Insurance Issues for Mixed Use-Mixed Ownership Common Interest Developments

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Linette Mae Walker
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1 Insurance Issues for Mixed Use-Mixed Ownership Common Interest Developments Mary Alexander, Robert Burton, David Van Atta 1 Introduction A mixed-use project, particularly one with multiple ownership interests, typically includes a mixture of both complementary and divergent uses. There will be common insurance requirements among all uses, but most likely also unique insurance requirements or risks for one use not shared by the other uses in the project. For ease of reference, this paper refers to the project s separately owned residential properties as units and all other separately owned areas as components. Units, components and shared common areas are collectively referred to as uses. In addition to the different risk profiles among uses, there will also be different insurance requirements related to the user. For example, a lease to a national retail tenant will likely have specific insurance requirements, e.g., endorsements, minimum coverage amounts, specific coverage requirements, or a permitted self-insurance program. Adding further complication are requirements often imposed by the project lenders (construction and permanent financing), or lenders of specific components in the project. The challenge for the developer or the insurance trustee 2 is to establish and administer an insurance program that includes the basic needs for the project, but that is flexible enough to respond to the requirements of each specific use, user, and lender, which requirements may not be known at the outset of a project. Additionally, state law or local regulations and the project s entitlement documents may impose specific insurance requirements that must be followed. Careful attention must be paid to each of these requirements to avoid gaps or costly overlaps in coverages. There is no one simple (or complicated) drafting solution to resolve and harmonize all the differing insurance requirements and issues that may arise during the planning, construction, and operations phases of a mixed-use project. However, these issues can be managed by asking the right questions, engaging an experienced insurance consultant as a member of the project team, working with counsel who is well-versed in state and local law requirements and designing some flexibility into the project s governing documentation. This paper is directed principally to a mixed-use project planned and constructed by the developer and submitted by the developer to a governance system, e.g., a master covenant or condominium declaration, that includes specific requirements, imposed upon either the insurance trustee or the various owners, related to the administration and placement of insurance for the project. The project may be created in whole or in part as a condominium subject to particular Uniform Act requirements (as applied in the state where the project is located) or may be platted 1 Mary S. Alexander, DMB Associates, Inc., Scottsdale Arizona; Robert D. Burton, Winstead PC, Austin, Texas and David M. Van Atta, Hanna & Van Atta, Palo Alto, California. 2 The term insurance trustee, as used in this paper, refers to the entity or owner, typically with the principal use, who will be responsible for placement and administration of insurance for the mixed-use project. The insurance trustee could be the specific owner of a use or an organization, e.g., property or condominium association, formed for administration of the project. 1

2 as a horizontal or vertical subdivision with separate ownerships and designated owners of shared components. For any project, whether it includes a single or multiple uses, there are several basic lines of insurance to be considered: property insurance, commercial general liability (commonly CGL insurance ), professional liability/errors and omissions insurance and directors and officers insurance 3. Property insurance may include separate policies or endorsements for damage caused by earthquake, flood, pollution, terrorism, and other specific risks present where the project is located. CGL insurance is a policy issued to business organizations to protect them against liability claims for bodily injury and property damage arising out of premises, operations, products, and completed operations; and advertising and personal injury liability. 4 Errors and omissions insurance is a type of policy that protects the insured professionals working on a project against third party claims alleging errors or omissions in performance of professional duties. 5 Directors and officers coverage provides protection for Board members of governance associations or other responsible owners for their decisions regarding risk management to protect the other owners from liability to third parties and from loss or damage to their own properties or to users of their properties. Any development project requires attention to a broad range of insurance products to fully cover the risks associated with planning, ownership, development and sale of a project. The complexity of mixed use projects with multiple ownerships and governance associations increases the challenge of placing appropriate insurance coverages without duplicating coverage for particular risks or parties and without leaving gaps in coverage. A chart indicating potential insured parties, types of coverage that may be required and sources of specific requirements that must be considered is attached as Exhibit 1. The Design Phase This stage of project planning primarily requires a focus on design professionals errors and omissions coverage. A mixed-use project with multiple uses and owners increases the likelihood for design defect claims after the project is completed. It is necessary to identify any specialty consultants who will contract directly with the owner as opposed to being retained by the architect and include consistent insurance requirements in their agreements with those of the principal architect s agreement. The standard AIA design contract provides for the Architect to maintain CGL insurance coverage, automobile liability insurance, workers compensation insurance at statutory limits, employers liability insurance, and professional liability insurance, with amounts of coverage to be negotiated. The contract requires the CGL and automobile policies, including any excess or umbrella policies, to include the owner as an additional insured. 6 3 This paper does not use the term casualty insurance because the term lacks specificity regarding the type of liability coverage. A treatise written on casualty insurance in 1956 notes that the problem of definition of the term casualty insurance has always existed, but the trend in recent years to comprehensive policy writing and multiple line underwriting has made the definition even more difficult. Casualty Insurance, Clarence A. Kulp, Third Edition, The Ronald Press Co., New York, 1956, pp. xi, See International Risk Management Institute, Glossary of Terms, Commercial General Liability Insurance, 5 International Risk Management Institute, Glossary of Terms, Errors and Omissions (E&O) Insurance, 6 American Institute of Architects, AIA Document B

3 All reputable design professionals involved in these types of complex projects will have some form of professional liability insurance. However, even if the coverage limits maintained by the professional appear adequate, the policy most likely has a single aggregate coverage limit. A single aggregate coverage limit means that the policy applies to all claims against the professional whether the claim arose from the project or a prior or future project. Once the aggregate policy limit has been reached or exceeded, the policy provides no further coverage without applicable excess or umbrella coverages. For complicated mixed-use projects, it may be sensible for the developer to consider a project-specific policy that covers all design professionals to assure that coverage limits are sufficient, although the premium cost for additional coverage beyond that typically carried by an architect often is charged to the owner. This type of errors and omissions coverage is issued on a claims made basis, so it must be maintained in effect to be available when claims arise. To solve this dilemma, tail coverage is available to cover work performed on a project for the applicable statutory period when claims may be presented. Also note that the owner may not be added as a named insured on a professional liability policy, so the architect manages handling the claim with his or her carrier. The Construction Phase The construction phase of a mixed-use project will require placement of a separate insurance program during the course of construction. This includes builder s risk insurance, i.e., property coverage for materials on site and incorporated into the work and CGL insurance. Builders risk insurance is a policy that is designed to cover [losses to] property in the course of construction. 7 CGL insurance during construction covers the same perils as CGL insurance for the completed project, but should be extended to cover completed operations to protect against risks of claims based on construction defects causing personal injury or property damage later to the end users. Because the local jurisdiction may want protection from risks associated with the development during this phase, you should be prepared to comply with insurance requirements imposed in development agreements or other entitlement approvals. A sample of requirements imposed by a City is attached as Exhibit 2. A form of typical lender insurance requirements during the construction phase is attached as Exhibit 3. Controlled Insurance Program. Prior to the commencement of construction, the developer/owner and the general contractor, along with their respective insurance consultants, will design and activate an insurance program for the construction phase of the project. Most large projects will utilize a controlled insurance program, also referred to as wrap-up ( CIP ), under which all parties performing construction work on the project, i.e., general contractor and sub-contractors, are covered in a single insurance program. The CIP program traditionally includes builder s risk, CGL coverage, worker s compensation and some excess or umbrella coverage, and may be endorsed to include contractors pollution legal liability. There are two forms of CIP coverage: an owner controlled insurance program ( OCIP ) and a contractor controlled insurance program ( CCIP ). One of the initial decisions for the developer is whether to use an OCIP or CCIP for the project. During the construction stage, the immediate stakeholders are probably limited to the developer and its partners and/or joint venturers, if any, general contractor, design professionals, and lenders. The project also may be subject to a 7 International Risk Management Institute, Glossary of Terms, Builders Risk Policy, 3

4 development agreement with a private or public third-party, to vest the entitlements prior to segregating the uses, ownership and administration of the completed project. This may be a source of additional insurance requirements to protect the local jurisdiction authorizing the development, particularly if the sale of Community Facilities District bonds is permitted. Another list of insurance requirements for the construction period will be included in the loan agreement between the developer and its lender. All of these requirements should be outlined in a detailed insurance matrix to be certain that multiple policies being purchased by different parties do not insure identical risks for the named insureds and additional insured parties. For example, the lender s requirements may be satisfied through an OCIP or a CCIP program, with the owner and lender named as additional insureds. The decision whether to use an OCIP or CCIP for the project is made by the developer and the general contractor in conjunction with their insurance consultants, with the developer most likely making the final decision. This may be determined in the first instance, by the project s budget. Because an OCIP program is required to be administered by the developer, the developer is required to enter into a separate service agreement with a third-party provider to operate the program, including the allocation of premiums and administration of claims, which will result in higher operational and administrative costs. However, this approach provides the Owner with control of the policy and administration of claims. The developer/owner may have the opportunity to realize cost savings through insurance premium reductions or reimbursements if the amount of work completed during the policy period is below the level of assumed construction work when the insurance was underwritten. In addition, the developer has the opportunity to more closely tailor the CCIP insurance program to project phasing during construction. The handling of claims under a CIP generally is coordinated and administered by one insurance provider covering all of the construction and development parties. For projects without such "wrap coverage," the developer, the contractor, the subcontractors and design professionals will have separate coverages with different carriers. This can lead to protracted and complicated claims resolution, with different parties and their insurance carriers pitting themselves against the other development parties and carriers in addition to defending litigation regarding the claim. An OCIP also provides the developer with the opportunity to determine how self-insurance components of the coverage will be shared with the contractors and subcontractors when a claim arises. Because contractors typically would have to pay a self-insured portion of a claim if utilizing their own CGL insurance, it is prudent to allocate responsibility for a portion of the selfinsured component of a claim under a CIP to the responsible contractors, either based upon their typical self-insured retention amounts or some other agreed upon formula. A potential gap exists if an owner relies exclusively on an OCIP to insure the project s contractors, because it does not include liability coverage for accidents or other occurrences outside the project s boundaries. Contracts should include insurance requirements for these types of risks separately and provide that the contractors must obtain their own policies naming ownerrelated parties as additional insureds. Coordination With State Enabling Statutes. A CIP provides coverage until the project or a defined component thereof is substantially complete, with the exception of coverage for 4

5 completed operations 8. If the developer/owner intends to retain title to the entire project, the timing of permanent replacement coverage, i.e., when permanent insurance takes over for the coverage provided by the CIP, is less troublesome as compared to a project in which components will be separately conveyed or financed. In several regulatory jurisdictions, substantial completion of the project may occur long after a use component can be conveyed to a thirdparty 9. In a vertically-integrated mixed-use project, the developer has legally segregated each use in accordance with the state-enabling statute (condominium act or horizontal property law). The enabling statute may have requirements for insurance that must be in place prior to conveyance of a use to a third-party. For example, Section of the Uniform Condominium Act (the Uniform Act ) requires that prior to the first conveyance of a unit to a third-party the condominium association maintain property and liability insurance. 10 Keep in mind that in each instance the insureds named on a property policy must have an insurable interest in the property. In contrast, some states, such as California, do not have any mandated insurance requirements for condominium projects. 11 Strict compliance with the applicable regulatory requirements through the acquisition of a separate policy during the CIP coverage period duplicates coverage and raises issues associated with coordination of claims. For the mixed-use project where components will be conveyed in stages prior to the CIP coverage term ending, these issues should be addressed at the inception of the project with the general contractor and insurance consultants and, if necessary, included in the governing document insurance provisions. One approach is to provide that partial occupancy or use shall not commence until the insurance companies providing builder s risk property coverage have consented to such partial occupancy. 8 Completed operations coverage is an endorsement or coverage provided under the commercial general liability policy placed as part of the CIP program and covers work done pursuant to the construction contract that causes personal injury or property damage to third parties. It does not provide recovery for the developer against the contractor for the developer s own injury or damage to the work, which should be covered under contractual warranties. 9 It is common among local building regulatory authorities to issue a temporary certificate of occupancy ( TCO ) prior to issuance of a permanent certificate of occupancy for the entire project. In most circumstances, if a TCO permit is issued for a specific use component of the project, that competent can then be separately conveyed and financed. 10 Arizona Revised Statutes section requires the following no later than the first conveyance of a unit to a person other than the Declarant: (a) Property insurance on the common elements insuring against all risks of direct physical loss commonly insured against or, as determined by the board of directors against fire and extended coverage perils. The total amount of insurance after application of any deductibles shall be not less than eighty percent of the actual cash value of the insured property at the time the insurance is purchased and at each renewal date, exclusive of land, excavations, foundations and other items normally excluded from property policies. (b) Liability insurance in an amount determined by the board of directors but not less than any amount specified in the declaration, covering all occurrences commonly insured against for death, bodily injury and property damage arising out of or in connection with the use, ownership or maintenance of the common elements. 11 California laws pertaining to common interest developments do not mandate or govern the amount of type of property insurance coverage that must be provided for or by a developer or association. A summary of an association's policies of insurance must be provided annually by a residential common interest development association under California Civil Code section There is no similar requirement for projects that do not have separate residential ownership interests, such as those that are governed by the Commercial and Industrial Common Interest Development Act. Cal. Civ. Code sec et seq. Since 2014 California has two distinct laws that separately govern residential common interest developments, Cal. Civ. Code sec et seq., and commercial and/or industrial common interest developments, Cal. Civ. Code sec et seq. 5

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