Building Bridges Helps Construction Insurers

A growing number of state legislatures have passed laws that provide you with new tools to more effectively control construction claims. Consider yourself on notice of this new opportunity!

The evolution of a construction defect lawsuit is not unique. A property owner is unhappy with workmanship that a contractor considers acceptable. But the property owner and contractor are not seasoned in the science of dispute resolution, and so even the most well-intentioned may not be able to constructively address the claim.

The lack of an effective framework to handle claims is further exacerbated when layers of subcontractors are involved, many of whom may have no relationship with the property owner or little allegiance to the contractor.

Under these circumstances, its not surprising that litigation may actually seem like the path of least resistance. Turn the mess over to the lawyers and let them sort out who is at fault.

Unfortunately, under the distorting spotlight of litigation, a property owner's perception of a contractor's fault is magnified, and a contractor's conviction about the quality of its workmanship becomes immutable. Throw in a diverse cast of cantankerous subcontractors and you get a toxic mix leading to skyrocketing legal expenses and the potential for significant damages.

Wouldn't it be great if you could rewind this scenario and give the property owner and contractor a constructive process designed to help them resolve their disputes without litigation?

In our litigious society, this question sounds a lot like finding a way to get Michael Moore invited to the Bush family Thanksgiving! But in a number of states, many of which are not exactly poster children for judicial restraint, the functional equivalent of a Bush-Moore union occurred state legislatures actually passed laws whose purpose is to promote dispute resolution without lawyers, judges or juries.

Commonly known as "notice and opportunity to repair" laws, these statutes establish a comprehensive set of alternate dispute resolution procedures, and are in place in a growing number of states, including construction litigation havens like California, Florida, Nevada and Texas.

Notice and opportunity to repair statutes require property owners to put contractors on notice of construction defect claims before lawsuits can be filed. Contractors then have a right to inspect the dwelling and assess the alleged defect. If the property owner and contractor agree, this inspection can include destructive testing.

The contractor also has the right to put any other potentially responsible contractors on notice of the claim, and those contractors then have a right to inspect the dwelling.

All contractors on notice typically have to respond to the property owner and offer to:

Repair the defect or damage at no cost,

Make a monetary offer to compromise, or

Dispute the claim.

How do these statues benefit insurers?

For starters, they may cause parties to resolve construction claims without seeking insurance coverage particularly in the case of smaller claims where contractors may be leery of future premium increases if they tender these claims for coverage.

Where insurers are put on notice of a claim made under an opportunity and notice to repair statue, insurers have an opportunity to investigate and review the facts to assess whether they have any indemnity obligations. This is preferable to reviewing coverage obligations when litigation has commenced, as the duty to defend is typically broader than the duty to indemnity, and the defense obligation is typically governed by the allegations of complaints that are often specifically drafted with an eye toward triggering insurance recovery.

To the extent that coverage may exist, the insurer has an opportunity to work with contractors to settle claims under the statute. Given the significant transactional costs associated with defending these cases, both the insurer and the contractor may have significant incentive to make proactive and meaningful offers to repair or compromise.

Some insurance trade groups have expressed concerns that notice and opportunity to repair statutes might be used to preclude insurers from participating in the adjustment of claims, and bind insurers to cover agreed upon costs of repair or offers of compromise. This is a legitimate concern, although well-known policy conditions may minimize this risk.

For example, the policy's notice clause should be triggered by claims made under notice and opportunity to repair statues, and a contractor that settles a claim under the statute without putting its insurer on notice, but who later seeks coverage for a settlement reached through the statutory process, has breached the policy's notice clause and arguably prejudiced the insurer in the process.

Similarly, a contractor that puts its insurer on notice but does not involve the insurer in the claims process risks breaching the policy's cooperation clause.

In addition, a settlement agreed to without putting the insurer on notice, or allowing the insurer to participate in the claim process, may constitute a voluntary payment that is not covered under the policy.

In at least one state, the notice and opportunity to repair statute directly addresses concerns that contractors will use the statutory process to avoid contractual obligations, but still recover under their policies. Floridas statute expressly provides that nothing in the law precludes a contractor from meeting all of its obligations under liability insurance policies, including contractual provisions that serve as conditions precedents to coverage, like the policy's notice requirements.

Another potential ramification of these statutes arises under first-party policies where property owners seek recovery under first-party coverage before availing themselves of a notice and opportunity to repair statute.

Under these circumstances, if the first-party insurer pays the claim, then it might lose a right of subrogation against the contractor if a subrogation action against the contractor is barred because the requirements of the notice and opportunity to repair statue were not satisfied. The failure of a property owner to first engage in the notice and opportunity to repair process arguably breaches the policyholder's contractual obligation to mitigate loss and prejudices the first-party insurer's interests by potentially jeopardizing its subrogation right.

Insurers are in the business of managing risks, and notice and opportunity to repair statues aid those efforts by creating mechanisms to resolve claims before they reach perhaps the riskiest and costliest forum around the courtroom.

By potentially heading off litigation, defense cost exposure which is often a driver of insurance exposure in these cases may be alleviated.

Furthermore, if insurers are engaged in the dispute resolution process, potential indemnity exposure may also be minimized and contractors may present themselves as useful allies with the common goal of resolving claims outside of litigation.

M. Keith Moskowitz is an attorney for Sonnenschein Nath & Rosenthal in Chicago, practicing in the field of complex commercial insurance litigation. He may be reached at mmoskowitz@sonnenschein.com.

Reproduced from National Underwriter Edition, October 1, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.