Legal Ease

Precedents and contract provisions


Sometimes, court decisions are surprising. And because case law develops through reliance on precedent, one surprising case decision can lead to several more cases with similar outcomes and the establishment of a legal principle that may not have been intended.

Several recent decisions interpreting property damage insurance provisions in The American Institute of Architects (AIA) standard contract documents illustrate this point. Appellate courts in several states have ruled that a contractor whose actions caused property damage to a building was not liable for the loss because AIA contract documents provide that the owner's property insurance was contractually stipulated to pay for the loss and the parties agreed to waive claims against one another.

If such rulings are relied on by other states, the effect would be that owners' property damage insurers, rather than roofing contractors and their insurers, would be liable for interior property damages that occur during reroofing of buildings.

AIA provisions

The widely used AIA General Conditions of the Contract for Construction—AIA Document A201—includes extensive provisions pertaining to insurance. A contractor is to purchase and maintain workers' compensation and general liability insurance to cover claims for personal injury and property damage other than to the contractor's work. Similarly, an owner is to purchase and maintain liability insurance.

For many years, AIA Document A201 has stipulated an owner is responsible for obtaining builder's risk insurance, which covers property damage during construction caused by perils identified in the policy.

Under the heading "property insurance," AIA Document A201-1997 requires an owner to purchase and maintain—unless the parties have agreed otherwise—a builder's risk insurance policy in the amount of the original contract plus the value of subsequent contract modifications. The policy is to be written on a replacement-cost basis and maintained until final payment has been made or no person or entity other than the owner has an insurable interest in the property. The builder's risk insurance, which is to protect the interests of the owner, contractor, subcontractors and sub-subcontractors, covers physical loss or damage caused by fire, theft, vandalism, malicious mischief, collapse, earthquake, flood and windstorm. If the builder's risk policy contains deductibles, the owner is to pay the costs not covered as a result of the deductibles.

If an owner does not intend to purchase builder's risk insurance, AIA Document A201 requires the owner to notify the contractor before work begins. The contractor then may obtain builder's risk coverage, and the cost will be added to the contract. If the owner neither purchases a builder's risk insurance policy nor informs the contractor of his failure to do so and there is a loss that would have been covered by the required builder's risk policy, the owner bears the loss.

AIA Document A201 also includes a waiver of subrogation provision. Although the numerical designations of provisions have changed during the years, the waiver provision has been included in numerous editions of AIA Document A201.

Pursuant to the waiver provision, all parties are to look to the property insurance coverage exclusively for recovery and no claims or lawsuits can be asserted by one party against another.

The question that has arisen in several recent cases concerns the waiver's scope and whether the waiver is limited to claims arising under a builder's risk insurance policy or would apply to all losses covered by the owner's property insurance. For new construction projects, the builder's risk insurance policy would apply to the entire project, but for reroofing and other construction work on a building, the distinction becomes critical.

Cases

In 1990, the Court of Appeals of New York in the case S.S.D.W Co. v. Brisk Waterproofing Co. Inc., ruled the waiver of subrogation in the AIA contract applied only to damage to the contractor's work, not other parts of the building. In this case, the owner of a New York City apartment building contracted with a waterproofing contractor to perform certain corrective work on the exterior masonry and concrete walls and parking garage floor slab. The standard AIA contract form was used.

During the course of the work, a fire broke out in a shed constructed by the contractor on the fifth floor. The fire caused about $140,000 in damages to the building, including interior hallways and apartments, and to the building's exterior. The owner's property insurance carrier paid the claim and then brought a claim against the waterproofing contractor.

The Court of Appeals of New York ruled that the waiver clause applied only to damage to the waterproofing contractor's work and, therefore, the owner's subrogation claim for damages to the building could proceed. The court said the waiver of subrogation clause bars subrogation only for damages covered by insurance that the owner has provided to meet the requirement of protecting the contractor's limited interest in the building, specifically damages to the work. The court did not find any contract language supporting the view that the waiver encompassed all damages flowing from the work. The court said it made no difference whether the owner purchased insurance specifically to insure the work pursuant to AIA requirements or maintained some other policy covering the owner's property in which the owner also provided coverage applicable to the contractor's work.

In reaching its decision, the New York Court of Appeals said the owner's interpretation of the limited scope of the waiver gave effect to all the insurance provisions in the contract and was consistent with a commonsense reading of the insurance provisions. Although the builder's risk insurance policy covered replacement of the waterproofing contractor's work, the contractor's liability insurance policy applied to damage to other parts of the building caused by the contractor's negligence. The court said its interpretation was consistent with earlier New York decisions and similar to a 1987 Washington case involving identical contract provisions.

In sharp contrast to the New York and Washington decisions, more recent appellate court decisions in Texas and Minnesota have concluded the waiver of subrogation applies to all property damage, including damage to an existing building and its contents, even if the damage is a result of a contractor's or subcontractor's negligence.

Although a subcontractor's negligence during construction was recognized to be the cause of damage to a building, the Texas Court of Appeals ruled in a May 2003 decision for Walker Engineering v. Bracebridge Corp. f/k/a MBNA Texas Properties that the owner waived its right to recover property damages to the extent the loss was covered by any of the owner's property insurance policies. The court's ruling was based on the waiver of subrogation provision in AIA Document A201.

The owner, MBNA Texas Properties, Dallas, entered into a $49 million construction contract relating to a project known as the Hallmark Center in Dallas. The contract included addition of a parking garage and an office building, as well as improvements to the building. The contract included standard AIA language. The general contractor retained an electrical subcontractor, Walker Engineering Inc., Dallas, to perform electrical work. While Walker Engineering was working in a hallway of the existing building, an electrical arc, or short, occurred as a result of Walker Engineering's negligence, creating a hole in a nearby water line. As a result, a significant portion of the building's first floor flooded, causing extensive damage to the building, the building's fixtures and personal property. Damage totaled $1.6 million.

The owner filed suit against Walker Engineering and others to recover the $1.6 million. All parties, including Walker Engineering, agreed the damages were a result of Walker Engineering's negligence. Walker Engineering defended the claim on the grounds that the owner had waived its right to recover property damages against the general contractor and subcontractors based on the waiver of subrogation provision.

The building owner had two property insurance policies. One policy provided coverage for the building and personal property. The parties agreed this policy covered the water damage to the building. The owner also had a builder's risk insurance policy that was part of its overall policy and applied to the new construction and improvements of the building.

The owner argued there was no waiver because damages to the building caused by the flooding were not covered by the builder's risk insurance or "other property insurance applicable to the Work." AIA defines "Work" as the construction and services to be performed by the contractor required by contract documents. The owner argued the waiver was limited to damages that could be recovered from the builder's risk policy and it was not precluded from pursuing a negligence claim against Walker Engineering for the damages to the building covered by its property insurance policy.

Walker Engineering contended the waiver extended to any loss arising out of the work covered by the owner's property insurance and applied to losses covered by the builder's risk policy or other property insurance.

The Texas Court of Appeals ruled in favor of the subcontractor and concluded the owner had waived its right to recover from Walker Engineering the damages caused by the flooding.

In direct contrast to the New York decision in the Brisk Waterproofing case, the Texas court stated the waiver of subrogation does not look to whether the property damaged is the work of the contractor or damage to other property. Rather, the court continued, the waiver provision focuses on the availability of property insurance coverage and requires a waiver between the owner and contractor of "all rights against ... each other ... for damages caused by fire or other perils to the extent covered by property insurance obtained pursuant to this paragraph 11.3 or other property insurance applicable to the Work."

Finding that, per the contract, the parties had agreed to allocate certain risks between them, the court mentioned the contract required the owner to purchase property insurance on an "all-risk policy form … for the entire Work at the site." The court also referred to other cases in which courts had considered a waiver of subrogation clause as a means by which the parties agreed in advance to avoid litigation, disruption and claims by requiring one party to provide property insurance for all parties. The court also referred to the waiver provision stating the waiver "is effective as to a person or entity even though that person or entity would otherwise have a duty of indemnification, contractual or otherwise."

The court concluded that to the extent the property damage was covered by the owner's insurance, the owner waived its right to sue to recover those damages.

Although the court's reasoning differed somewhat, a similar result was reached in 2001 by the Minnesota Court of Appeals in a reroofing situation in Independent School District 833 vs. Bor-Son Construction Inc. During the course of reroofing several schools, the roofing contractor failed to keep three elementary schools protected during reroofing, leading to extensive interior damage and mold growth at each school. Instead of making a liability claim against the contractor, the school district obtained recovery from its property damage carrier, which subsequently filed a subrogation claim against the contractor for $775,086 in interior damages. The school district had purchased builder's risk insurance for the reroofing work in the form of an endorsement to its existing property insurance policy.

In its decision, the court ruled the school district had waived its subrogation rights because of the waiver provision in AIA Document A201. In reaching its decision, the court focused on the builder's risk insurance policy being an endorsement to the owner's existing policy and, therefore, part of the existing policy rather than a separate policy. Because the builder's risk insurance was an endorsement to the existing policy, the court ruled the waiver covered both claims covered under the builder's risk endorsement and the school district's existing property damage policy, which covered interior damage. The net effect of the court's decision was the school district and its insurer were precluded from asserting a liability claim against the contractor.

Looking forward

Given the decisions of the Texas and Minnesota courts, AIA undoubtedly will give attention to and perhaps rewrite the property insurance and waiver provisions in its next edition of AIA Document A201. Meanwhile, contractors should be aware there is case law supporting the view that if contract language provides for a waiver of rights when there is property insurance, the waiver may extend to interior water damage claims regardless of who is at fault for the damage.

Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.

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