As a general matter, after payment of a loss is issued to an insured, the insurer is entitled to pursue any right of action the insured may have against a third party whose negligence or wrongful act caused the loss. The insurer is able to do this through subrogation.
Insurers can be subrogated only to those rights possessed by the insured. In other words, the insurer “steps into the shoes” of its insured in seeking recovery of its payment for a loss. Therefore, any defenses available against the insured would also apply to the insurer in the subrogation action.
A common defense to a subrogation action is an express “waiver of subrogation” provision contained in a contract between the insured and the allegedly negligent third party. In a waiver of subrogation provision, the parties to a contract agree to waive any rights of recovery against each other to the extent the loss at issue is covered by insurance. The purpose behind waivers of this type is to avoid the hassle of litigation and allocate the risk of loss related to the contract to the insurance carrier. This provision is most commonly used in construction contracts.
However, waiver of subrogation provisions can also be found in real property lease agreements and other similar agreements. Let’s discuss some common interpretation and enforcement issues as well as ways for insurance carriers and claims professionals to avoid the harmful effects of this provision.
Other Contract Provisions
Waiver of subrogation provisions are not interpreted as stand-alone provisions. Courts often look to related contract provisions when analyzing the scope of the waiver. Insurers also try to avoid the effect of a subrogation waiver by arguing that it conflicts with other provisions in the contract.
Construction contracts often contain a provision that requires the contractor to indemnify the owner of the property for damage to the property to the extent such damage is caused by the negligence of the contractor. This type of indemnity provision would seem to contradict a waiver of subrogation provision releasing the contractor from liability to extent of insurance coverage. Many subrogation waivers, however, expressly provide that the waiver is effective even when the party seeking protection of the waiver would otherwise have a duty to indemnify the owner of the property.
Insurance carriers seeking to exercise subrogation rights have argued that subrogation waivers can be read to conflict with indemnity clauses and should be stricken from the contract.
Some courts have held that these two provisions are consistent by concluding that the indemnity clause was designed to protect the property owner from third-party claims as opposed to damage to the owner’s property. Other courts have found that the two provisions create an ambiguity which must be resolved through introduction of extrinsic evidence as to the parties’ intent.
Waiver of subrogation provisions in construction contracts are typically designed to apply to the work to be performed by the contractor as defined by the contract. Accordingly, the contract’s definition of “the work” can be very important in determining the scope of the waiver. Disputes often arise as to whether damage to existing or adjacent property falls within the definition of “the work.” The scope of the waiver, as expressed in the language of the contract, is important in all contexts involving subrogation waivers. Courts will tend to focus on the language of the contract to determine the parties’ intent as to the scope of the waiver of subrogation.
Many construction contracts require the owner of the property to procure builder’s risk insurance which covers damage to the portion of the property where the work is to be performed by the contractor. This is consistent with most subrogation waivers which limit their application to the work to be performed by the contractor. In some cases, however, the owner has also procured insurance covering property which was not part of the work to be performed either pursuant to the terms of the construction contract or voluntarily.
Some courts have held that subrogation waivers seemingly limited to the work to be performed can be extended to apply to damage to parts of the property outside the scope of the work because the owner procured insurance covering the damage at issue in the case.
In summary, the critical first step in determining whether a waiver of subrogation is valid is to review the language used in the waiver and other relevant contract provisions. Next, a review of the applicable state laws is needed to determine if your state applies waivers broadly or narrowly.
Breach of the Insurance Policy
As a general rule, waiver of subrogation agreements are usually upheld by the courts to preclude an insurer from pursuing a subrogation action. Many insurance policies do not prohibit subrogation waivers when they are entered into before the loss has occurred. Accordingly, in the typical situation, a pre-loss waiver of subrogation will operate as intended by the parties to the contract. Namely, the risk of loss will have been shifted to the insurance carrier to extent of the available coverage.
However, parties without a subrogation waiver agreement at the time of a loss might seek to avoid litigation with a post-loss subrogation waiver. To address this situation, most insurance policies contain a provision stating that its insured must do nothing to impair the insurer’s subrogation rights after the loss without the insurer’s consent. This insurance policy provision may allow the insurance carrier to deny coverage if a post-loss subrogation waiver is executed without the insurer’s consent because the insured prejudiced the insurer’s subrogation rights in violation of the policy’s terms. Denial of coverage would be necessary in this situation because the post-loss waiver might otherwise remain effective as between the insured and tortfeasor.
Other breaches of the insurance policy by the insured can also lead to denial of coverage. Common examples of policy breaches by insureds include failure to cooperate, failure to pay premiums and material misrepresentations. When an insurer denies coverage for a loss which is subject to a waiver of subrogation, the denial of coverage effectively nullifies the subrogation waiver from the perspective of the insurer because the insurer simply refuses to pay for the loss.
Public Policy and Gross Negligence
Insurance carriers seeking to avoid the application of a subrogation waiver have asserted that such waivers should not be enforced when the released party’s conduct in causing the loss amounted to gross negligence. In these cases, the insurer argues that subrogation waivers should be held unenforceable because public policy generally precludes contractually releasing one’s liability for gross negligence.
There is a split of authority among jurisdictions as to whether waivers of subrogation can be enforced when the released party committed gross negligence. Some courts, including courts in Maine, New York, Nebraska and Vermont, have distinguished waivers of subrogation from typical liability releases based on the fact that there is no risk of one party being left uncompensated for a loss under a waiver of subrogation because the risk of loss has been shifted to the insurance carrier as opposed to the injured party. Courts in these states—as well as in Massachusetts—have also recognized that subrogation waivers serve an important public policy not addressed by liability release provisions. Specifically, subrogation waivers avoid disruption of construction projects and reduce complex construction litigation. Courts in other jurisdictions, including Kansas and Georgia, have essentially equated waivers of subrogation to traditional liability releases in holding that waivers of subrogation are ineffective when applied to grossly negligent conduct.
In the construction context, it is easy to assume that waivers of subrogation provisions apply only to losses occurring during the construction process. However, some courts have held that subrogation waivers apply to losses which occurred after work was completed and final payment was made. When courts have addressed this issue, the determinative factor has usually been whether the contract language indicates that the parties intended the waiver of subrogation to apply to post-completion losses.
Some contracts contain a subrogation continuation clause which provides that, if insurance is to be provided on the completed project, the owner shall waive all rights under the same terms of the waiver of subrogation provision for losses covered by the insurance. Courts have generally held that a subrogation continuation clause extends the waiver to post-completion losses. Courts have been somewhat less willing to similarly extend waivers of subrogation when the contract did not contain a subrogation continuation provision.
Subrogation Waived Without an Express Provision
In some jurisdictions, an insurer’s subrogation rights are waived when a party merely agrees to procure insurance to cover damage caused by the negligence of another. In Walker v. Vanderpool, the Virginia Supreme Court held that where “a plaintiff has contracted to protect the defendant from a loss by procuring insurance, the plaintiff (or his subrogee) may not recover for that loss from the defendant even if the loss is caused by the defendant’s negligence.”
In these jurisdictions, including Virginia, Missouri, Iowa, Florida, Georgia, Indiana, Minnesota, Maryland, New Jersey and Wyoming, the scope of the implied subrogation waiver would only be limited by the scope of insurance coverage available under the policy.
Options for the Carrier
Insurers can protect themselves from waivers of subrogation in several ways. In many jurisdictions, insurers can insert a policy exclusion which permits the insurer to deny coverage if an insured waives the insurer’s subrogation rights. Similarly, insurers can require their insureds to warrant at the time the policy is issued that the insured has not, and will not, waive the insurer’s subrogation rights. Insurers can also investigate their insured to determine whether subrogation rights have already been waived. If subrogation rights have been waived, then insurers can raise their premiums to offset any payments for losses where there is no subrogation right. Finally, insurers can obtain reinsurance to cover any waived subrogation rights.
By carefully reviewing the relevant documents with these questions in mind, the claims professional can better determine the insurance carrier’s rights and options following a loss involving waiver of subrogation issues.