By Luke J. Farley and Dixie T. Wells
One of the most important functions of a construction contract is to allocate risk between the parties. Among the key risk-shifting terms of any construction contract are the insurance provisions. Most contracts have an entire section devoted to insurance that describes the types and amounts of coverage both the contractor and the owner must maintain during the project. These provisions also require the parties to obtain insurance policies that include particular terms such as who is covered under the policy and which parties can sue each other for losses covered by insurance. Not obtaining the required insurance can be a breach of contract. This article examines the most common insurance terms, what they mean, and how to negotiate them.
TIP: When negotiating a construction contract, consider consulting your insurance agent. The agent can tell you whether you already have the required types and levels of coverage, and, if not, what it will cost to obtain what you need.
TYPES OF INSURANCE
The basic terms of the contract should list the types and levels of insurance coverage each party must maintain during the project. Three common types of insurance required in construction contracts include Commercial General Liability, Workers’ Compensation, and Builder’s Risk.
TIP: Many contracts refer to insurance “limits.” This can lead to confusion. The contracts establish the minimum amount of insurance a party must carry. The “limit” is a limit on the amount the insurance company could be required to pay under the policy, not the contractor’s overall liability to the owner. To limit liability, contractors should negotiate other provisions that waive consequential damages or cap overall damages.
Contracts almost always require contractors to maintain Commercial General Liability (CGL) and Worker’s Compensation insurance. CGL coverage insures against losses from personal injury or property damage due to the contractor’s negligence. In the current market, the typical amount of coverage required for a CGL policy is $1 million per “occurrence” (i.e., per single accident) and $2 million in the “aggregate” (i.e., total amount payable during the policy term, usually a year). The amount of Worker’s Compensation coverage is usually dictated by state law. Contractors may also be required to carry automobile, pollution, environmental, property, and umbrella insurance.
TIP: When negotiating insurance requirements, contractors should consider whether the required insurance is relevant to their scope of work. For instance, there may be no need to require a contractor building a parking deck to maintain environmental or pollution insurance if the work does not involve hazardous chemicals.
Contracts usually require owners, for their part, to also carry CGL insurance.
The parties will often negotiate whether the owner or the contractor will provide the Builder’s Risk policy. Builder’s Risk is property insurance that covers the building under construction plus materials and equipment on site. It provides critical protection to the project during construction because ordinary property insurance does not cover construction in progress. Builder’s Risk insurance can either limit coverage to certain risks (e.g., vandalism, fire, etc.) or be written on a broad, “all-risks” basis. Both the owner and the contractor will benefit from an “all-risks” policy. Owners and contractors must take care to ensure that one of them obtains the Builder’s Risk.
TIP: Whichever party obtains the Builder’s Risk policy will have more control over making a claim under the policy and receiving payment for a loss.
Before starting work or getting paid, the contractor will often be required to prove it has the required insurance by providing the owner with certificates of insurance showing the proper type and level of coverage.
ADDITIONAL INSURED
Contracts frequently require the contractor to name the owner as an “additional insured” under the contractor’s insurance policies. Naming the owner as an additional insured entitles the owner to make a claim under a policy of insurance as if the owner was the primary named insured. Owners like being an additional insured because it allows the owner to make a claim under someone else’s policy and avoid the premium increase that would likely result from the claim. Adding an additional insured to a policy increases the insurance company’s risk—another person can now make a claim—and so there is an added cost to the contractor. Adding the owner as an additional insured does not happen automatically simply because it is required by the contract; instead, the contractor must purchase an “endorsement” (i.e., amendment) to the insurance policy.
WAIVER OF SUBROGATION
The term “subrogation” means to stand in the shoes of another person. In the insurance context, it means an insurance company standing in the shoes of its policyholder. Construction contracts often require each party to waive the right of its insurance company to be subrogated. Consider the following scenario. A contractor builds a warehouse for an owner. The warehouse is built with faulty wiring, catches fire, and burns down. The owner makes a claim on its own insurance policy and the insurance company pays the claim. Because the insurance company has paid for the loss, the insurance company gets to stand in the shoes of the owner and sue the contractor to recover the amount the insurance company paid to the owner. When the parties agree to waive subrogation, they agree that their insurance companies cannot sue the other party that supposedly caused the loss. Waivers of subrogation increase the insurance company’s exposure—the insurance company may have to pay a claim without having recourse against the responsible party—and so the waiver can only be added to the insurance policy by purchasing an endorsement. Like naming an additional insured, it is not sufficient for the contract between the owner and the contractor to contain the waiver of subrogation. Waivers of subrogation are popular with owners and contractors alike because they tend to cut down on litigation; if a party suffers a loss and that loss is paid by an insurance company, that is the end of the story.
CLOSING THOUGHT
Insurance provisions read like technical legalese and can be an afterthought when negotiating the construction contract. But with a basic understanding of the contractual insurance provisions, contractors can be empowered to actively negotiate these key risk-shifting terms.
About the Authors:
Dixie T. Wells is a partner in the Greensboro, North Carolina, office of Ellis & Winters LLP. She represents clients in lawsuits involving engineering issues, higher education law, complex commercial transactions, and products liability. She is a member of the Construction Law and Litigation Committee of the International Association of Defense Counsel. She can be reached at dixie.wells@elliswinters.com.
Luke J. Farley is a construction attorney and partner in the Raleigh, North Carolina, office of Ellis & Winters LLP. The majority of his practice is devoted to contract disputes, state and federal Miller Act claims, mechanics’ liens, and OSHA citations. He also assists clients with contract negotiation and project-level advice. He can be reached at luke.farley@elliswinters.com.
This article is not legal advice and does not create an attorney-client relationship.
Modern Contractor Solutions, January 2022
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