POST: VIRGINIA SURETY vs. NORTHERN INSURANCE CO.

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1 10 South Riverside Plaza, Suite 1530 Chicago, Illinois Fax: SEMINAR May 1, 2007 POST: VIRGINIA SURETY vs. NORTHERN INSURANCE CO. The Ramifications to All on the Lack of Coverage for an Assumed Contractual Risk Gregory G. Vacala Managing Partner, Civil Litigation Department Direct Line: (312) POST: VIRGINIA SURETY vs. NORTHERN INSURANCE CO.

2 TABLE OF CONTENTS PARTIES AFFECTED...1 I. THE PRACTICAL IMPLICATIONS: The Ultimate Nightmare II. BACKGROUND FACTS AND LAW A. The Facts: Contractual Indemnity Provision Exemplar for Discussion...2 B. The Case Law Kotecki Cap Braye Waiver...3 III. DISCUSSION OF INSURANCE IMPLICATIONS A. Employers Liability Policies Do Not Cover a Braye Waiver...4 B. Commercial General Liability Policies - Insured Contract Exception to Exclusion Pre-2007 There was a Conflict Between the Appellate Districts as to CGL Coverage Virginia Surety: No CGL Coverage IV. EFFECT OF VIRGINIA SURETY ON INSURERS A. Employers Liability Policies...6 B. Commercial General Liability Policies...7 C. Construction Industry vs. Non-Construction Industries (2007) General Rules a. A construction contract assuming the tort liability of another will never trigger coverage as the underlying contract will ii

3 be void b. A non-construction contract assuming such liability will trigger coverage V. EFFECT ON PARTIES TO INSURED CONTRACTS A. Effect on Indemnitors....8 B. Effect on Indemnitees VI. VII. SAFEGUARDS TO AVOID POST-JUDGMENT DISCOVERY OF INSUFFICIENT FUNDS INSURANCE COMPANY ENDORSEMENTS...10 A. Suggested: EL Policy Endorsement to Provide Coverage for Braye Waiver...10 B. Suggested: CGL Endorsement to Provide Coverage for Braye Waiver...10 iii

4 PARTIES AFFECTED The Illinois Supreme Court s opinion in Virginia Surety Company, Inc. v. Northern Insurance Company of New York (Supreme Court of Illinois docket No ), has significant ramifications to the following: 1. Parties providing contractual indemnity; 2. Parties who assume they are protected by an indemnity provision, and; 3. Insurers (both employers liability and commercial general liability). I. THE PRACTICAL IMPLICATIONS: The Ultimate Nightmare For those wondering the significance of the Virginia Surety decision, I will provide an example of the worst case scenario. Let s assume a simple construction scenario of an owner who retains a general contractor and the general contractor retains a subcontractor. If the subcontractor s employee is injured on the job, he has the right to sue both the owner and general contractor. The owner and general contractor have the right to contribution or third party action against the subcontractor. Let s assume that the employee sues the owner and general contractor; and that the owner and general contractor sue the subcontractor. Further assume that the subcontractor has waived its Kotecki protection against both the general contractor and the owner. follows: Each of the parties has $2 million in insurance coverage. The jury awards a verdict as Owner: General Contractor: Subcontractor: $1 million; $3 million; $2 million Total Verdict: $6 million. Following the holding in Virginia Surety, unless there are specifically endorsed policies to - 1 -

5 the contrary, the subcontractor will be uninsured for the $2 million judgment. Assuming a nonviable entity, the burden of the entire judgment will now fall upon the owner and general contractor. They will be funding the $6 million exposure with $4 million in insurance, remaining personally liable for the excess verdict. II. BACKGROUND FACTS AND LAW By way of background, the issue concerns the availability of insurance coverage to an (employer) insured who agrees to contractually indemnify an owner or general contractor pursuant to an express agreement. The contract which generates the entire basis for analysis generally contains an indemnity provision or paragraph similar to the following: A. The Facts: Contractual Indemnity Provision Exemplar for Discussion To the fullest extent permitted by law, the Subcontract WAIVES ANY RIGHT OF CONTRIBUTION AGAINST AND shall indemnify and hold harmless, the Owner, Contractor, Architect, Architect s consults, and agents and employees of any of them from and against claims, damages losses and expenses * * * arising out of or resulting from performance of the Subcontractor s Work under this Subcontract, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself) including loss of use therefrom WHICH IS caused in whole or in part by negligent acts or omissions of the subcontractor, the Sub-contractor s subcontractors, anyone directly or indirectly employed by them or any for whose acts they may be liable, regardless of whether or not such claim, loss or expenses is caused in part by a party indemnified hereunder

6 B. The Case Law To appreciate the ramifications to an employer providing contractual indemnity, a brief review of case law is appropriate to distinguish the employer-insured s statutory protection; and the consequences of the waiver : 1. Kotecki Cap Absent the agreement to indemnify, the employer would enjoy a cap on its exposure in a suit against it for contribution by a defendant - third party plaintiff such as the owner or general contractor. Kotecki held that an employer s maximum exposure is limited to the amount of its workers compensation liability (statutory indemnity and medical payments). Kotecki v. Cyclops Welding, 146 Ill. 2d 155, 585 N.E. 2d 1023, 166 Ill. Dec.1 (1991). With Kotecki protection, an employer can never sustain exposure in excess of its payments for statutory workers compensation benefits. Any jury verdict for contribution in excess of statutory workers compensation payments is reduced by the court in a post trial hearing. 2. Braye Waiver The supreme court recognized the ability of an (employer) insured to waive its Kotecki protection by the execution of a contract or agreement. Under Braye v. Archer-Daniels-Midland Company, 175 Ill. 2d 201, 676 N.E. 2d 1295, 222 Ill. Dec. 91 (1997), The employer was entitled to bargain away or waive by agreement any limitations (e.g., the Kotecki cap) upon its own liability in contribution. An employer who waives Kotecki by signing an indemnity agreement is liable in contribution as any other co-defendant. Its exposure is not capped. III

7 DISCUSSION OF INSURANCE IMPLICATIONS A. Employers Liability Policies Do Not Cover a Braye Waiver Since 2000, it has been the law of our state that the standard employers liability policy (EL Section B) excludes liability for the indemnity of an insured employer for any exposure in excess of Kotecki protection. The policies have an express exclusion for any assumed contractual liability. B. Commercial General Liability Policies - Insured Contract Exception to Exclusion Since 1999 an issue has existed in Illinois as to whether the insured contract provision of a commercial liability insurance policy provides coverage for an insured employer who assumed tort liability of another party in an indemnity contract which exposed the insured employer to unlimited assumed tort liability for such bodily injuries, e.g., a Braye waiver of the Kotecki cap. The most common example occurs in the construction arena when the subcontractor signs and contract including to indemnify the general contractor, and/or waive its Kotecki cap as to the owner or general contractor. Thereafter, the subcontractor s employee is injured and sues the owner and the general contractor. Pursuant to Braye, as to the contract, the subcontractor is now liable for unlimited contribution and looks for insurance coverage for its CGL. 1. Pre-2007 There was a Conflict Between the Appellate Districts as to CGL Coverage Before Virginia Surety, two second district appellate courts (Michael Nicholas and West Bend) held that the Braye waiver was insured by the CGL policy. However, there was a decisive conflict of law between the Third and Fifth Districts (Virginia Surety v. Northern Insurance, ; and Hankins v. Pekin Insurance, 305 Ill. App. 3d 1088, 713 N.E. 2d 1244, 239 Ill. Dec. 394 (5 th Dist. 1999)) with the Second District (Michael Nicholas v

8 Royal Insurance, 321 Ill. App. 3d 909, 748 N.E. 2d 786, 255 Ill. Dec. 82 (2 nd Dist. 2001)); and West Bend Mutual Insurance Company v. Mulligan Masonry, 337 Ill. App.3d 698, 786 N.E. 2d 1078, 272 Ill. Dec. 244 (2 nd Dist. 2003)) on the following issue: Whether the "insured contract provision of a commercial liability insurance policy provides coverage for an insured employer who assumed tort liability of another party in an indemnity contract which exposed the insured employer to unlimited assumed tort liability for such bodily injuries? In Nicholas and West Bend, the Second District answered, Yes. In Hankins and now the case at bar, the Fifth and Third Districts, respectively, have answered, No. Ironically, prior to the opinion at bar, the holding of the Fifth District in Hankins may have been reconcilable with the Second District in West Bend and Michael Nicholas, as construction accident versus non-construction accident. The ruling of the Third District as affirmed by the Illinois Supreme Court at bar closed that door Virginia Surety: No CGL Coverage In Virginia Surety, the primary issue presented to the Illinois Supreme Court was whether an employer had coverage under its commercial general liability policy when it contractually waived its Kotecki protection (a cap announced by the Illinois Supreme Court that an employer could never be liable for contribution in excess of its workers compensation payments). The court answered No. There is no CGL coverage available to the employer. Prior to the decision, the Illinois Appellate Courts were split. (Hankins no coverage; Michael Nicholas-West Bend coverage.) The primary holding of the court is that a commercial general liability policy insured contract exception to exclusion does not provide contractual indemnity coverage for an employer who has waived its protection of the Kotecki cap (Kotecki v. Cyclops Welding Corporation, 146 Ill. 2d 155, - 5 -

9 585 N.E. 2d 1023 (1991)) pursuant to a Braye waiver (Braye v. Archer-Daniels-Midland Company, 175 Ill. 2d 201, 676 N.E. 2d 1295 (1997). Although this is an extremely complicated issue concerning contractual indemnity vis-à-vis the Contribution Act (740 ILCS 100/1 et seq.) and the Joint and Several Liability Act (735 ILCS 5/2-1117), the court held that a Braye waiver of Kotecki protection is not covered since the indemnitor has not assumed the tort liability of the indemnitee. While I disagree with this logic as a fallacy in semantics, insureds and insurers are left to function in the following environment in the contractual indemnity arena as created by the holding in Virginia Surety: IV. EFFECT OF VIRGINIA SURETY ON INSURERS A. Employers Liability Policies The employer liability carrier [EL] does not have liability for a Braye waiver of the Kotecki cap under the Christy-Foltz doctrine. (Christy-Foltz v. Safety Mutual Casualty Corp., 309 Ill. App. 3d 686 (Ill.App.Ct. 2000).) From the Virginia Surety decision, I would anticipate an attack on the Christy-Foltz protection enjoyed by employer liability carriers. Conservatively, as to EL carriers, I would suggest continued denial of any tenders for EL coverage and the filing of a declaratory lawsuit upon any tender by an EL insured for a Braye waiver which remains active. B. Commercial General Liability Policies Commercial general liability [CGL] carriers should enjoy freedom from providing coverage for Braye waivers. I would suggest to any commercial liability carrier defending under a reservation of rights that the time is ripe for withdrawal of the defense and denial of coverage. I would also - 6 -

10 suggest proceeding with your declaratory action through judgment. Ultimately, however, I anticipate parties to attempt to distinguish the contractual language of the indemnity from Virginia Surety to attempt to attach coverage. C. Construction Industry vs. Non-Construction Industries (2007) 1. General Rules: a. A construction contract assuming the tort liability of another will never trigger coverage as the underlying contract will be void. b. A non-construction contract assuming such liability will trigger coverage. Prior to the Virginia Surety decision, Hankins was distinguishable with Michael Nicholas & West Bend as construction industry vs. non-construction industry cases. In Hankins, CGL coverage was not triggered because the indemnitor did not agree to indemnify the indemnitee for its own negligence. Conversely, Nicholas and West Bend were construction industry cases. If the indemnity had been extended for one s own negligence, same would have violated the Construction Indemnity Act (740 ILCS 35/0.01 et seq) and been deemed unenforceable. Prior to Virginia Surety, in West Bend and Nicholas, the courts would red line the indemnity violative of the Construction Indemnity Act and construe the offensive language as a Braye waiver triggering the CGL coverage for both defense and indemnity. Accordingly, following Virginia Surety it would appear that construction industry contracts containing a Braye waiver can never trigger CGL coverage since the indemnity required to attach the coverage, would be construed void ab initio prior to application of the insurance coverage pursuant to the Construction Indemnity Act. Applying Virginia Surety, in accord with Hankins I would suggest that an indemnity agreement providing coverage for the insured s own negligence outside the construction industry - 7 -

11 will trigger the CGL policy s insured contract exception to exclusion and attach coverage. V. EFFECT ON PARTIES TO INSURED CONTRACTS A. Effect on Indemnitors [those providing indemnity to another party] In general, in the construction industry, we are all familiar with the subcontractor [indemnitor] providing indemnity to the general contractor or owner [indemnitee]. To avoid being naked (without insurance coverage) to honor the contractual obligation to indemnify, I would suggest that all indemnitors (under an indemnity contract provision) obtain a rider or endorsement from their CGL/EL carriers, to cover all liability that the indemnitor has assumed pursuant to a Braye waiver of the Kotecki cap or indemnity clause. In the non-construction industries, in addition to a specific endorsement, CGL coverage should remain intact premised upon the indemnitee being indemnified for its own negligence. The indemnitor may also wish to review its umbrella/excess policies to determine if same provide coverage, since many business umbrella policies vertically exclude all matters excluded by the underlying primary coverage. B. Effect on Indemnitees [those receiving the benefit of indemnity] In my opinion, the effect on the indemnified party will be the most significant. Illinois law contains the Joint and Several Liability Act (735 ILCS 5/2-1117). Post verdict or judgment, a plaintiff may elect to collect its entire award from anyone of the joint tor feasors who have been found responsible for 25% or more of a verdict. For example, if plaintiff obtained a judgment for three million against defendants A, B and C, each in the amount of 33-1/3%, the plaintiff may elect to collect the entire judgment against one - 8 -

12 defendant. He can request A, B or C to pay the three million. The tagged or targeted defendant then has a right against the other defendants. If a defendant is uninsured, the reliance on the indemnity is solely contingent upon net worth to satisfy an uninsured judgment. VI. SAFEGUARDS TO AVOID POST-JUDGMENT DISCOVERY OF INSUFFICIENT FUNDS The indemnitee receiving the benefit of the contractual indemnification should investigate and require proof that the contract is backed by a policy of insurance. In general, safe practice dictates having your company named as an additional insured on all the indemnitor s coverages. Your contract should specifically require the indemnitor to provide such insurance. In addition to obtaining a certificate of insurance naming you as an additional insured (not just a certificate holder), you should be certain that your indemnitor actually has attachable insurance coverage for the specific contractual indemnity it has assumed. In a substantial contract for indemnity, I would suggest requiring proof that your specific contract is expressly identified by name and date of on the face of a provided insurance policy endorsement. The key to avoid a surprise is to be certain that you are named as an additional insured and also that all contractual indemnity is insured. VII. INSURANCE COMPANY ENDORSEMENTS (To Provide Coverage to an Insured for a Braye Waiver) Since under standard ISO and WC forms the construction insureds will be naked as to a Braye waiver, should a carrier wish to write and provide the insured coverage for a Braye waiver, I - 9 -

13 would suggest the following: A. Suggested: EL Policy Endorsement to Provide Coverage for Braye Waiver 1. Liability assumed under contract. This exclusion does not apply to the following: a. the part of any written contract that constitutes a waiver of your right to limit your tort liability for contribution under the Illinois Joint Tortfeasor Contribution Act to the amount of benefits payable under the Illinois Workers Compensation Act, because of bodily injury to your employee, B. Suggested: CGL Endorsement to Provide Coverage for Braye Waiver Section I Coverages, 2. Exclusion (b) is modified as follows: 2. Exclusions. This insurance does not apply to:... b. Contractual Liability... This exclusion does not apply to liability for damages:... (2)...the part of any written contract that constitutes a waiver of your right to limit your tort liability for contribution under the Illinois Joint Tortfeasor Contribution Act to the amount of benefits payable under the Illinois Workers Compensation Act, because of bodily injury to your employee

14 Post Virginia Surety v. Northern Ins. Co Seminar ( DOC)

2015 IL App (2d) No Opinion filed March 26, 2015 IN THE APPELLATE COURT OF ILLINOIS SECOND DISTRICT

2015 IL App (2d) No Opinion filed March 26, 2015 IN THE APPELLATE COURT OF ILLINOIS SECOND DISTRICT No. 2-14-0292 Opinion filed March 26, 2015 IN THE APPELLATE COURT OF ILLINOIS SECOND DISTRICT BITUMINOUS CASUALTY ) Appeal from the Circuit Court CORPORATION, ) of Kendall County. ) Plaintiff-Appellant,