Expert Commentary

What Is Subrogation, and Why Is My Contract Waiving It?

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.


Risk Financing Info
July 2021

* 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.

— Source: AIA Standard Form of Agreement between Owner and Architect, B101–2017, Article 8.1.2.

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.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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