Contractual Insurance Requirements: Traps for the Unwary

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2019 Real Estate and Construction Issue
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Contractual Insurance Requirements: Traps for the Unwary

By: Lyndon Bittle

Every real estate and construction contract (not to mention a merger agreement or other commercial contract) contains a list of insurance requirements identifying specific types and amounts of coverage that one or both parties must maintain throughout the contract’s performance (and sometimes beyond). Too often these requirements are included in a form exhibit that is attached to contracts year after year, project after project, without careful review.

I get it; who wants to get bogged down in insurance mumbo-jumbo when there are so many more exciting things to do? I hate to bear bad news, but that practice creates potential uninsured risks for both parties. This article discusses a few “traps for the unwary” lurking in construction contract insurance requirements, focusing on the ubiquitous commercial general liability (CGL) policy.

If you are the party on which the insurance requirements are imposed (typically the contractor or subcontractor), it is important to confirm the required coverage terms are either included in your current insurance program, or can be purchased at a reasonable additional price, i.e., one that does not significantly affect the profitability of the contract. To do this, you must find the time to have your insurance agent or broker review the requirements and your current program to identify potential discrepancies. (To effectively provide more thorough advice, your agent (or coverage lawyer) needs to understand your business and the nature of the project contemplated by the contract.) Waiting until after the contract is signed (or worse, after a claim arises) is a recipe for disaster.

If, on the other hand, you are the property owner, developer, or other party seeking protection through insurance purchased by other (usually “downstream”) parties, it is important that the insurance requirements provide the protection you want, and can reasonably be obtained by the contractor. Requiring coverage that is either ambiguous or unavailable provides a false sense of security. If the contractor’s insurance program does not strictly comply with the contract’s requirements, you may have a claim for breach of contract, but that will be little comfort if, as is usually true, the damages are beyond the contractor’s financial resources. Far better to get it right in the first place.

So, what traps are we worried about? Many pop up in connection with making one party an additional insured on the other party’s liability policies. One deceptively problematic provision is a requirement that the owner be “named an additional insured,” without further details. That request conveys almost nothing.

There are more than a dozen additional-insured endorsements issued by ISO (an insurance industry organization that develops “standard” forms that are used by many, but not all, insurers) that can be attached to one or more of ISO’s CGL policy forms. And then there are countless different forms used by specific insurers that are similar, but not necessarily identical, to the ISO forms. Endorsements vary in the language they use to identify which parties are deemed additional insureds, as well as the scope of coverage provided. For example, some forms provide coverage for completed operations, while others cover only ongoing work. The solution is to determine the scope of additional-insured coverage you need (including any affiliated entities that need to be included), and put those details in your contract.

Another common error is requiring coverage under outdated insurance forms or using obsolete terms that create ambiguity. To cite just one example, some insurance requirements purport to require that the owner be named an additional insured under ISO endorsement CG 20 26 11 85. The last two sets of digits identify the date the endorsement was adopted by the ISO. In this example, that means the November 1985 version of the endorsement, which has been amended several times in the intervening years, most recently in April 2013. Granted, those seeking additional-insured coverage preferred the 1985 form’s language because it was interpreted to provide the broadest possible coverage, for all liability “arising out of” work on the project. Insurance companies, on the other hand, are loathe to offer coverage under those terms (at least at a reasonable price), which increases the risk that the contractor will not obtain the specified endorsement or will have a policy including a later version, and the parties will argue after a claim arises about whether the contract was breached. Further, some of the more recent modifications to the 20 26 endorsement (and other forms), were made to bring coverage more closely in line with statutory changes (including the Texas Anti-indemnity Act, adopted in 2012), or to close a “gap” created by judicial interpretations of the previous language.

How do you avoid that trap? One option is to specify a current endorsement form “or substantial equivalent” that generally includes the desired coverages, and review that requirement annually to determine if it is still appropriate. A better option, in my view, is to spell out the additional-insured coverage you expect the policy to provide, which would generally include coverage of both ongoing and completed operations on a “primary and noncontributory basis” to the fullest extent permitted by law for bodily injury and property damage. It might also include other provisions appropriate for the specific risks arising from the project.

Additional issues can arise from a requirement to provide coverage for “contractual liability.” This is a misnomer, and may create unrealistic expectations. No standard CGL policy will cover a pure breach of contract, such as failure to comply with delivery or payment terms of the contract. Indeed, there is a universal exclusion for “contractual liability.” Coverage is available, however, for some types of contractual liability, described in specified exceptions to the exclusion, which can vary between policies.

Virtually all CGL policies will except (that is, cover) the insured’s liability arising from a duty that exists apart from the contract, like the duty to maintain a safe workplace. Most CGL policies also include an exception for an “insured contract,’’ which generally includes indemnity obligations. There is, however, an endorsement form explicitly removing that exception to the contractual-liability exclusion, which can be devastating to coverage for indemnity obligations.

In short, the intent of requesting “contractual liability” coverage is to prohibit policies that eliminate or substantially restrict the exceptions to the contractual-liability exclusion—but it doesn’t say that. A policy that covers some contractual liability but not liability assumed under an indemnity agreement would arguably comply with the request for contractual-liability coverage. But it would likely not provide the coverage the owner or the contractor needs. In a familiar refrain, the solution is to determine (with professional assistance as needed) the scope of contractual-liability coverage you want, and put it in your contract.

Not paying careful attention to the insurance requirements of your contracts can result in serious headaches down the road, when you find yourself relying on the coverage you requested or agreed to provide. So stifle that yawn and have your contracts’ insurance requirements reviewed and updated regularly.