Daily Development for Tuesday, September 8, 2009
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

INSURANCE; FIRE INSURANCE; SUBROGATION; WAIVERS; CONSTRUCTION COMPLETION CLAUSE:   Construction contract provision that there would be waiver of subrogation to extent of “other insurance applicable to the Work,” did not extend the period of waiver to periods following construction even when the owner had obtained insurance.  Insurer not barred from subrogation claim.

Hartford Underwriters Insurance Company v. Phoebus, 2009 WESTLAW 271327, (Md. Ct. Spec. App.  8/31/09) (not yet released for publication.)

A construction contract for a fast food restaurant required the owner to maintain during the an “all risk” policy, including builder’s risk.  This insurance was to be maintained during  course of construction and until final payment “or until no person or entity has an insurable interest in the property.” 

This language was followed in the contract by a waiver of subrogation clause that stated that there was a mutual waiver of “all rights” “for damages caused by fire or other causes of loss “to the extent covered by property insurance obtained pursuant to [the language described above] or other property insurance applicable to the Work,  . . . the policies that provide such waivers of subrogation . . . .”

“Work” was defined in the contract as “the construction and services required by the Contract Documents, whether completed or partially completed. . . . The work may constitute the whole or part of the project.”

This definition is similar to AIA form contract language.

One last piece of the contract - the “final completion and final payment clause,” stated:

“The making of final payment shall constitute a waiver of claims by the others except those arising from:

        2) failure of the Work to comply with the requirements of the Contract Documents;”

Two and a half years later, a fire broke out, causing over a million dollars in damages.   Owner alleged that the cause of the fire was defective electrical work.  It was paid for the damages by its new property insurer, which then brought a suit in subrogation against the Contractor.

On summary judgment, the trial court ruled that the waiver of claims and waiver of subrogation clause was effective because it applied to “property insurance applicable to the Work,” as and because this intent of the parties was not disclaimed by the reservation of rights set forth in the  “final completion and final payment clause” as an exception to the waivers contained in that clause.  Summary judgment to Contractor.

        The Special Court of Appeals reviewed the question of whether the contract was ambiguous de novo.  The insurer argued that it was ambiguous - that it was unclear whether the parities that any insurer, ever in the future, would be viewed as waiving subrogation against the Contractor for construction defects, particularly in light of the reservation of rights to sue  for (in effect) construction defects in the “final completion and final payment clause.” 

        The appeals court first stated that the question boiled down to whether the completed restaurant was part of the “Work” as defined above.  It noted that language contained in a typical “Complete Project Insurance” clause” in other construction contracts would have plainly included a waiver of subrogation for the contractor for the completed project.  This clause, more specific than the language in the case at hand, has been upheld in a number of decisions in Oregon, Georgia and Texas and Indiana.  All of these cases contained the AIA definition of “Work” and the court ruled that the temporal scope of waivers of subrogation for such work ran beyond the end of the contract.

        But in a case in Missouri that did not have a “Completed Project Insurance” clause, the court found that the definition of “work” - albeit the same language - was ambiguous in light of the reservation of rights contained in a “final payment clause” similar to the one in the instant case.  The Missouri court denied subrogation protection.

        The Insurer stressed the ambiguity that existed when a contract contained by Completed Project Insurance” clause, as in the present case, and argued that the policy considerations supporting a waiver of subrogation - that one policy should be viewed as covering essentially the same risk when both Contractor and Owner have shared interests in the project - does not extend to periods beyond the completion of the project.

        The appeals court bought this argument, noting also that another term used in the contract - “Project” - appeared when the parties intended to refer to the completed restaurant, and that the term “Work” didn’t necessarily connote the same concept. 

        Following the general rule that waivers should be read narrowly, the court concluded that the parties to the present contract did not intend to waive claims or subrogation as to damages arising after completion of the project caused by negligent or nonconforming construction practices.  Reversed. 

Comment: The editor has scant experience in construction law, but his incredible chutzpa moves him to make a comment anyway. 

The general purpose of waiver of subrogation clauses is the recognition of the fact that the parties share a mutual interest in the same property and that insurance undertaken by one party is likely to cover the same risk of loss faced by the other.  Thus, the parties choose to rely on only one comprehensive property damage policy and mutually waive claims and subrogation.  The insurer goes along with it because it recognizes that it is still insuring the same risk of loss.

Applied to construction claims, one could assay the argument that both the contractor and owner share a mutual interest in the same property - and that insurance against property damages would cover the same risk - damage during construction.  Is this true as to injury caused by claimed defects following construction?  It would appear that some parties in the industry feel that way - hence the “completed project insurance” clause.  If the same arguments apply, then certainly there was sufficient language in the instant contract to support the interpretation of the parties’ intent reached by the trial court - that subrogation has been waived.  As the court does not tell us the policy arguments raised by the Insurer and makes no other analysis of the business practices - but just tries to parce the contract in a somewhat inconvincing manner, the editor finds the decision unsatisfying - sort of like a coconut cream covered sawdust cake.

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