Construction risk transfer is an inherently fluid process. It is a constant dance of identifying and refining goals and creating more precise trade contract and insurance policy language to most accurately match those goals. "Priority of coverage"—the debate over horizontal and vertical exhaustion where multiple policies are triggered—is one particular area that has been subject to close scrutiny in recent years, and it looks as though the next evolution of that discussion has arrived.
The goal of a traditional risk transfer scheme1 is for risk to be borne by those closest to the construction work who are best able to control the work and mitigate risk from the onset—most commonly downstream parties. More precisely, downstream parties' insurance is generally intended to provide cover before upstream insurance. Horizontal exhaustion case law upended those expectations, to a degree, by dictating that upstream parties' insurance be treated as co-primary. In response, contractors placed an increased emphasis on trade contract and insurance policy language, requiring that lower-tier contractors' insurance pay on a primary and noncontributory basis.
While this approach has become the standard, it has not always lead to consistency in results. Rather, aggressive case law in certain jurisdictions (e.g., New York) and inconsistency of middle-market insurance products often subvert this goal. And in certain scenarios, typical primary/noncontributory language can have too limited a reach—addressing the upstream/downstream obligations between only two entities (e.g., the general contractor and subcontractor). It does not always solve the priority problem when two different-tier entities owe additional insured coverage to a third party (e.g., the general contractor and the subcontractor both owing insurance to the owner/developer).
Ultimately, this often leaves upstream parties without the intended additional insured coverage and, because of stringent anti-indemnity laws, little in the way of viable recourse against the downstream party or its insurance.
Who's in Control?
Part of the problem involves control. Upstream parties have little ability to ensure that the insurance specifications in the trade contract will actually bear out in a downstream parties' insurance program. So part of the solution has to involve control. In addressing the interplay between various responding insurance policies, the most effective solutions come from making adjustments to those materials most directly governing the insurance obligations (the insurance policies, not the trade contract) over which the upstream has the ability to directly influence—namely, its own program.
That is where the horizontal exhaustion debate has lead today. In light of the routine failings, particularly as respects priority when insurance is owed to a third party such as the owner/developer, upstream risk managers and insurance professionals have begun developing alternative solutions that focus on their own program.
HDI-Gerling v. Zurich
One such endorsement was recently the subject of litigation in New York, with interesting results.
On April 16, 2015, a New York trial court issued HDI-Gerling Am. Ins. Co. v. Zurich Am. Ins. Co., 2015 N.Y. Misc. LEXIS 1851 (N.Y. Sup. Ct. 2015).2 This case involved a priority of coverage dispute between two insurers of downstream parties that each agreed to name the City of New York (the "City") as an additional insured, but with one notable exception: the parties competing over insurance priority were not in contractual privity with one another.
Thus far, this article has discussed the dynamic between parties that negotiate and contract with one another (or at least operate in the same contractual chain) regarding insurance priority. HDI-Gerling involves parties that separately contracted with the owner to provide the owner with additional insured coverage and the outcome when both of their corporate programs were implicated by a loss. The distinction is not inconsequential and highlights important considerations about the evolution of corporate risk transfer.
In HDI-Gerling, Skanska USA Civil Northeast and Siemens Corp. were each independently hired by the City to perform work on the construction of a water treatment facility in the Bronx, New York. Skanska and Siemens entered into separate contracts with the City. The contracts had identical insurance provisions, requiring that each party agree to procure commercial general liability (CGL) insurance and add the City as an additional insured under its insurance policy on a primary and noncontributory basis to the City's own insurance. Siemens purchased its policy from HDI-Gerling America Insurance (HGA), and Skanska purchased its policy from Zurich American Insurance. Skanska's policy included a unique manuscript endorsement designed to more precisely address the priority of coverage afforded to additional insureds (the "Skanska Endorsement"), as follows.
Section IV. Commercial General Liability Condition, 4. Other Insurance is amended per the following:
The following paragraph is added under a. Primary Insurance:
This insurance is primary insurance as respects our coverage to an additional insured person or organization, where the written contract or written agreement requires that this insurance be primary and non-contributory. In that event, we will not seek contribution from any other insurance policy available to the additional insured on which the additional insured person or organization is a Named Insured.
The following paragraph is added under b. Excess Insurance:
This insurance is excess over:
Any of the other insurance whether primary, excess, contingent or on any other basis, available to an additional insured, in which the additional insured on our policy is also covered as an additional insured by attachment of an endorsement to another policy providing coverage for the same "occurrence," claim or "suit." This provision does not apply to any policy in which the additional insured is a Named Insured on such other policy and where our policy is required by written contract or written agreement to provide coverage to the additional insured on a primary and non-contributory basis.
In short, the Skanska Endorsement provided that where an additional insured on the Zurich policy, such as the City, was also an additional insured on another policy, the Zurich policy would be excess to that other insurance policy. At the same time, the Skanska Endorsement made clear that the Zurich policy would be primary to the City's own insurance in order to satisfy Skanska's own contractual obligation to have its (Skanska's) insurance pay before the City's program. The HGA policy contained no primary/noncontributory language comparable to the Skanska Endorsement.
In the priority of coverage dispute, HGA argued that both the Zurich and HGA policies were co-primary and, therefore, were required to contribute to the loss on a pro-rata basis. Alternatively, Skanska and Zurich argued that, per the Skanska Endorsement, the Zurich policy was excess over any other additional insured coverage available to the City. The court agreed with Skanska.
Based on the Skanska Endorsement, the court found that the Zurich policy was excess over the HGA policy and that the HGA policy, by its own terms, required that it provide primary coverage without sharing with other insurance. The court also agreed that the Skanska Endorsement created an exception to co-primary insurance coverage for instances where the written contract required the insurance to be primary and noncontributory, as the contract between Skanska and the City did.
Though not a part of the court's discussion, it seems likely that the case would have resolved differently if Siemens used a comparable endorsement on its policy. In that situation, the "other insurance" clauses would cancel each other out and applicable common law would have the two programs share on a pro-rated basis.
Overall, there are a few key takeaways from the court's ruling. First, it reinforces that these types of modifications are becoming more prevalent in the market, and contractors who regularly confront additional insured issues should be planning accordingly. That may mean incorporating a similar measure into one's own program or understanding the impact when contracting with other entities already doing so and making appropriate adjustments. A word of caution on this point: simply adding this or comparable language to a program without consideration of the many resulting implications can be problematic. Careful consultation among risk management, the broker, and coverage counsel is critical to ensuring appropriate application.
Second, creative problem solving actually works! In this situation, the manuscript endorsement at issue represents an effort to craft new insurance policy language to address a concern and better reflect the risk transfer intent of the parties. And the court interpreted the language exactly as intended.3
The author would like to acknowledge and thank coauthor H. Scott Williams, Esq. for his contributions to this commentary.
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.
1 Where indemnity and insurance requirements emanate from a series of contracts between the owner/developer on the one hand and contractors of various tiers on the other.
2 This decision is on appeal to the New York Supreme Court Appellate Division First Department under the caption HDI-Gerling America Insurance Company and the City of New York v. Zurich American Insurance Co., Slattery USA Civil Northeast, Inc, Slatterly Skanska Inc. et al., Index No. 158475/13.
3 Of note, SDV lawyer Jeremiah M. Welch, working with Skanska's broker Aon, crafted the Skanska Endorsement, and litigated the ensuing coverage dispute with assistance from SDV's H. Scott Williams (co-author of this article).