Recent Case Shines Light on Insurance Clauses

When you draft a contract for your next construction project, consider the protections and consequences that an insurance clause may bring. Based on a recent Indiana Supreme Court decision, such a clause can have unexpected ramifications.

In U.S. Automatic Sprinkler Corp. v. Erie Insurance Exchange, an office complex tenant, Sycamore Springs Surgery Center, LLC, hired U.S. Automatic Sprinkler Corp. to install a sprinkler system in the building. This tenant had a lease amendment making it responsible for the sprinkler system and its maintenance. The amendment also required Surgery Center to have an insurance policy to cover any damage resulting from the system. In November 2016, Automatic Sprinkler tested the system and concluded it was working correctly. However, the following month, a building maintenance worker noticed a leak and contacted Automatic Sprinkler directly (not through Surgery Center). An Automatic Sprinkler employer visited the property and made an adjustment to the system. A few days later, pipes froze and then burst, which caused damage to several co-tenants, including a dentist insured by Erie Insurance Exchange.

The co-tenants then filed suit against Automatic Sprinkler. In addition, Travelers (the Surgery Center insurer) and Erie filed suit against Automatic Sprinkler in subrogation. These claims were consolidated.

In response, Automatic Sprinkler sought summary judgment against the co-tenants and Travelers. It argued that the agreement to insure and the subrogation waiver in the inspection agreement precluded the subrogation action from Travelers. As for the co-tenants, Automatic Sprinkler asserted that it had no responsibility to these parties and was not liable for their damages.

How the Courts Ruled

Both motions were denied by the trial court, and Automatic Sprinkler appealed. The Court of Appeals affirmed the denial of the motion against Travelers. It stated that the inspection agreement was not applicable since the damaging work occurred outside its scope. However, it reversed the denial of Automatic Sprinkler’s motion against the co-tenants. It stated that with no contractual privity, Automatic Sprinkler was not responsible for their damages.

The case then reached the Indiana Supreme Court. That court determined that the contractor was entitled to summary judgment against both the insurer and the co-tenants. Due to the contract’s agreement to insure and its subrogation waiver, the court unanimously agreed that Travelers could not recover through subrogation. The contract placed all liability on insurance. And based on Indiana common law, the court determined in a 4-1 decision that there was no contractual privity between Automatic Sprinkler and the co-tenants, precluding them from recovering property damages (and noting there were no personal injuries). Therefore, the court reversed the trial court’s decision and entered a summary judgment in favor of Automatic Sprinkler.

The Role of Insurance in This Case

It is common for construction contracts to include provisions related to liability for loss. Some provisions may assign responsibility for loss to one party, limit liability for future loss, or require the parties to insure against loss. In the event that a waiver of subrogation is paired with an insurance requirement, most courts will determine that the affected parties must rely on the insurance for recovery, even if the insurance coverage is not fully adequate.

The premise of subrogation allows a third party, such as the insurance company, to collect a debt or recover damages. However, since the policyholder in this case signed a subrogation waiver, the insurance company was not allowed to pursue such action.

The Indiana Supreme Court explained: “An agreement to insure is intended ‘to provide both parties with the benefits of insurance regardless of the cause of the loss (excepting wanton and willful acts).’” It went on to state: “Like an agreement to insure, a subrogation waiver signifies the contracting parties’ intent to recover damages ‘through insurance claims, not lawsuits’—but perhaps more explicitly.”

Quite often, it is not problematic to place the risk of loss solely on the insurance that the contract requires, as long as all parties agree and the policy coverage is sufficient. However, property owners must not assume that contractors are liable for any damages that result from work they were hired to perform. Instead, the contract may limit their recovery only to the insurance payout.

In this case, Travelers and the co-tenants pursued claims against the contractor. However, there is also a question of liability for Surgery Center, the customer who hired the contractor. In such an instance, the customer would be smart to include an indemnity clause in the contract, ensuring that any liability for faulty work would fall to the contractor doing the work and the applicable liability insurance.

Final Thoughts

This case illustrates the impact of insurance on a construction project, and it demonstrates that contractors are not necessarily liable for defective work. Before you sign your next contract, check it for insurance requirements and be certain you fully understand where the liability lies.

Author’s note: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.

About the author: Trent Cotney is a partner and Construction Practice Group Leader at the law firm of Adams and Reese LLP and NRCA General Counsel. For more information, call (866) 303-5868 or email tr[email protected].