Evolving AI Endorsement Interpretations Create More Headaches For Contractors

Conflicting court decisions relating to the scope of the coverage grant under additional insured endorsements are further clouding an already complex landscape of liability insurance coverage for the construction industry.

Vast differences in the wording of additional insured endorsements are among several factors that have contributed to inconsistent application of this critical coverage over the years.

More recently, a 2008 coverage ruling by a Washington appeals court holding that certain language within an additional insured endorsement did not provide for products/completed operations coverage--a finding directly opposed to a ruling by another court in the same state two years earlier--has added new headaches.

Ongoing revisions to state anti-indemnity statutes muddy the situation even further.

These developments have arisen at a time when potential risks are growing. Recent trends include the rise of overall total claim costs (both indemnity and expense payments), increased requirements of insured retention levels, and the unknown exposures encountered by contractors from new project delivery methods, environmental building requirements and the ownership and approval of electronic software for design drawings.

Additional insured endorsements continue to be among the most important tools utilized in a risk-transfer process within the construction industry. They arguably remain one of the frequently discussed topics found in today's risk management strategies.

Generally, risk transfer in the construction arena is initially handled contractually--in agreements between the owner and general contractor or between the general contractor and subcontractor.

In a contract between a general contractor and subcontractor, for example, the subcontractor typically agrees to indemnify and hold the general contractor harmless of a wide range of risks. In most cases, a subcontractor's insurance policy will be endorsed with an additional insured endorsement to cover that transfer of risk, which is typically required by contract.

Essentially, an additional insured endorsement allows the subcontractor to list a general contractor as an additional insured on the subcontractor's policy (or a contractor to list a project owner as an additional insured on the contractor's policy).

The application of additional insured endorsements for presented claims relies heavily upon the version of the Insurance Services Office policy form and any applicable court rulings from individual state jurisdictions.

In the past, most parties utilized the endorsement language contained within ISO's 11/85 edition. The endorsement language included additional insured's liability "arising out of [the named insured contractor's] work."

This resulted in the additional insured having broad coverage for both direct and vicarious liability in connection with both ongoing and completed operations, including liability arising out of their sole negligence. The subsequent endorsement revisions (October 1993, March 1997 and October 2001) were created to refine and reduce coverage to the additional insured.

The 2004 ISO editions further impacted the most commonly utilized endorsements (CG 2010, CG 2033 and CG 2426) and remain the major endorsement wording being utilized today. These changes created coverage form language for additional insured's liability "caused in whole or in part by [the named insured contractors'] acts or omissions...in the performance of [the named insured contractor's] ongoing operations."

Overall, very little case law has developed over the years for these endorsement editions and the applications of the coverage for completed projects are just now being experienced in the industry.

Of the decided coverage case law, many of the opinions have conflicted in their interpretation of the endorsements' application. Recently we experienced opposing opinions for the intent and application of these utilized coverage forms in the same jurisdictions.

In Valley Insurance v. Wellington Cheswick, LLC in 2006, the U.S. District Court for the Western District of Washington found that "ongoing operations" includes damages that have resulted from completed work. Since the policy itself did not define "ongoing operations," the court looked at its plain meaning for interpretation.

"While property damage may not have occurred during [the] ongoing operations, the alleged liability did," the court said, ruling that a general contractor did have coverage for construction defect allegations brought after a subcontractor's work had been completed even though the wording of the additional insured endorsement at issue limited coverage to claims arising out of the named insured subcontractor's ongoing operations.

However, in July 2008, the Court of Appeals Division 1 of the State of Washington issued a differing opinion on this debate. In The Hartford Insurance v. American States Insurance Company, the Washington court found that the "ongoing operations" language within the endorsement of a subcontractor's policy did not provide for products/completed operations coverage of the additional insured--a condominium developer.

The court noted that its conclusion was supported by an earlier California appeals court ruling in 2000 in Pardee Construction Co. v. Insurance Co of the West. In Pardee, the Califonia court had examined the evolution of the endorsement language to find that the phrase "ongoing operations" demonstrated the intent to provide coverage to an additional insured only for liability that arises while work is still in progress.

"Without such clearly limiting language, the coverage could be interpreted as extending to completed operations. This would allow a contractor who is an additional insured to be indemnified for damages arising from a subcontractor's work even if it is not discovered for years," the court said.

Despite creating a differing opinion on this issue for the state of Washington, the appeals court in the Hartford Insurance case left open the possibility that "completed" damages which were incurred during the "ongoing operations" period could be covered by the endorsement.

The court also discussed coverage for defense costs, noting that factual allegations determine whether the insurer that provides a policy with an additional insured endorsement must tender a defense for the additional insured for claims that did not arise out of the policyholder's ongoing operations.

In this particular case, the complaint against the additional insured--the developer--brought by a condo association alleged only "construction defects." The complaint "did not specifically allege liability arising from the work of subcontractors while it was still in progress," the court said.

In addition, the court noted that the insurer in this case refused coverage in a letter stating that the named insured subcontractor's work was completed and accepted by the developer before the condo owners took ownership of their units.

Thus the debate and confusion on the application of the additional insured language will continue to evolve and develop, leaving many risk managers trying to determine what protection they may have from this provided coverage. This issue will continue to grow as an increasing amount of losses will arise from completed projects which utilized this endorsement edition.

Unfortunately, the changing interpretation of the additional insured endorsement is not being limited to case law. A majority of states have created anti-indemnity statutes, which define the scope of legal liability that one party may transfer to another in a contract. However, many jurisdictions have recently applied new standards on their anti-indemnity statutes that also apply to additional insured endorsements.

Despite continued arguments that these risk-transfer tools are separate and distinct from each other, the legislators and courts in several jurisdictions--such as Colorado, Oregon, New Mexico and Montana--have linked anti-indemnity statutes to also apply to potentially broadly worded additional insured endorsements.

In many cases, this result has left many contractors without any typical risk-transfer tools due to both the indemnification agreement and additional insured endorsement being nullified because of their violation of the anti-indemnity statute.

For risk managers to accurately evaluate their exposures from the use of certain additional insured endorsement wording, they must continue to keep abreast of the changing case law and the broader application of anti-indemnity statutes.

This process should also include constant legal reviews of jurisdictions where construction projects have and will be completed. In addition, proactive management of losses and effective strategies in the pursuit of risk transfer enforcement will be vital.

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