A recent New Jersey appellate decision highlights an important concept that
parties often get wrong—while indemnification and insurance are both critical
risk transfer tools, they should not be conflated.
Each tool provides a separate, independent basis for allocating risk, and
parties should pay careful attention to both the indemnity and insurance
language in their contracts to ensure that they are not assuming more risk than
they intend.
The Gateway Park Decision
In Gateway Park, LLC v. Travelers Ins. Co., 2020 N.J. Super. Unpub.
LEXIS 785 (N.J. Super. Ct. App. Div. Apr. 29, 2020), an employee of a
commercial tenant ("Tenant") fell on ice in the parking lot adjacent
to the Tenant's building on her way into work. She subsequently sued the
building's landlord, plaintiff Gateway Park, LLC ("Landlord").
Landlord tendered the claim to Tenant's insurer for defense and indemnity
as an additional insured under Tenant's commercial general liability (CGL)
policy. The insurer denied coverage and Landlord filed suit seeking a
declaration that it was covered under the policy.
The lease agreement between Landlord and the policyholder required the
defendant to include Landlord "as [an] additional insured, against all
liability for injury to or death of a person or persons ... arising from the
use and occupancy of the Premises." Id. at *3. Tenant's CGL
policy included an additional insured endorsement, which provided coverage for
"[a]ny ... premises owner, manager or lessor ... that you have agreed in a
written contract or agreement to name as an additional insured," "but
only with respect to liability for 'bodily injury' ... that ...
[a]rises out of the ownership, maintenance or use of that part of any premises
leased to [Tenant]."
Landlord argued that it was entitled to coverage under the plain language of
the additional insured endorsement because Tenant had agreed to include
Landlord as an additional insured in the lease agreement and the claim arose
out of Tenant's use of the premises, as the plaintiff was on her way into
work in the building when she was injured.
The trial court initially held that Landlord was entitled to additional
insured coverage. The court later reversed itself, however, holding that
Landlord was not an additional insured. The trial court based its reversal on
the indemnification provision of the lease agreement, which provided that
Tenant was to indemnify the Landlord but only for claims caused by the
Tenant's negligence or willful misconduct. The trial court reasoned that
"it was outside of the reasonable expectations of the lease contract
between the parties that ... [Tenant] would be required to indemnify [Landlord]
for [Landlord's] negligence," and thus, Landlord "should not be
entitled to ... additional insured coverage" under Tenant's CGL
policy.
On appeal, the New Jersey Appellate Division reversed, finding that
Landlord's entitlement to additional insured coverage was based on the
language of the policy, not the lease agreement. Id. at 16.
("[T]he [trial] court erred by failing to give effect to the policy's
plain language, and by incorrectly relying on the lease to define the coverage
under the policy.") Landlord was an additional insured because the two
requirements of the additional insured endorsement in the policy—that the lease
agreement require it to be an additional insured and that the liability arises
out of the named insured's use of the premises—were met. Id. at
15.
Indemnity versus Additional Insured Coverage
The mistake made by the trial court—conflating the scope of additional
insured coverage with the scope of the parties' indemnification
obligations—is a common one, particularly in the construction industry.
Indemnification and additional insured coverage are both risk transfer
mechanisms; however, there are times when the parties to a contract do not
intend for the scope of indemnity and the scope of additional insured coverage
to be coextensive.
For example, in the construction context, it might make sense for the
parties to maybe agree on a more limited scope of indemnity (i.e., the
downstream contractor only agrees to indemnify the upstream contractor or owner
for its vicarious liability) because the downstream contractor may not have the
financial wherewithal to absorb liability for losses caused by its own
negligence and the negligence of the upstream party but can afford to provide
that protection in the form of insurance. As a result, the parties may intend
for the scope of additional insured coverage to be broader than the scope of
indemnity in order to transfer as much risk as possible to the downstream
contractor's insurer. This risk transfer arrangement is reflected in the
anti-indemnity statutes of many states, which prohibit contractors or
subcontractors from agreeing to indemnify an upstream party for that
party's own negligence but will permit an agreement to provide additional
insured coverage for the upstream party's own negligence.
Other times, however, the parties may intend for the scope of additional
insured coverage to be coextensive with the scope of indemnification. Indeed,
there are a number of reasons why a downstream contractor that limits its
indemnification obligation to claims caused by its negligence may not want to
provide broader additional insured coverage to the upstream party. For example,
providing broader additional insured coverage could draw down the downstream
contractor's limits, which are required for other projects. Moreover, if
the scope of additional insured coverage is broader than the scope of
indemnity, a policyholder with a large deductible or fronting policy could end
up paying for the additional insured's own negligence, effectively negating
the effect of a more limited indemnity obligation.
Limiting Additional Insured Coverage to the Scope of Indemnity
So, what does a downstream party do if it does not want to provide broader
additional insured coverage than the indemnity obligation it has assumed in its
contracts? As Gateway Park teaches, to determine the scope of
additional insured coverage, you must look to the language of the policy,
specifically, the additional insured endorsement. Thus, the first step is to
ensure you are using the correct additional insured endorsement.
Early versions of standard Insurance Services Office, Inc. (ISO), additional
insured endorsements generally provided the additional insured coverage for
liability "arising out of" the named insured's work (e.g., CG 20
10 11 85; CG 20 10 10 01; CG 20 37 10 01). Many courts construed the phrase
"arising out of" broadly such that the additional insured was
afforded coverage for its own negligence, even its sole negligence. See,
e.g., McIntosh v. Scottsdale Ins. Co., 992 F.2d 251 (10th Cir.
1993); Admiral Ins. Co. v. Trident NGL, Inc., 988 S.W.2d 451 (Tex. Ct.
App. 1999).
Later ISO additional insured endorsement versions replaced "arising out
of" with "caused, in whole or in part, by" (e.g., CG 20 10 07
04; CG 20 37 07 04) with the intention of narrowing the scope of coverage
afforded to additional insureds. A majority of courts have construed
"caused, in whole or in part, by" to provide coverage for the
additional insured's own negligence, so long as the named insured was at
least partially at fault. See, e.g., Capital City Real Estate, LLC v.
Certain Underwriters at Lloyd's London, 788 F.3d 375 (4th Cir. 2015);
Gilbane Bldg. Co. v. Admiral Ins. Co., 664 F.3d 589 (5th Cir. 2011).
None of these endorsements, however, incorporate the terms of the underlying
contract; as such, the additional insured coverage they convey will not
necessarily align with the agreed-upon risk transfer in the underlying
contract.
In 2013, however, ISO released new additional insured endorsements that
expressly incorporated certain limitations to additional insured coverage
contained in the underlying contract (e.g., CG 20 10 04 13; CG 20 37
04 13). Among other things, these endorsements provide that "[i]f coverage
provided to the additional insured is required by a contract or agreement, the
insurance afforded to such additional insured will not be broader than that
which you are required by the contract or agreement to provide to such
additional insured." The 2019 ISO additional insured endorsements retain
this language. Accordingly, these endorsements should incorporate any
limitations to the scope of additional insured coverage contained in the
underlying contract.
Notably, however, while these endorsements reference limitations on the
scope of additional insured coverage in the underlying contract, they do not
reference the indemnity provisions of the underlying contract. Thus, if the
goal is to align the scope of additional insured coverage with the scope of
indemnity, it is not enough to simply use a 2013 or 2019 ISO additional insured
endorsement. The underlying contract will have to include language in the
insurance requirements that limit the scope of additional insured coverage
to the scope of indemnity assumed in the contract.
Unfortunately, the insurance requirements of contracts, particularly in the
construction industry, are often overlooked and misunderstood. As a result,
many downstream parties find themselves providing a far broader scope of
additional insured coverage than they intended. If the goal, however, is to
provide additional insured coverage that is no broader than the scope of
indemnity in the underlying contract, then it is critical to use the correct
additional insured endorsement and give careful consideration to the language
in the insurance requirements of the contract.