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Additional Insured Coverage

A general contractor brought an action against the insurer of a subcontractor, alleging that the insurer breached its duty to defend and indemnify the general contractor in a lawsuit brought by an employee of the subcontractor. The construction contract between the general contractor and the subcontractor required the sub to obtain additional liability insurance for the general contractor. This was questioned by the insurer which relied on an Oregon law—ORS 30.140(1)—that prohibited construction agreements from requiring a person to indemnify another party against liability caused in whole or in part by the indemnitee's negligence.

The facts of the case were clear. The general contractor (Walsh) entered into a subcontract with a subcontractor (Rust) to perform some work. The contract required Rust to procure liability insurance coverage naming Walsh as an additional insured on the policy; the policy that Rust had already did contain a blanket additional insured endorsement that automatically extended the coverage that the subcontract required. A Rust employee was injured on the job and made a claim against Walsh. Walsh then tendered the claim to Rust's insurer. The insurer refused coverage, arguing that the additional insured provision of the subcontract violated Oregon law. Walsh settled with the employee and brought an action against the insurer. Both parties moved for summary judgment and both the trial court and the appeals court found for the insurer. The case was then taken up by the Oregon Supreme Court.

The insurer argued that, because the additional insured provision of the subcontract was void under ORS 30.140(1), Walsh was not a legally cognizable additional insured and so, was not entitled to defense or indemnity. Walsh argued that ORS 20.140(1) applied only to agreements to indemnify and that an agreement to procure insurance is something different; Walsh said that the subcontract only required Rust to procure insurance so the statute was not applicable. The wording of the statute was: “any provision in a construction agreement that requires a person or that person's insurer to indemnify another against liability for damage arising out of death or bodily injury caused in whole or in part by the negligence of the indemnitee is void.”

The court examined the statute and found that the law remained constant in prohibiting agreements by which a party's insurer would be required to indemnify another party for damages arising from the latter party's negligence. The court said that the text and the historic evolution of the statute strongly suggests that the law prohibits not only direct indemnity arrangements between parties to construction agreements, but also additional insurance arrangements by which one party is obligated to procure insurance for losses arising in whole or in part from the other's fault. The opinions of the lower courts were upheld.

Basically, what the court decided was that the policy's additional insured coverage was applicable for vicarious liability situations. Liability arising out of the sole negligence of the additional insured (Walsh, in this instance) could not, by law, be transferred to the named insured (Rust) simply by means of a contractual agreement. This decision puts the state of Oregon on the side of those courts that do not see additional insured agreements as permitting coverage for claims arising out of the sole negligence of the additional insured.

The case is Walsh Construction Company v. Mutual of Enumclaw, 104 P.3d 1146 (Or. 2005).

Faulty Workmanship Does Not Constitute an Occurrence

Bituminous Fire and Marine Insurance brought the underlying declaratory judgment action, seeking a determination as to whether a commercial general liability policy covered damage caused by faulty workmanship. The lower court found for the insured, but the South Carolina Supreme Court reversed the decision. The case is L-J, Inc. v. Bituminous Fire and Marine Insurance Company, 2004 WL 3540903 (S.C.). Note that this case has not been released for publication and is therefore subject to revision or withdrawal.

The contractor, L-J, was hired to perform site-development work and to build roads for a housing subdivision. L-J hired subcontractors to perform most of the work. Some years after the project was completed, the roads deteriorated and the project developer sued L-J for breach of contract, breach of warranty, and negligence. The lawsuit was settled and L-J sought indemnification from Bituminous. The insurer refused. When the dispute ended up in court, the lower courts found that the damage constituted an occurrence and that no exclusions applied. The case then went to the state supreme court.

The court saw the issue as whether property damage to the work alone, caused by faulty workmanship, constituted an occurrence. The court noted that, even though this was a question of first impression in South Carolina , a majority of other jurisdictions that had decided the issue held that faulty workmanship standing alone, resulting in damage only to the work itself, did not constitute an occurrence under a CGL policy. Cases from Iowa, Indiana, Ohio, and Illinois were cited as examples.

The facts presented to the court were that, four years after the contractor completed construction of the road system, the roads began to deteriorate and crack. Expert witnesses testified that approximately fifty percent of the cracking was caused by insufficient road subgrade preparation. This was due to the contractor's failure to properly remove tree stumps from the subgrade and to compact the soft, wet clay in the subgrade. Improper drainage was also deemed a cause of the damage. Based on this, the court said that the only occurrences were various negligent acts by L-J during road design, preparation, and construction, which led to the premature deterioration of the roads. The court found that these negligent acts constituted faulty workmanship that damaged the roadway system only. And, the court went on, because faulty workmanship is not something that is typically caused by an accident or by exposure to the same general harmful conditions, the damage in this case did not constitute an occurrence. The CGL form may provide coverage in cases where faulty workmanship causes a third party bodily injury or property damage, but not in cases where faulty workmanship damages the work alone. The CGL form is not to be a performance bond, which guarantees the work, but rather is an insurance policy which is intended to insure against accidents. The Supreme Court ruled in favor of the insurer and held that the damage to the road system was not covered under the Bituminous CGL policy.

Must Insurer Demonstrate Substantial Prejudice to Deny Coverage?

Some states require that the insurer show it has been prejudiced by the actions or inactions of the insured before the insurer can be allowed to deny coverage. New Mexico is one of the states that has held that the insurer must show prejudice by the insured's filing late notice of claim before denying coverage. The following case from New Mexico holds that the insured's breach of the consent-to-settle provision in the policy does not foreclose the right to benefits unless the insurer demonstrates substantial prejudice from the breach. The case is State Farm Mutual Automobile Insurance Company v. Fennema, 110 P.3d 491 (N.M. 2005).

In this case, Fennema appealed a district court summary judgment in favor of State Farm. The court had ruled that State Farm was not liable for underinsured motorist benefits to Fennema because Fennema breached a contract provision requiring the written consent of the insurer before settling a claim. Fennema had been seriously injured in an auto accident caused by Moses. Contrary to the provisions of the auto policy that Fennema had with State Farm, Fennema settled with Moses without obtaining State Farm's written consent. Fennema then sought UIM benefits from State Farm but the insurer denied the claim because of the breach. The dispute eventually ended up in the New Mexico Supreme Court.

That court looked at previous rulings and noted that it had required the insurer to show substantial prejudice before voiding any insurance policy. The court said that the rationale for the rule is that failure by an insurer to show substantial prejudice by an insured's breach will frustrate the insured's reasonable expectation that coverage will not be denied arbitrarily. Furthermore, as to this case, the court said that it was consistent with the purpose of the state's uninsured motorist statute to require a showing of substantial prejudice. And, it would be inconsistent with this purpose to deny an insured indemnification when the insured's breach of a consent-to-settle provision had no real effect on the insurer's ability to recover from an insolvent tortfeasor through subrogation. The court then noted that a significant body of judicial precedents support the showing of the prejudice requirement; cases from Ohio, Hawaii, and Maine were listed.

However, after deciding that the insurer had to demonstrate substantial prejudice before denying coverage, the court held that a presumption of substantial prejudice arose from the proof that the insured breached a consent-to-settle provision; it was undisputed that Fennema breached this policy provision. Fennema then had a duty to rebut the presumption of substantial prejudice that his actions created. This he failed to do. Fennema failed to meet or rebut the presumption and so, the Supreme Court affirmed the summary judgment in favor of State Farm.

What Are the States Doing?

These changes deal mainly with nonrenewal and cancellation notice requirements.

California has expanded the definition of actual cash value (ACV) under a fire insurance policy that requires payment of actual cash value. ACV is now the policy limit or the fair market value of the structure, whichever is less. As for policies that require payment of replacement cost for a loss, the law now states that the indemnity is the amount it would cost to repair, replace, or rebuild the item lost or damaged, or the policy limit, whichever is less.

Connecticut requires that nonrenewal or cancellation notice must provide a specific reason for the cancellation or nonrenewal to the insured.

Montana amended the state code to introduce an exception to the 45 days' notice requirement for cancellation of any policy insuring private residences. The exception now allows twenty days' notice of cancellation for nonpayment of premium.

New Jersey has revised the minimum number of days' notice that must be provided for nonrenewal of a medical malpractice liability policy from thirty days to sixty days prior to the expiration date of the policy.

Oregon has revised the law to read, in part, that nonrenewal of a commercial liability policy shall not be effective until at least forty-fve days after the insured receives a written notice of nonrenewal from the insurer. Oregon law also now requires the statement to elect lower UM/UIM coverage limits to be signed within sixty days of the time the named insured makes the election.

Rhode Island requires every insurance policy to provide clear language on the method of calculation of the unearned premium portion to be returned to the insured if the policy is cancelled.

Virginia has amended its code to require ninety days' notice to the insured for cancellation and nonrenewal of medical malpractice policies.

Wyoming has revised its notice requirements for professional health care malpractice liability policies. The state now requires 90 days' notice.

Noteworthy Case:

An insured's failure to pay a renewal premium is not the equivalent of an insurer's cancellation of a policy, and therefore the insurer does not need to send cancellation notice. This was the finding in Blackwell v. Farmers Insurance Exchange, 2005 WL 1595246 (Oh. App. 4 2005). The insured received notice of renewal premium, which said the policy would be renewed if either the full or the optional budget payment was received by the renewal date, March 29. The insured did not pay the renewal. On April 10 the insurer sent an expiration notice, which said that if payment was received within 15 days after the due date, the policy would renew with no lapse. The notice added that if the payment was not received within the 15 days, coverage would cease as of the due date. The insured did not respond.

A fire on April 20 destroyed the insured's home, and on April 22 she express-mailed a check to the insurer. She subsequently stopped payment on this check, and took a check to her agent on April 24. But on April 25, the insurer mailed a notice saying the policy had cancelled for non-payment effective March 29. The insurer agreed to reinstate the policy effective April 24, the date the agent received payment, but denied coverage for the fire damage. The mortgagee claimed coverage, and the insurer paid its claim.

The insured sued, alleging the insurer had failed to properly cancel the policy, so it remained in force. She asserted that law required she receive a notice of cancellation ten days before the cancellation date as well as the premium notice, and that the fact that the insurer paid the mortgagee's claim proved coverage had been in force.

The court, in finding for the insurer, observed that the insured's failure to pay the renewal meant that the policy had lapsed, and so the insurer did not have to comply with state law regarding cancellation. (The court looked at Ohio code, and found the provision cited by the insured did not apply to homeowners insurance policies.) Further, stated the court, the insured was only speculating as to why the insurer paid the mortgagee, and speculation was “not sufficient to overcome a properly supported summary judgment motion.

Third Quarter Losses

Reuters reports that, according to ISO, U.S. property and casualty insurers paid an all-time record $40 billion to homeowners and businesses in fourteen states for the third quarter. Insured losses for the first nine months of 2005 stand at $43.8 billion, “thanks” to nineteen catastrophic events. Hurricanes Katrina, Rita, and Dennis account for over $40 billion of this amount.