Laurin: Well-crafted contracts can avoid subrogation disputes

By Sam Laurin

Laurin

Most Indiana construction law practitioners would probably agree that Indiana caselaw on construction issues is hardly robust. One exception is cases that address the enforceability of waiver of subrogation provisions (usually under AIA contracts) to prevent claims for damage to the “Work” (again usually as defined by AIA contracts) when a builder’s risk policy should or does cover the damage.

Two recent cases have addressed this issue in different fact patterns than prior cases: Allen County Public Library v. Shambaugh & Sons, 997 N.E.2d 48 (Ind. Ct. App. 2013), opinion on rehearing 2 N.E.3d 132 (Ind. Ct. App. 2014); and Board of Commissioners of the County of Jefferson v. Teton Corp., 3 N.E.3d 566 (Ind. Ct. App. 2014). (Editor's note: The Indiana Supreme Court accepted Teton Corp. on transfer Oct. 20.)  What makes the Allen County and Teton Corp. decisions particularly noteworthy is that they address the enforceability of waiver of subrogation provisions to damages that are not traditionally thought of as damage to the “Work.” It is well settled in Indiana that the AIA waiver of subrogation provisions applies to damage to the “Work” as defined in AIA contracts. E.g. S.C. Nestle, Inc. v. Future Const. Inc., 836 N.E.2d 445 (Ind. Ct. App 2005).

The greatly simplified facts of Teton Corp. are as follows. During a renovation of a courthouse, a fire occurred, causing damage to the courthouse. The owner did not purchase a builder’s risk policy but had what appears to be a very comprehensive property policy. The property policy covered work-related damages but not damages to the contents in the courthouse. The majority in Teton Corp. enforced the waiver of subrogation and held that the owner could not sue the contractor for damages to the contents. The majority adopted the “majority rule” that the waiver applies to the “Work” and “Non-work” as opposed to the “minority rule” which holds that the waiver only applies to the “Work.”

The dissent relied upon the fact that paragraph 11.3.5 of the AIA contract at issue provided that: “If during the Project construction period the Owner insures properties, real or personal or both, adjoining or adjacent to the site by property insurance under policies separate from those insuring the Project …[the Owner waived subrogation].” (emphasis added) The dissent believed that the waiver of subrogation did not apply because the contents were at the site (i.e. the courthouse) rather than adjacent or adjoining to the site. The dissent also stated that this conclusion was bolstered by that fact that Indiana had appeared to adopt the “minority view” in Midwestern Indemn. Co. v. Sys. Builders Inc. 801 N.E.2d 661 (Ind. Ct. App. 2004) trans. denied.

This author believes the dissent’s point is well taken. The language at issue in Teton Corp. is different from the current language in paragraph 11.3.5 of the AIA 201 General Conditions that says “at or adjacent to the site … .” Had this current language been in the contract at issue in Teton Corp. then it would have been clear that the waiver of subrogation was enforceable. Additionally, this author respectfully submits that adopting a “rule” for the scope of the waiver of subrogation is at odds with the established caselaw that courts should not interfere with the parties’ freedom to contract, and will usually enforce contracts as written. Trimble v. Bloomington Auto Parts, 700 N.E.2d 1128 (Ind. 1998). If a waiver of subrogation on its face does not cover the damages at issue, it should not be enforced because of a rule.

The Indiana Court of Appeals in Allen County addressed the issue of whether the waiver of subrogation applied to cleaning up a diesel fuel leak that occurred during construction. The builder’s risk policy excluded the land on which the property was located but had a “coverage extension” to cover pollutants from the land or water. However, that coverage had limits of $5,000. The trial court found that the wavier applied because the pollution was a consequential damage caused by the “Work.” The Court of Appeals reversed, relying on Midwestern and the fact that the contractor was required to purchase insurance to cover damages to other than the “Work” itself resulting from the contractor’s operations and completed operations. Lawyers who are faced with waiver of subrogation issues now have authority to argue for either the “majority rule” or the “minority rule.”

The reasoning of these cases is important reading for construction lawyers or coverage counsel. Perhaps even more important is to understand the unique issues that arise if there is the possibility of damage to something other than the “Work” that is being constructed under the applicable contract, and to address the issues at the beginning of the project in the contract language and insurance requirements. Probably the most common factual scenario that merits close attention is the construction of an addition to an existing structure. The issues arise when during construction of the addition, the “Work” damages the existing structure.

One way to avoid litigation is to require the property insurer who covers the existing property to agree to waive subrogation against the contractor who damages the existing structure. It is in every project participant’s interest to have damages that occur during construction to be covered by some policy through enforceable contract language and by having the right policies in place rather than relying on a rule which good litigators can always argue does not apply (for example reasonable minds can disagree with analysis of the relevant cases in this article). As the court in Teton Corp. recognized when citing a decision by the Nebraska Supreme Court in Lexington Insurance Co. v. Entrex Communications Services, Inc. 275 Neb. 702, 749 N.W.2d 124, 136: “the waiver’s purpose is to [avoid] disruption and disputes among the parties to the project by eliminating the need for litigation.”•

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Sam Laurin is a partner of Bose McKinney & Evans LLP, where he serves as the chair of the firm’s litigation group, as well as the chair of its construction law group. The opinions expressed are those of the author.