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By Verne A. Pedro, Special Counsel, Goldberg Segalla LLP
Injured visitors, faulty construction, mold, critters, fire, natural disasters-businesses face substantial risks from a host of potentially devastating unforeseen events. Does your company have adequate insurance coverage to handle potential exposures associated with these risks?
In this difficult economy, it is more important than ever for businesses to focus on minimizing risk and maximizing coverage. This article discusses a number of critical insurance concepts, outlines various types of policies and coverage, and highlights predominant issues facing business owners and their counsel today. The article also provides an overview of risk-transfer issues and practical considerations for managing potential liability.
KNOW YOUR INSURANCE PROGRAM
Generally, business insurance can be categorized as first-party or third-party insurance. There are significant differences between first-party property policies and third-party liability policies. Because different risks are at issue under each type of coverage, different principles apply to determine whether coverage is triggered, as well as the scope and extent of coverage.
Commercial property insurance is considered first-party coverage-i.e., it provides financial protection against loss caused by direct physical loss or damage to the policyholder's property. Physical damage to property generally means a distinct, demonstrable, and physical alteration of the structure of covered property.
Commercial property insurance generally is offered in the form of either an "all-risk" policy or a "named-perils" policy.
Under a standard all-risk policy, the claimis covered and recovery is allowed for all losses caused by any fortuitous peril not specifically excluded under the policy. See Murray v. State Farm Fire and Cas. Co., 203 W. Va. 477, 509 S.E.2d 1, 7 (W. Va. 1998). All-risks policies may, however, exclude certain perils. See Northwest Bedding Co. v. Natl. Fire Ins. Co. Of Hartford, 225 P.3d 484 (Wash. App. 2010).
Fortuity is required, which means that the loss must be accidental in some sense in order to be the valid subject of an insurance contract.
A named-perils policy (or provision) only protects against specific, enumerated perils. See French v. Allstate Indem. Co., 637 F.3d 571, 590 (5th Cir. 2011). Generally speaking, the coverage provided by a named-perils policy is narrower than that provided by an all-risks policy. See Phillips v. Natl. Sec. Fire & Cas. Co., 59 So. 3d 711, 715 (Ala. Civ. App. 2010).
All-risk coverage and named-peril coverage may be combined in a single policy. For instance, physical damage to a structure may be covered under a broad all-risk coverage form, while coverage for damage to its contents may be covered only if damaged by an enumerated cause. See Kodrin v. State Farm Fire & Cas. Co., 314 Fed Appx. 671, 677 (5th Cir. 2009). This is significant because the insurer has the burden of proof to show that damage under an all-risk policy is excluded. Id. However, when insurance is provided under a named-perils policy or provision, the policyholder has the initial burden to prove that the loss occurred by a specific named peril. French, 637 F.3d at 590.
Of course, multi-peril policies or endorsements are available to provide specific additional coverage beyond the scope of coverage provided under standard policy forms.
Business Interruption (BI) Coverage
BI coverage is a standard component of commercial property insurance and is intended to indemnify the policyholder against losses arising from the inability to continue normal operations due to damage caused by an insured risk. See Howard Stores Corp. v. Foremost Ins. Co., 82 A.D.2d 398, 400-01 (1st Dept. 1981). The policyholder has the burden of establishing both the loss from business interruption and the damage from a covered risk under the policy. Actual physical loss is required before BI coverage is triggered. In most jurisdictions, a complete cessation of business is required before coverage is triggered under a business income provision. See Home Indem. Co. v. Hyplains Beef, L.C., 893 F. Supp. 987, 991-92 (D. Kan. 1995). Calculations of BI losses are estimated on experience of the business before the catastrophe and its probable experience afterwards.
Contingent Business Interruption (CBI) Insurance
Businesses that rely on third parties sometimes purchase CBI coverage as a policy extension in case their income is disrupted by damage to third-party property. See Zurich v. ABM Indus., 397 F.3d 158, 168 (2d Cir. 2005). CBI coverage protects against events that prevent entities from supplying goods to, or receiving goods from, the policyholder. These provisions typically provide coverage to enumerated dependent properties and entities, such as those who supply materials for the policyholder, purchase the policyholder's goods or services, or attract customers to the policyholder's business. Id.
In order to obtain coverage under a first-party insurance policy, the policyholder must show that the loss was caused by direct physical loss resulting from a covered peril (in a named-perils policy) or that it did not result from an excluded peril (in an all-risk policy).
A covered peril and an excluded peril can combine to cause a covered loss, such as water and wind damage during a hurricane. In such cases, courts typically apply the efficient proximate cause rule-meaning that the insured is entitled to coverage only if the covered peril is the predominant cause of the loss or damage. See Shelter Mut. Ins. Co. v. Maples, 309 F.3d 1068, 1070-71 (8th Cir. 2002); Album Realty Corp. v. Am. Home Assur. 80 N.Y.2d 1008 (1992).
The efficient proximate cause doctrine, or concurrent causation doctrine, holds that when there are two or more causes of loss, the policyholder's claim is covered as long as the immediate or proximate cause of loss is covered by the policy.
Efficient proximate cause refers to the first event that sets other events in motion. See Safeco Ins. Co. of Am. v. Hirschmann, 112 Wn.2d 621, 773 P.2d 413, 416-17 (Wash. 1989) ("When an insured risk sets into operation a chain of causation in which the last step may be an excluded risk, the exclusion will not defeat recovery."); Kula v. State Farm Fire & Cas. Co., 212 A.D.2d 16, 628 N.Y.S.2d 988, 991 (N.Y. App. Div. 1995).
Only the most direct and obvious (efficient) cause is considered for purposes of an exclusionary clause. Kula, 628 N.Y.S.2d at 991. When the court interprets an insurance policy excluding from coverage any injuries caused by a certain class of conditions, the causation inquiry stops at the efficient physical cause of the loss; it does not trace events back to their metaphysical beginnings. See Kimmins Indus. Serv. Corp. v. Reliance Ins. Co., 19 F.3d 78, 81 (2d Cir. 1994) (internal citations and selected quotation marks omitted). Accordingly, courts will not overlook unambiguous policy language in favor of applying the efficient proximate cause to excluded claims. See Rolyn Cos. v. R&J Salews of Tex., Inc., 671 F. Supp. 2d 1314, 1332-33 (S.D. Fla. 2009) (enforcing mold exclusion over policyholder's argument that cause of property damage was water intrusion, not mold); Hawkesworth v. Nationwide Mut. Ins. Co., 2011 U.S. Dist. LEXIS 66016 at *21-22 (D. Maine 2011) (explaining that Maine has not adopted efficient proximate cause doctrine and holding that mold exclusion applied to preclude coverage for damage claims in any event).
In some jurisdictions, the acts of third parties may not necessarily constitute an independent peril that would justify cov erage under the efficient proximate cause rule. See Gillin v. Univ. Underwriters Ins. Co., 2011 U.S. Dist. LEXIS 21842 at *18-19 (E.D. Pa. 2011). Other courts have applied the rule to negligence caused by third parties. See DeBruyn v. Farmers Group, Inc., 158 Cal. App 4th 1213, 1218-20 (Cal. App. 2008).
Some policies contain anti-concurrent cause provisions, which may pre-empt the proximate cause analysis. These policies generally provide: "We will not pay for loss or damage caused directly or indirectly by any of the following... Such loss or damage is excluded regardless of any other cause or event that constitutes concurrently or in any sequence to the loss." Courts have held that these provisions will bar coverage when a loss is a caused or contributed to by a non-covered loss. See ABI Asset Corp. v. Twin City Fire Ins. Co., 1997 U.S. Dist. LEXIS 18265 at *2 (S.D.N.Y. 1997) (granting summary judgment in favor of insurer based on anti-concurrent cause language).
When Did the Damage Occur?
To answer this question-and to determine which policy must respond when more than one policy is involved-courts apply different theories of coverage, including the manifestation theory, the injury-in- fact theory, the continuous trigger theory, and the exposure theory. The overarching issue is whether physical damage occurred during the applicable policy period.
The determination of when coverage for a loss is triggered by an event should not be made without initial analysis of the policy language, as the policy expresses the parties' mutual intent and its language determines the operative conditions upon which the insurer's obligation to indemnify the insured is based. The application of the appropriate theory of the trigger of coverage also depends upon the specific policy language of the particular policy at issue, as the various trigger theories developed by the courts are themselves direct outgrowths of the interpretation of relevant terms used in policies, such as "occurrence." See Mangerchine v. Reaves, 2011 La. App. LEXIS 354 at *11-13 (La. App. 2011).
Some courts apply the manifestation trigger under first-party policies, which means that the insurer on the risk at the time that damage manifests itself is the only insurer obligated to pay a covered claim. See, e.g., Winding Hills Condo. Assn. v. N. Am. Specialty Ins. Co., 332 N.J. Super. 85 (App. Div. 2000). Coverage is not determined by when the alleged negligence occurred or the moment that the resulting injury or damage first occurred. Rather, courts have held that the "manifestation" of the "occurrence" of property damage is the time that such damage was discernable and reasonably discoverable either because it was open and obvious or upon a prudent engineering investigation, and not the time of actual discovery where the two circumstances come about in sequence at different times.
In applying the manifestation trigger, courts have rejected application of the continuous trigger. Moreover, it is widely accepted that damage does not occur upon installation. See Alliance Mutual Insurance Company v. Guilford Ins. Co., 2011 N.C. App. LEXIS 473 at *101-12 (N.C. Ct. App. 2011) (holding that improper installation of water supply line is not an "occurrence" for purposes of determining which of two policies is triggered by flood damage).
Under the "injury-in-fact" theory, the policy triggered is the one on the risk when the actual damage to property takes place, as a matter of scientific fact, regardless of when the property was exposed to the incident or condition that caused the damage. See American Home Products Corp. v. Liberty Mut. Ins. Co., 748 F.2d 760, 765, 1984 U.S. App. LEXIS 16755 (2d Cir. 1984). This rule applies regardless of when the damage was actually discovered or manifested itself. Id.
The continuous-trigger rule, commonly associated with asbestos-related injuries, environmental cases and mass torts, provides that when progressive indivisible injury or damage results from exposure to injurious conditions, courts may reasonably treat the progressive injury or damage as an occurrence within each of the years of a commercial general liability (CGL) policy. See Polarome Intl., Inc. v. Greenwich Ins. Co., 404 N.J. Super. 241, 262-63 (App. Div. 2008); Keene v. Ins. Co. of North America, 667 F.2d 1034, 1047, 1981 U.S. App. LEXIS 17234 (D.C. Cir. 1981).
Some courts apply a modified continuous trigger in a case of progressive property damage, such as in construction defect cases, holding that coverage is triggered at the time of an injury-in-fact and continuously thereafter to allow coverage under all policies in effect from the time of injury-in-fact during the progressive damage. See Builders Mut. Ins. Co. v. Wingard Props., 2010 U.S. Dist. LEXIS 104087 at*20-21 (D.S.C. 2010). The justification for this theory is that it allows the allocation of risk among insurers when more than one insurance policy is in effect during the progressive damage. Builders Mut., 2010 U.S. Dist.LEXIS 104087 at *20.
Under the exposure theory, coverage is triggered when the property is exposed to the harmful conditions during the policy period. See Mangerchine, 2011 La. App. LEXIS 354 at *12.
General liability policies are occurrence-based and are primarily designed to protect the insured business owner from liability to third parties (a non-party to the insurance contract) for claims involving bodily injury and property damage. These types of policies cover a wide range of business liability. However, note that contractual claims and claims of faulty workmanship do not constitute an "occurrence" and will not trigger coverage under a CGL policy, because those risks do not constitute an accident or continuous or repeated exposure to a harmful condition. See George A. Fuller Co. v. United States Fid. & Guar. Co., 200 AD2d 255, 613 N.Y.S.2d 152 (1st Dept. 1994).
Under the terms of the policy, primary coverage attaches immediately upon the occurrence of a loss or an event giving rise to liability.
Excess insurance is secondary coverage that provides coverage only upon the exhaustion of underlying primary insurance and it does not broaden the underlying coverage. An excess insurer has no duty to defend unless the underlying primary insurance is exhausted, absent policy language to the contrary.
In addition to primary and excess insurance coverage, a business may obtain umbrella liability insurance. An umbrella policy serves two functions: (a) to provide for a higher limit of liability for those losses typically covered by primary coverage; and (b) to eliminate gaps in coverage by insuring against a claim that may not be covered under the primary policies. The first scenario is typically referred to as vertical coverage and the latter as horizontal. See Am. Special Risk Ins. Co. v. A-Best Prods., Inc., 975 F. Supp. 1022 (N.D. Ohio 1997).
Unlike most excess policies, umbrella policies may also provide broader coverage than the underlying insurance to fill gaps in coverage left open by the primary coverage, in addition to increasing the total possible recovery available to the insured, so as to provide "primary" coverage for claims not covered by the underlying policy. The specific policy language will control whether the policy affords additional coverage or coverage that differs from the primary coverage.
An "umbrella" policy is on top of other coverage and is "excess" in the sense that it is usually over "any type of primary coverage, excess provisions arising in any manner, or escape clauses." Continental Ins. Co. v. Lexington Ins. Co., 55 Cal. App. 4th 637, 647, 64 Cal. Rptr. 2d 116 (1997).
Directors' and Officers'/Professional Liability
Directors' and officers' (D&O) policies generally provide coverage (defense and indemnity) to the directors and officers of a company, or to the insured organization itself, for damages and defense costs stemming from losses resulting from any actual or alleged error or wrongful acts committed by the policyholders in their capacity as directors or officers (D&Os). Coverage is written on a "claims made" basis, meaning that coverage is effective when a claim alleging a "wrongful act" is first made against a D&O and notice is provided to the insurance company during the policy period.
Professional liability policies similarly afford coverage on a "claims made" basis for "wrongful acts" arising out of the rendering of professional services.
PRINCIPLES OF INSURANCE POLICY INTERPRETATION
Basic Rules of Contract Interpretation Apply
Most courts adhere to the rule that when an insurance policy is clear and unambiguous, the language of the policy controls-and courts are bound to enforce the express terms as they are written. See, e.g., Gaston Cty. Dyeing Machine Co. v. Northfield Ins. Co., et al., 351 N.C. 293, 299 (N.C. 2000); Hansen v. United Servs. Auto Assoc., 350 S.C. 62 (S.C. Ct. App. 2002); Bank of the West v. Superior Court, 2 Cal. 4th 1254, 1264, 10Cal. Rptr. 2d 538, 833 P.2d 545 (1992).
In addition, courts have uniformly recognized that an insurance policy is to be interpreted according to its plain and ordinary meaning, and the clear intent of policy provisions cannot be disregarded. See Dawes v. Nash Cty., 357 N.C. 442, 448- 49 (2003); Liberty Mut. Fire Ins. Co. v. J.T. Walker Industries, Inc., 2010 U.S. Dist LEXIS 30690 at * 7-8 (D.S.C. 2010).
Policies should be construed liberally in the policyholder's favor so that coverage is afforded to the full extent that any fair interpretation will allow. See Polarome, 404 N.J. Super. at 259; Bay Cities Paving & Grading, Inc. v. Lawyers' Mut. Ins. Co., 5 Cal. 4th 854, 866, 21 Cal. Rptr. 2d 691, 855 P.2d 1263 (1993). Finally, insurance contracts may be construed in a manner that recognizes the policyholder's reasonable expectations. Zuckerman v. Nat. Union Fire Ins., 100 N.J. 304, 320-21 (1985).
Ambiguity Construed Against Insurer
Ambiguous terms are strictly construed against the insurer, but the policy language must not be tortured to create ambiguities where none exist. See State Farm Mut. Auto. Ins. Co. v. Tenn. Farmers Mut. Ins. Co., 645 N.W.2d 169, 175 (Minn. Ct. App. 2002).
As a general rule, policy language is considered ambiguous if it is susceptible to more than one reasonable interpretation in the context of the policy as a whole. When an ambiguity exists, it will be resolved against the insurer. DiOrio v. New Jersey Manufacturers Ins. Company, 79 N.J. 257, 269 (1979). If the controlling language of the policy supports two meanings, one favorable to the insurer and one favorable to the policyholder, the interpretation supporting coverage will be applied. Corcoran v. Hartford Fire Ins. Co., 132 N.J. Super. 234, 243 (App. Div. 1975). Yet, an insurance policy is not ambiguous merely because two conflicting interpretations have been offered by the litigants. Rosario v. Haywood., 351 N.J. Super. 521, 530-531 (App. Div. 2002). A genuine ambiguity exists only when the policy language at issue is so confusing that the average policyholder cannot make out the boundaries of coverage. Lee v. General Accident Ins. Co., 337 N.J. Super 509, 513 (App. Div. 2001).
Courts may not, under the guise of construing an ambiguous term or provision, rewrite the contract or impose liabilities on the parties not bargained for and not contained in the policy. Woods v. Nationwide Mut. Ins. Co., 295 N.C. 500, 505 (1978); Mixson, Inc. v. American Loyalty Insurance Co., 349 S.C. 394, 399-400 (S.C. App. 2002). Courts must use and give effect to defined terms as written. Woods, supra, at 505-06. The intent of the parties and the reasonable expectations of the policyholder are irrelevant unless the terms of the insurance contract are deemed ambiguous. See Andy Warhol Found. for Visual Arts, Inc. v. Fed. Ins. Co., 189 F.3d 208, 215 (2d Cir. 1999).
Finally, courts cannot modify unambiguous terms by judicial construction or resort to extrinsic evidence when the contract on its face is reasonably susceptible of only one meaning. See Polygon Northwest Co., LLC v. Steadfast Ins. Co., 682 F. Supp. 2d 1231, 1234 (W.D. Wa. 2009); Vigilant Ins. Co. v. Bear Sterns, 10 N.Y. 3d 170, 855 N.Y.S.2d 45 (2008); Pepsico, Inc. v. Winterthur Int'l Am. Ins. Co., 13 A.D.3d 599, 788 N.Y.S.2d 142, 144 (2d Dept. 2004).
Policyholder Has Burden of Proving Coverage
It is well-settled that a policyholder has the paramount burden of showing the alleged claim is covered in the first instance and that it suffered an actual loss. See Servidone Constr. Corp. v Security Ins. Co. of Hartford, 64 N.Y.2d 419, 423-425 (1985) (holding that an insurer has no duty to pay unless it is first determined that the insurer is liable for a loss covered by the policy); Roundabout Theater Co., Inc. v. Continental Cas. Co., 302 A.D.2d 1, 6 (1st Dept. 2002) (emphasizing that the policyholder bears the affirmative burden of proving coverage; burden remains the same under an "all risk" policy).
Insurer Must Show Exclusions Squarely Apply
When a policyholder shows that a loss occurred while an insurance policy was in force, but the insurance company contends that an exclusion bars coverage, the insurer has the burden of proving the applicability of the exclusion. National Mut. Ins. Co. v. McMahon & Sons, Inc., 177 W. Va. 734, 356 S.E.2d 488 (1987); Mosser Constr., Inc. v. Travelers Indem. Co., 2011 U.S. App. LEXIS 14455 at *8-9 (6th Cir. 2011). As such, coverage clauses will be interpreted liberally, whereas exclusions will be strictly construed against the insurer. Polarome, 404 N.J. Super. at 259. Once the insurer establishes that an exclusion is applicable, however, the burden shifts back to the policyholder to establish the applicability of an exception to the exclusion. See Mosser, 2011 U.S. App. LEXIS at *9.
The term self-insured retention (SIR) or retained limit is generally defined as "[t]he amount of an otherwise-covered loss that is not covered by an insurance policy and that usually must be paid before the insurer will pay benefits." See Black's Law Dictionary 1391 (8th ed. 2004). Practically speaking, this is the amount of a loss or liability that the policyholder agrees to bear before coverage can arise under the policy.
It is widely recognized that an SIR applies to the aggregate of exposure due to a single condition during the policy period, and not to individual claims. See United States Mineral Products v. Am. Ins. Co., 348 N.J. Super. 526, 541-42 (App. Div. 2002); Owens-Illinois v. Aetna, 597 F. Supp. 1515, 1525 (D.D.C.1984).
Thus, a primary CGL policy provision requiring that the insured cover the first portion of a loss has the effect of rendering the carrier an "excess" insurer with respect to the policyholder, to the extent of the SIR. Until the SIR is satisfied, the policyholder is its own "primary insurer" and the insurer has no duty to defend or to indemnify. City of Oxnard v. Twin City Fire Ins. Co., 37 Cal. App. 4th 1072, 1077-78, 44 Cal. Rptr. 2d 177 (1995).
Courts have recognized that policies subject to self-insured retentions are treated as excess policies. The SIR is the equivalent of primary insurance and the policies subject to the SIR are "excess policies" that have no duty to indemnify until the self-insured retention is exhausted. Pacific Employers Ins. Co. v. Domino's Pizza. Inc., 144 F.3d 1270, 1276-77 (9th Cir. 1998).
That being said, it has also been recognized that self-insurance is not insurance for purposes of an "other insurance" or equitable contribution analysis with other applicable policies. See Con. Ed. Co. of N.Y., Inc. v. Liberty Mut., 749 N.Y.S.2d 402, 404 (N.Y. Sup. Ct. 2002); Home Depot U.S.A. v. National Fire Ins. Co., 2007 U.S. Dist. LEXIS 20032 at *21-24 (N.D. Tex. 2007); but see Nabisco, Inc. v. Transp. Indem. Co., 143 Cal. App. 3d 831, 192 Cal. Rptr. 207, 208-09 (Cal. Ct. App. 1983) (finding self-insurance to be "other insurance" where policy explicitly stated that its coverage was excess if there was "other insurance or self-insurance.").
Depending on the jurisdiction, policyholders are required to exhaust their liability coverage either vertically or horizontally. See LSH Techs., Inc. v. United States Fire Ins. Co., 2010 U.S. Dist LEXIS 140879 at *26-27 (E.D. Tex. 2010). "Horizontal exhaustion" means that each primary insurance policy triggered by a continuous loss must indemnify the policyholder to the full extent of its policy limits before any excess insurer can be required to pay. Id. at *26-27. "Vertical exhaustion" means that the first-in-time primary and excess policies will be exhausted before the next-in-time primary policy and excess policies will be tapped. Id. at *27. In other words, vertical exhaustion provides that each excess policy in a triggered year is required to contribute to indemnification as soon as its particular underlying coverage is exhausted, even if other triggered primary policies (covering other periods) remain "untapped." Id.
Policies generally require prompt or immediate notice of accident, claim, or suit as a condition precedent to coverage. Notice requirements are construed by courts as imposing a requirement of reasonable notice
under the circumstances or substantial compliance. An insurer is typically required to show that it was substantially prejudiced by a policyholder's failure to provide notice before coverage can be denied on notice grounds. Prejudice will depend on the particular facts and circumstances, but is typically a high burden for the insurer to satisfy and is not an absolute bar to coverage absent a showing of prejudice. Although it may not be obligated to do so, depending on the jurisdiction, a policyholder can further overcome a claim of late notice by showing that it had a reasonable excuse for the delay or a reasonable belief in nonliability.
RISK TRANSFER ISSUES-WHO BEARS THE RISK OF LOSS?
Risk managers and business owners have significant responsibilities to protect their commercial interests and investments. Of course, the interests of business owners and the parties they contract with may not be aligned. Each can be expected to attempt to forecast and protect their respective companies from potential liability that may arise during the relationship. One way to safeguard is to shift the risk to another party. For instance, in a typical construction project, an owner attempts to shift the risk to the general contractor. The general contractor attempts to shift the risk to the subcontractor and so on downstream.
Commercial contracts typically include risk-shifting provisions that require (1) one party to defend and indemnify the other for claims arising from the actions or inactions of the indemnitor, and (2) to add the indemnitee as an additional insured under the indemnitor's general liability policy. Although distinct, the obligations are related-in both cases, liability is shifted from the indemnitee to the indemnitor's insurer.
An "indemnity clause," also known as a hold-harmless or save-harmless clause, is "a contractual provision in which one party agrees to answer for any specified or unspecified liability or harm that the other party might incur." See Black's Law Dictionary 784 (9th ed. 2009). An indemnity clause must clearly express that one party is releasing the other from its own negligence and requires precise language.
Generally there are three types of contractual indemnity clauses. The first is a broader form, in which the indemnitee is entitled to reimbursement for the entire judgment or loss, regardless of its own liability in causing the accident and even if the injuries were caused solely by its own conduct. The second is narrower, providing that the indemnitee is protected only to the extent that its negligence is not the sole cause of the accident. The third specifically limits the indemnity obligation so that the indemnitee is indemnified only for its vicarious liability arising from the indemnitor's conduct. See James v. Burlington Northern Santa Fe Railroad, 636 F. Supp. 2d 961, 967-68 (D. Ariz. 2007).
In some states, agreements indemnifying or holding a party harmless for its own negligence are deemed void as against public policy. See United Rentals Northwest, Inc. v. Yearout Mech. Inc., 384 F. App'x 719, 722-23 (10th Cir. 2010). Courts will generally void the indemnity provision and enforce other portions of the contract.
Even where it is not against public policy to indemnify another for that person's sole negligence, most courts have held that such an agreement must be clear and explicit, or otherwise the contract will not be construed to allow for such indemnity. See Mantilla v. NC Mall Assoc., 167 N.J. 262, 274 (2001); Nabholz Constr. Corp. v. Graham, 892 S.W.2d 456, 459 (Ark. 1995).
Some jurisdictions have recognized an exception to this requirement, distinguishing "between contracts with consumers and contracts between businesses of equal power and sophistication." Util. Serv., 163 S.W.3d at 913. The notion is that sophisticated business parties require less precision in the terms of the indemnity clause, and it is irrelevant whether the businesses bargained for the provision. Id. at 913- 14 ("Courts enforce the objective terms of contracts between sophisticated businesses, without regard to the parties' subjective intent. The character and quality of negotiations do not vary the terms of a written contract between sophisticated businesses.").
Insurance Procurement Requirements
Requiring another party to obtain insurance on your behalf is another effective risk-transfer vehicle. Generally, a party can require another party to purchase insurance covering the first party's negligence without violating the prohibition against being indemnified for one's own negligence. See Shea v. Royal Enters., 2011 U.S. Dist. LEXIS 1192 at *12-13 (S.D.N.Y. 2011); Cappello v. Phillips, 2011 Conn. Super. LEXIS 1371 at *48-50 (Conn. Super. 2011). If done via insurance, a party can be indemnified for its own negligence because an agreement to procure insurance is generally not considered an agreement to indemnify. Cappello, 2011 Conn. Super LEXIS at *48.
While the purpose of an indemnification agreement is to relieve the promise of liability, an agreement to procure insurance specifically anticipates the promisee's continued responsibility for its own negligence for which the promisor is obligated to furnish insurance. Id. Moreover, this particular distinction is what renders indemnification, but not insurance-procurement, agreements violative of the public policies underlying "sole-negligence" anti-indemnity statutes. Id. at *49. While an agreement purporting to hold an owner or a general contractor free from liability for its own negligence undermines the strong public policy of placing and keeping responsibility for maintaining a safe workplace on those parties, the same cannot be said for an agreement that simply obligates one of the parties to a construction contract to obtain a liability policy insuring the other. Id.
Not all states allow an indemnitee to procure insurance from another for the indemnitee's own negligence. See, e.g., Walsh Const. Co. v. Mutual of Enumclaw, 104 P.3d 1146 (Or. 2005) (citing Walsh Const. Co. v. Mutual of Enumclaw, 76 P.3d 164, 168 (Or. App. 2003); (Or. Rev. Stat. §30.140 "prohibits not only 'direct' indemnity arrangements between parties to construction agreements but also 'additional insurance' arrangements by which one party is obligated to procure insurance for losses arising in whole or in part from the other's fault").
Businesses looking to protect themselves from potential liability should also require that subordinate parties name them as additional insureds under an indemnitor's insurance policies. These are prevalent in the construction context, as well as under vendor's agreements, leases and services contracts. The rights and obligations of the additional insured are generally controlled by the specific policy language, and some provisions are narrower than others. For that reason, contracting parties will want to pay close attention to these additional insured provisions to make sure they provide the necessary protection sought. Additional insured endorsements are typically construed broadly in conjunction with the underlying contractual obligations between the parties. See, e.g., County of Hudson v. Selective Ins. Co., 332 N.J. Super. 107, 113 (App. Div. 2000).
Each business faces a unique set of circumstances and associated risks, some of which may be unavoidable. When the unforeseen happens, you want to be ready. As highlighted by the discussion above, owners and in-house counsel should become familiar with the basic types of coverage available-and the way these policies are interpreted-as one path to protecting against losses and managing potential risks. Contractual risk transfer is also an important part of an effective mitigation strategy, and business are well-served by knowing when potential liability can be allocated or transferred downstream to other parties and their insurers.
Verne A. Pedro is special counsel in the Global Insurance Services Practice Group at Goldberg Segalla LLP. He is resident in the firm's Princeton, New Jersey, office. Mr. Pedro's practice focuses principally on complex insurance coverage disputes nationwide, commercial litigation, and product liability litigation. He has handled insurance matters in various disciplines, including aviation, first-party property, construction defect claims, environmental claims, international arbitration of pharmaceutical coverage claims, professional liability claims, directors' and officers' liability claims, and personal injury litigation.
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