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When Construction Results in a Catastrophic Loss—Is There Insurance Coverage?

August 21, 2019

by Diane Tokarsky, Jonathan Rudd and Nick Fox

Reprinted with permission from the August 16, 2019 edition of The Legal Intelligencer © 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Few can forget the harrowing images of the Notre Dame Cathedral engulfed in flames after it abruptly caught fire on the evening of April 15. It is reported that more than 400 firefighters were engaged, with another hundred tasked with moving precious objects—some legitimately priceless—to safety.

The fire broke out in the attic beneath the cathedral’s roof at a time when the cathedral’s spire was undergoing renovations. Of the five companies contracted to restore the spire, it has been reported that only a scaffolding crew was at work the day of the fire. While no conclusion as to the origin of the fire has been released in the media, it has been reported that cigarette butts were discovered on the erected scaffolding (which is in derogation to policies in place for workers). Another theory involves an electrical malfunction in the electrical supply to temporary lights and an elevator.

Built in the 12th century, this Parisian landmark had been owned by the state since 1905. Neither the cathedral nor the state-owned contents were privately insured. While few domestic construction projects will involve centuries-old iconic structures or unequivocally priceless artifacts (e.g., the crown of thorns)—much can be learned from the Notre Dame tragedy, especially when considering the myriad of insurance products available to manage risk on a commercial construction project.

The events involving the Notre Dame Cathedral fire provide a good framework for analyzing the potential insurance issues if a similar event happened on a commercial project in the United States. Some of these issues involve whether there would be insurance to pay for the various losses and damages arising from such a catastrophic event, and if so, what are the potentially available insurance products to pay for the various types of losses and damages. An analysis of the insurance issues involved in any large loss on a commercial construction project will involve determinations as to which party carries the various insurance products, and whose insurance should pay for the different types of losses and damages.

  • Owner Coverage. Commonly the project’s owner purchases, at a minimum, the following coverages: commercial general liability coverage (a CGL); and property insurance.

Property insurance. The property insurance is obtained specifically for the construction project, and the coverage limits may be less than, meet, or exceed the total value for the project plus any modifications (change orders). The amount of property insurance needed for the constructions project is typically calculated on a replacement cost basis. If the owner elects to insure the construction project by means of a standard builder’s risk policy, then such property insurance typically protects the interests of the owner, as well as the contractors, and subcontractors working on the project (so long as each has an insurable interest).

Where the owner is doing a renovation to an existing building that is previously insured, it might elect not to purchase a new and separate property insurance policy because most commercial property policies define the “building” to include additions that are under construction, alterations, and repairs to the building or structure. However, the interests of the contractors and subcontractors might not be covered under the owner’s existing property insurance policy.

If the state had property insurance in the case of the Notre Dame fire, then the state’s property insurance very likely would have provided coverage for the damage to the cathedral and its contents. If a similar incident occurred in the United States, there would be issues as to whether the owner’s insurer would be able to pursue any responsible party for reimbursement of the amount paid out under the property insurance policy. Unless the owner had waived the subrogation rights of its insurer prior to the loss, which is not an uncommon practice in the United States, then the owner’s insurer would be entitled to pursue those parties that it believed to have caused the loss. In a similar case to the Notre Dame Cathedral fire, this would almost certainly include the scaffolding contractor, and likely all of the other contractors working on the jobsite.

The type of property insurance maintained by the owner would control whether the contractors and subcontractors would be covered for their work in progress. Under a typical builder’s risk insurance policy, these additional parties would be covered. However, if the owner elected to insure the project under its existing property insurance policy, the contractors and subcontractors would likely not be covered and could be exposed to having to replace work in progress that was not yet accepted and paid for by the owner.

Another aspect of property insurance that must be considered is the separation of each insured’s interests. Where there are multiple insureds, it is typical that conduct of one insured will not jeopardize the coverage available to other insureds. This most frequently becomes an issue where there is an intentional act by one insured that leads to the loss. A classic example is the deliberate setting of a fire or other intentional destruction of property. Although the insured responsible for the individuals engaging in such conduct would not be covered, the remaining innocent insureds would still be entitled to coverage for their own interests.

  • Contractor Coverage. The contractor coverages that would come into play in the Notre Dame scenario are: property insurance policies (for first party coverage); and the contractor’s CGL (for third-party coverage).

Property insurance. In some instances, on commercial projects in the United States, the contractor, rather than the owner, will purchase property insurance for the project in the form of a builder’s risk insurance policy. A contractor’s builder’s risk policy will typically cover similar perils as the owner’s property insurance, but also includes the interests of not only the owner, but also the contractor and subcontractors. Certainly, peril of fire would be covered under a builder’s risk policy and provide coverage to the contractor and subcontractors for any work in progress that had yet to be accepted and paid for by the owner. Based on the separation of insured provisions contained in most standard builder’s risk insurance policies, the contractor would be protected even if the loss was caused by the intentional acts of a subcontractor.        

Under the contractor’s builder’s risk policy, the insurer would pay out on any claim for property damage incurred by the contractor and any of the additional insureds. However, an insurance company’s subrogation rights are limited since it is fundamental principle of insurance law that an insurer cannot subrogate against its own insured. Thus, to the extent the owner, contractor and subcontractors are all insured under the contractor’s builder’s risk policy, they will all be protected from any subrogation claims resulting from an insured loss.

Liability insurance. The contractor’s CGL policy may also respond to any claims lodged against the contractor by third parties, whom allege injury to person or property. Typical claimants in this scenario would be the state (seeking payment for damages to the cathedral and its contents), neighboring residents (property damage and any personal injuries incurred) and also from first responders, nonemployee workers and members of the general public (for bodily injuries). A CGL policy commonly covers damages because of death, bodily injury, sickness, or disease and injury to tangible property. This is known as third-party coverage because the claimant is someone other than the insured.

  • Subcontractor Coverage. Subcontractors are typically required to have a CGL policy which provides coverage that is virtually identical to the contractor’s CGL. With regard to property insurance, the subcontractors will often purchase their own policies to cover their own materials and equipment separate and apart from owner-supplied property insurance or a builder’s risk policy; this coverage is known as an installation floater. This type of insurance is often employed when the Subcontractor is installing something of value (e.g., mechanical equipment, expensive fixtures, copper wiring, fiber optic cable, etc.) and when other project-wide insurance is nonexistent or insufficient to protect the subcontractor’s interest.

Generally subcontractors are situated similarly to the contractor in the event of an insured loss, with one key distinction—the subcontractor has likely contractually agreed to add the contractor as an additional insured, and also to a broad indemnity provision which obligates the subcontractor to exhaust its insurance first, before the insurance of the contractor is invoked. The contractor sits “above” the subcontractors with liability being pushed downstream to the subcontractors’ insurance policies. In similar fashion, the owner sits “above” the contractor. This hierarchy, left unchecked, is a recipe for a lengthy and expensive litigation in the event of an insured loss on the project.

  • The Seemingly Endless Cycle of Insurers Chasing Insurers. Two concepts can greatly reduce the proverbial finger pointing (and litigation) when a catastrophic event occurs at the jobsite.

Subrogation Waivers. It is very common for the owner, contractor, and subcontractors to waive the subrogation rights of their respective insurers as to each other. In layman’s terms, this means that after the insurer pays a claim, the insurer forgoes further pursuit of any culpable construction participant whose conduct (or omission) caused the loss. This cuts off the string of lengthy litigation between construction participants that would otherwise occur, where the insurer seeks to invoke the indemnification rights of its insured or otherwise collect from the person or entity that has caused the loss. The insurer will still be entitled to pursue any party that is not included within the waiver of subrogation, such as equipment manufacturers that might be responsible due to defective equipment that caused the loss. This in turn makes it important for a contractor or subcontractor purchasing equipment to make sure it is not indirectly assuming responsibility for a loss by having agreed to indemnify the equipment manufacturer for any claim asserted related to the equipment.

Wraps. Another option to reduce litigation among the project stakeholders in the event of a catastrophic event is wrap insurance. Two common types are owner controlled insurance programs (OCIPs) and contractor controlled insurance programs (CCIPs). Under wrap insurance, the owner, the contractor, and all subcontractors are named insureds under a single insurance policy that covers a specific construction project. In some cases, the wrap will cover multiple projects.  Wrap insurance is not appropriate for every project, and so a well-thought analysis of the cost/benefit of wrap insurance is imperative.

In the present example, had there been a wrap policy, then a single insurer would have responded to covered claims, thus eliminating the lengthy and expensive process of litigation among insurers, which often erodes the funds in the policy limit which are otherwise available to pay out for viable claims.

A catastrophic event, such as the one at Notre Dame, is an unfortunate reminder of the importance of insurance and other risk management tools that are available to stakeholders in the construction industry. A catastrophic event is rarely expected and is always unwelcome, and for these reasons, owners, contractors, and subcontractors should revisit and carefully assess their insurance protections and indemnity obligations before executing contracts for the next upcoming project.