liability limits mandated by statute. The court reasoned that the coverage was virtually non-existent because the lowest liability limits another motorist could ever have would be the statutory minimum, yet the underinsured motorist limits were also the minimum; therefore, there could never be a claim.

The court acknowledged that the insured could get into an accident in a state with lower statutory minimum liability limits than Illinois, and that there were 16 states with lower limits. Thus, there would be actual coverage for accidents occurring in those states with minimally insured motorists. Nonetheless, the court found the coverage fraudulent, because it would never apply to accidents occurring in Illinois. Although Glazewski was not an illusory coverage case per se, it was recognized as the standard for determining illusory coverage in American Country Ins. Co. v Cline, supra, 722 NE2d 755, 763 (Ill App 1999) ("courts will not construe or enforce a policy in a way that renders the coverage provided of no value to the insured," citing Glazewski).

Conclusion

The time has come for Illinois courts to confront this issue squarely. General contractors can only be liable for their own negligence, and an additional insured endorsement that excludes the additional insured's own negligence covers nothing. It is therefore illusory. The judicial gymnastics employed by the Illinois Appellate Court in the last 10 years to avoid that simple conclusion have left confusion and injustice in their wake. If the Illinois Appellate Court will not reexamine this issue, the Illinois Supreme Court should take up the challenge of its late chief justice and hold these endorsements illusory. Courts outside Illinois would be well advised to avoid getting mired in the quicksand these decisions have produced.


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