Anytime you sign a contract, you should understand the consequences of each
clause in the agreement. This may sound like simple common sense, but do you
really understand the standard waiver of subrogation provision contained in
most form agreements, why it is there, and how it helps you manage the risk of
your business? This article will help clear up some of the confusion.
* This article is an update and expansion of an IRMI.com article by Kenneth
A. Slavens by Veronica Bates, JD, CRIS, senior research analyst at IRMI.
What Is Subrogation?
Subrogation means, in a legal sense, one party has the right to "step
into the shoes" of another party to bring a claim for damages against a
negligent third party. Subrogation claims are commonly brought by an insurer
against a responsible third party to recover payments that the insurer has
already paid to its insured under the policy. Even though the insurer's
legal right of subrogation generally arises automatically after payment of a
claim, most insurance policies contain a standard subrogation clause. These
clauses generally do not use the actual word "subrogation" but rather
are identified by the use of phrases such as "Transfer of Rights to
Recovery." The insurer "steps into the shoes" of the
policyholder—meaning that it has the same rights as the policyholder to seek
recovery against another party—since the policy's subrogation clause
effectively transfers those rights from the policyholder to the insurer. Most
subrogation clauses also prohibit a policyholder from taking certain actions
that would impair the insurer's right of subrogation. However, not all
types of claims may be subrogated, and subrogation laws vary from state to
state. One of the most common types of claims that can be subrogated is
property damage claims.
For example, if you are involved in an auto accident where no one is
injured, but the vehicles are damaged, and you are free of fault, your insurer
will pay to have your vehicle damage repaired. If your insurer pays for the
"property damage" to your vehicle, in most states, your insurer then
becomes "subrogated" to your rights for you to recover the costs of
that property damage. In other words, your insurer can "step into your
shoes" and make a claim against the other driver that caused the damage
for which your insurer had to pay the repair cost. If the other driver does not
voluntarily pay for the damage, your insurer may even bring a lawsuit against
the other driver. By "stepping into your shoes," your insurer may
bring that lawsuit in your name—just as if you were bringing the suit yourself.
Of course, the insurer would pay for all costs of the subrogation suit.
Sample Subrogation Clauses in Insurance Policies
The following is an example of a subrogation clause in
a personal auto policy.
10. Recoveries
a. When "we" make
a payment under this policy and the person or entity to whom or on whose
behalf "we" make payment has a right to recover damages from
another source, "we" may require that such right of recovery be
assigned to "us", up to the amount "we" pay. That
person or entity must:
1) do whatever is required
to enable "us" to exercise "our" rights; and
2) do nothing after the
loss to impair "our" right to recover against others….
PA 0001 07 16 American Association of Insurance
Services, Inc., 2016.
The standard CGL policy contains the following
subrogation clause.
8. Transfer Of Rights Of
Recovery Against Others To Us
If the insured has rights
to recover all or part of any payment we have made under this Coverage
Part, those rights are transferred to us. The insured must do nothing after
loss to impair them. At our request, the insured will bring
"suit" or transfer those rights to us and help us enforce
them.
CG 00 01 04 13 Insurance Services Office, Inc.,
2012
Clearly, the right of subrogation is important to insurers as it allows them
to recoup millions of dollars from responsible third parties. However, it is
common for contracting parties to request that the terms of the contract
include what is called a "waiver of subrogation" clause. This type of
clause simply states that the parties will waive any rights against one another
in connection with certain damages that may arise from work performed under the
contract. Such a clause has the effect of overriding the ability of the parties
(and their insurers) to subrogate for any payments. A waiver of subrogation
clause is placed in a contract to minimize lawsuits and claims among the
parties. The result is that the risk of loss is agreed among the parties to lie
with the insurers, and the cost of the insurance coverage is contractually
allocated among the parties as they may agree. The risk, once assigned to the
insurers by the parties, is determined to stop there, without allowing the
insurer to seek redress from the party "at fault."
In the professional services setting, the clause usually provides that the
owner and design professional waive all rights against each other and against
others for damages covered by any property insurance in place during
construction. To ensure the effectiveness of the waiver of subrogation clause,
the owner and design professional generally require the same type of waivers
from the contractors, other consultants, and agents. Most form contract
documents assign the responsibility for procuring the applicable insurance, for
demonstrating the coverage is in place (e.g., certificates of insurance), and
for the cost.
Example of a Contractual Waiver of Subrogation Provision
The most commonly used "family" of form documents for
architects is that promulgated by the American Institute of Architects
(AIA). Contained therein is the following waiver of subrogation clause:
To the extent damages are covered by property
insurance, the Owner and Architect waive all rights against each other and
against the contractors, consultants, agents, and employees of the other
for damages, except such rights as they may have to the proceeds of such
insurance as set forth in AIA Document A201–2017, General Conditions of the
Contract for Construction. The Owner or the Architect, as appropriate,
shall require of the contractors, consultants, agents, and employees of any
of them, similar waivers in favor of the other parties enumerated
herein.
The waiver is intended to minimize the potential for lawsuits, cross-suits,
and countersuits arising from damages or injuries that may occur during the
project. An effective waiver will prevent the various insurers involved from
suing the parties to the construction contracts. One reason to use the
available industry form contracts is that the entire network of the waiver of
subrogation provisions has already been thought through, drafted, put in place
and ready to use, and tested in many courts.
When insurance is involved, as it almost always is, the parties must ensure
that the insurance policies allow for a waiver of subrogation. If the insured
misses this critical step, they may risk violating policy terms that strictly
forbid a policyholder from impairing an insurer's right of subrogation.
Typically, the waiver of subrogation clause in the contract speaks to the
insurance requirements and the need to ensure that the policy allows a waiver
of subrogation. While some policy forms contain language allowing for a waiver
of subrogation, many times this waiver is accomplished by attaching a waiver of
subrogation endorsement.
Examples of Waiver of Subrogation Clauses in Insurance
Policies
Although the commercial general liability (CGL)
insurance policy form implicitly allows for wavier of subrogation pre-loss,
it is common, at least in the construction industry, for such policies to
also contain an endorsement that explicitly allows for a waiver of
subrogation.
The following is added to
Paragraph 8. Transfer of Rights of Recovery Against Others To Us of Section
IV—Conditions:
We waive any right of
recovery against the person(s) or organization(s) shown in the Schedule
above because of payments we make under this Coverage Part. Such waiver by
us applies only to the extent that the insured has waived its right of
recovery against such person(s) or organization(s) prior to loss. This
endorsement applies only to the person(s) or organization(s) shown in the
Schedule above.
— Source: CG 24 04 12 19, Insurance Services Office,
Inc., 2018
The following is an example of a professional
liability policy that explicitly allows for waiver of subrogation so long
as such waiver is effective prior to the date of the "wrongful
act."
Section X. SUBROGATION does
not apply if the Insured, prior to the date a Wrongful Act is committed,
has waived its right of recovery for Damages that result from such Wrongful
Act.
— Source: Travelers Insurance Company, Design
Professionals Liability Coverage, PTC-1001 Ed. 11–08.
"Waiver of subrogation" endorsements are not available in personal
lines policies. So, in our personal auto accident example, the insurer is free
to subrogate against the negligent driver. However, waiving subrogation rights
is common in commercial and professional lines. For example, in contracts with
an enforceable "waiver of subrogation" agreement at the time of your
loss, even though the insurer for the innocent party must pay for the
loss, that insurer would not be allowed to seek damages from the party "at
fault." The reason is that the parties had agreed to waive the right of
subrogation, and the insurer's rights can be no greater than the
insured's rights. Of course, this assumes that the terms of the policy
allowed the insured to waive these rights in the first place. If not, then the
insurer may be relieved of any responsibility under the policy as illustrated
in the case below.
Does the clause have real-world application, or does it mainly exist in the
tangled netherworld of insurance? The answer is both. Not all subrogation
claims involve insurance. For example, when a guarantor of a loan is forced to
pay that loan, the guarantor is subrogated to the lender's claim against
the defaulting party. However, since the right of subrogation is prolific in
the insurance world, and since waiver of subrogation is commonplace among
certain contracting parties, subrogation claims commonly involve insurance.
Therefore, it is critical for all parties and insurers to understand their
respective duties and obligations. For example, an insurer may be left
"holding the bag" if its insured has agreed to waive subrogation.
Such was the case of Sentry Ins. v. Stanley Convergent Sec. Sols.,
Inc., No. 5:20-cv-8-Oc-30PRL, 2020 U.S. Dist. LEXIS 92900 (M.D. Fla. May
12, 2020).
In that case, Stihl contracted with SCSS to provide security monitoring of
its business facility. Per the terms of the agreement, SCSS was to notify
Stihl, its emergency contact list, or the local police if a security alarm was
tripped. On September 19, 2018, the facility was broken into, and almost $1
million worth of inventory and equipment was stolen. SCSS failed to notify
anyone of the alarm as required by the contract. Sentry Insurance paid its
insured, Stihl, for the loss of inventory and equipment, and thereafter
attempted to subrogate against SCSS, the negligent party. However, the contract
between Stihl and SCSS contained a waiver of subrogation clause. The court
recognized that, under New York law, as is the case in many states, an
effective waiver of subrogation in a contract is a total defense of all claims.
The court ruled that it was irrelevant that Sentry did not agree to the waiver
of subrogation or that it did not give approval of it. As a result, Sentry
could not pursue SCSS for the almost $1 million payment. The case did not
address whether Sentry may have had a claim against its insured, Stihl, for
impairing Sentry's subrogation rights.
On the other hand, an insured may be left "holding the bag" if it
breaches the policy terms and impairs the insurer's subrogation rights. See
Consol. Ins. Co. v. National Water Servs. LLC, 994 N.E.2d 1192 (Ind.
Ct. App. 2013). In this case, NWS obtained an employee dishonesty policy from
CIC that contained a subrogation clause transferring all of NWS's rights to
CIC and requiring NWS to "do everything necessary to secure those rights
and do nothing after loss to impair them." NWS filed suit against Arnold,
one of its employees, for wrongful acts that allegedly cost NWS $497,500. NWS
settled that suit with Arnold for $30,000 and released him from any further
action. NWS then sought to recover the entire $497,500 from its insurer, CIC.
CIC asserted that NWS was not entitled to coverage for its losses since it
released Arnold, the liable third party, which effectively destroyed CIC's
subrogation rights. The court agreed and held that, because NWS breached the
terms of the policy by impairing CIC's right of subrogation, CIC did not
owe any coverage for this loss. Had NWS obtained a waiver of subrogation from
its insurer prior to the loss, coverage would still be intact.
The lesson for the contracting parties is to ensure that all related
contracts and insurance policies be carefully reviewed to confirm that the
parties' intent with regard to subrogation and any waiver of subrogation is
clearly aligned in all of these documents.
Conclusion
Subrogation is an odd name for a rather simple concept. When party A
(usually an insurer) pays money to party B (the insured) because of something
Party C did or did not do, then party A is entitled to recover the money it
paid from party C. This recovery usually requires the insurer to institute a
subrogation lawsuit. A waiver of subrogation may allow you to avoid becoming
engaged in the complexities of lawsuits and insurance claims while managing the
risk and associated expenses.
As the cases illustrate, if the parties choose to waive any subrogation
rights, it is imperative to review any potentially applicable insurance
policies to determine whether such a waiver is permissible. If those policies
do not contain language that allows for waivers of subrogation, then an
impairment to the insurer's subrogation rights may relieve that insurer of
any responsibility under the policy. Of course, the law of the state with
regard to the enforceability of waivers of subrogation must also be considered.
If done effectively, though, a waiver of subrogation clause can certainly save
the contracting parties from lengthy and expensive litigation.