Navigating Performance Bonds, Subcontractor Default, and CGL Coverage for Defective Workmanship and Property Damage

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Navigating Performance Bonds, Subcontractor Default, and CGL Coverage for Defective Workmanship and Property Damage TUESDAY, DECEMBER 13, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Michele Leo Hintson, Esq., Partner, Shumaker Loop & Kendrick, LLP, Tampa, Fla. Kirk D. Johnston, Partner, Smith Currie & Hancock, Atlanta Michael S. McNamara, Partner, Pillsbury Winthrop Shaw Pittman, Washington, D.C. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Navigating Performance Bonds, Subcontractor Default, and CGL Coverage for Defective Workmanship and Property Damage Presented by: Michele Leo Hintson Kirk D. Johnston Michael S. McNamara

6 Performance Bonds and CGL Coverage Michele Leo Hintson Shumaker, Loop & Kendrick, LLP

7 INTRODUCTION Background and Experience Goals for Today 7

8 THE TYPICAL CASE Surety issues performance and payment bond on a Project Certificate of Occupancy issued Notice of potential construction defect is sent to surety Surety determines through investigation that poor workmanship attributable to the principal and its subcontractors Lawsuit is filed against Surety, principal and its Subcontractors Surety begins strategic plan regarding its avenues of recovery 8

9 THE SURETY BOND V. INSURANCE What is Bonded and Insured 9

10 THE SURETY BOND V. INSURANCE The Underlying Agreement or Contract Insurance Business risk management tool Only a Two party contract The Carrier pays that loss which is covered under the Policy Surety Performance Bond At least a three party agreement (the tripartite relationship) Issued by the Surety on behalf of the Principal The Bond insures completion of the Project The construction contract is usually incorporated by reference 10

11 THE SURETY BOND V. INSURANCE The Security Provided by Each Instrument Insurance Protects the Insured against risk of accidents Performance Bond Protects the obligee against a default of the principal 11

12 THE SURETY BOND V. INSURANCE The Money Insurance premium paid is formulated to cover potential losses and the risk associated with such losses Performance Bond premium is paid to guarantee that the principal satisfies its obligations afforded under the Contract 12

13 THE SURETY BOND V. INSURANCE The Risk Insurance Losses are just part of the business Rates are adjusted to cover the forecast of loss Performance Bond Losses are not expected and bonds are issued only in theory to those whose risk of a default is low Sureties can seek recovery from the principal and indemnitors as a result of the loss (the GAI ) 13

14 THE SURETY BOND V. INSURANCE Claims Insurance Claims must be covered by policy, and exclusions exist that preclude coverage Carrier does not expect payment by insured Performance Bond Contract and Bond form define coverage (completion) payment expected by principal 14

15 THE SURETY BOND V. INSURANCE Florida Specific Issues Bad Faith Claims Attorneys Fees 15

16 THE SURETY BOND V. INSURANCE The Duty to Defend Elements Unique to Insurance Implications for Surety if Principal Not Defended Florida follows Eight Corners Rule If there is question of coverage, insurer must defend an entire suit Insured required to defense even if true facts later show no coverage All doubts as to coverage resolved in favor of insured 16

17 THE SURETY BOND V. INSURANCE The Duty to Indemnify Must determine when property damage occurs under the policy to trigger coverage Florida is in flux as to when coverage is triggered Manifestation Theory (when the damage first manifests itself) Injury in fact (when the property damage actually occurs) 17

18 THE SURETY BOND V. INSURANCE-THE SURETIES RIGHTS AS AN ASSIGNEE AND SUBROGEE OF ITS PRINCIPAL When a surety sustains a loss, it stands in the shoes of its principal A surety may obtain standing to sue its principal s CGL carrier either as an assignee or equitable subrogee, or both Surety has been found to have claims as a first party claimant under policy Subrogation arises when a surety paid a judgment for the principal s wrongs or towards a settlement to resolve the claims of the principal Courts have held that if a principal has a right to a defense against an obligee s claim, the surety also by law benefits from such a defense 18

19 POTENTIAL AVENUES OF RECOVERY BY THE SURETY AGAINST A CGL CARRIER Equitable Subrogation Assignment Contractual Indemnity Additional Insured Status 19

20 POTENTIAL AVENUES OF RECOVERY BY THE SURETY AGAINST A CGL CARRIER Equitable Subrogation Little case law authority Western Word Ins. Co., Inc. v. Travelers Indem. Co., 358 So. 2d 602 (Fla. 1 st DCA 1978) Difficult avenue for surety based upon lack of case law 20

21 POTENTIAL AVENUES OF RECOVERY BY THE SURETY AGAINST A CGL CARRIER Contractual Indemnity Case law supports a surety recovery under this theory Indemnity Obligation commonly falls within the definition of insured contract Merrick Const. Co., Inc. v. Hartford Fire Ins. Co., 449 So.2d 85 (La. App. Ct. 1984) Spirco Environmental, Inc. v. American Int l Spec. Lines Insur., 555 F.3d 637 (8 th Cir. 2009) 21

22 POTENTIAL AVENUES OF RECOVERY BY THE SURETY AGAINST A CGL CARRIER Assignment Anti-Assignment clause in CGL policies Basic tenant of Florida law that the policyholder may freely assign post-loss insurance claims, even with such a clause Lack of specificity of assignment Prior courts found that GAI assignments do not constitute an assignment of rights of the principal to sue its CGL carrier for insurance coverage (specifically as it relates to recovery of its attorneys fees) 22

23 POTENTIAL AVENUES OF RECOVERY BY THE SURETY AGAINST A CGL CARRIER Additional Insured Status Surety generally will not be considered additional insured under principal s policy If principal was required to be additional insured under subcontractor policy, may have avenue of recovery against subcontractor CGL policy 23

24 BEST PRACTICES AND POINTERS FOR SURETIES/PRINCIPALS UPON RECEIPT OF POTENTIAL CLAIM Perform coverage analysis early Use books and records rights to get all applicable policies and certificates of insurance Request information about subcontractors Insurance Put carrier on notice immediately 24

25 BEST PRACTICES AND POINTERS FOR SURETIES/PRINCIPALS UPON RECEIPT OF POTENTIAL CLAIM Conduct a Factual Investigation Is there still coverage under the Bond? Is there an occurrence? Is this limited to defective workmanship? Is there property damage? Are there ongoing operations at the site? 25

26 CGL Coverage for Defective Workmanship and Property Damage Kirk D. Johnston Smith, Currie & Hancock LLP

27 Parts of the CGL Policy Declarations Insuring Agreement Exclusions Exceptions Definitions Endorsements 27

28 Declarations 28

29 Insuring Agreement Scope of Coverage We will pay those sums that the insured becomes obligated to pay as damages because of bodily injury or property damage to which this insurance applies 29

30 Insuring Agreement When is the policy applicable This insurance applies to property damage only if the property damage is caused by an occurrence 30

31 Occurrence Policy defines an occurrence as an accident No definition for accident Courts define accident as an unexpected happening 31

32 Faulty Workmanship Accidental? Two conflicting statements of absolute truth Trends in case law 32

33 State of the Union The occurrence debate has, for the most part, been resolved. Most courts now recognize and apply the subcontractor exception to exclusion l and recognize its intended effect. More jurisdictions are applying j(5) and j(6) in a manner that gives effect to the that particular part language. 33

34 Is Faulty Workmanship an Occurrence, i.e., Accidental? Washington California Oregon Nevada Idaho Utah Montana Wyoming Colorado North Dakota South Dakota Nebraska Kansas Minnesota Wisconsin Iowa Illinois Missouri Michigan Ohio Indiana Kentucky New York Pennsylvania West Virginia Virginia Maine New Hampshire Vermont Massachusetts Rhode Island Connecticut New Jersey Delaware Maryland Arizona New Mexico Oklahoma Arkansas Tennessee North Carolina South Carolina Alabama Mississippi Georgia Texas Louisiana No - Cases/Statute Florida Unclear Conflicting Cases/Statute Alaska Hawaii Yes - Supreme Court or Statute Yes - Lower Court or Federal Court No - Supreme Court No - Lower Court or Federal Court 34

35 The Crux of the Debate A difference exists between a claim for: The cost of repairing or removing defective work and The costs for repairing damage caused by the defective work 35

36 Property Damage Physical Property Damage Tangible Capable of seeing or touching Intangible Property Damage Loss of Use 36

37 What has to be Damaged? Insured s Own Work vs Other Work vs Third-Party Property Traditional View: Damage must occur to third-party property Emerging Middle Ground Defective work itself, even if physically damaged, is not property damage Damage to otherwise non-defective part of the project, i.e., other work can constitute property damage Damage to insured s own work can constitute property damage 37

38 Jurisdictional Trends Ark. Code Ann A commercial general liability insurance policy offered for sale in this state shall contain a definition of occurrence that includes: (1) Accidents, including continuous or repeated exposure to substantially the same general harmful conditions; and (2) property damage or bodily injury resulting from faulty workmanship. (Effective July 27, 2011) 38

39 Jurisdictional Trends S.C Code Ann Commercial general liability insurance policies shall contain or be deemed to contain a definition of occurrence that includes: (1) an accident, including continuous or repeated exposure to substantially the same general harmful conditions; and (2) property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself. (Effective May 17, 2011) 39

40 Business Risk Exclusions Real Property - Exclusion (j)(5) Performance of Work - Exclusion (j)(6) Your Work - Exclusion (l) 40

41 Real Property Exclusion j(5) That particular part of real property on which you or any contractor working on your behalf are performing operations, if the property damage arises out of those operations Excludes Particular part of workmanship Only applicable to ongoing operations Temporal element 41

42 Real Property Exclusion j(6) That particular part of any property that must be restored, repaired or replaced because your work was incorrectly performed on it Does not apply to property damage included in the products-completed operations hazard. Products completed operations hazard Temporal element 42

43 Your Work Exclusion (l) (Two Critical Parts) Exclusion Property damage to your work arising out of it or any part of it and included in the products-completed operations hazard. Exception This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor. 43

44 Subcontractor Exception (History) Prior to 1976 No coverage arising out of your work regardless if subcontractor involved 1976 BFPD Endorsement Coverage arising out of your work performed by subcontractor 1986 BFPD added for form policy 2006 Endorsement to form policy Excluding coverage arising out of your work performed by subcontractor 44

45 Your Work Exclusion (l) (Two Critical Parts) Exclusion Property damage to your work arising out of it or any part of it and included in the products-completed operations hazard. Exception This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor. 45

46 Damage to Work Performed by Subcontractors (CG 22 94) 46

47 Damage to Work Performed by Subcontractors (CG 22 95) 47

48 Contractual Liability Coverage Coverage for indemnity obligation Exclusion Exception to Exclusion 48

49 Contractual Liability (CG 21 39) The definition of an insured contract is modified by removing subparagraph f. No coverage for indemnity obligation 49

50 Notice Requirements You must see to it that we are notified as soon as practicable of an occurrence or an offense which may result in a claim. Immediately Conditions Precedent to Coverage 50

51 Subcontractor Default Insurance Michael S. McNamara Pillsbury Winthrop Shaw Pittman

52 Subcontractor Default Insurance Subcontractor Default Insurance vs. Subcontractor Performance Bonds What is default insurance? A blanket policy that indemnifies the contractor (insured) from a loss incurred as a result of default by an enrolled subcontractor or supplier on a project. It provides an alternative to subcontractors providing payment and performance bonds to guarantee subcontract performance. Who sells default insurance? Zurich has been in the market the longest Arch and XL are now established as well 52

53 Subcontractor Default Insurance Performance bonds involve a three-party relationship Subcontractor negotiates surety line GC pays subcontractor for bonds and limits of coverage (typically the subcontract amount) Defaulted subcontractor s surety negotiates claim with GC Surety s customer is defaulted subcontractor not the GC In many states, GC must default terminate the subcontractor to trigger coverage Even under AIA forms, scope of coverage varies from state to state 53

54 Subcontractor Default Insurance Subcontractor Default Insurance only involves a two-party relationship GC negotiates coverage with SDI carrier GC pays carrier directly for insurance Carrier indemnifies insured GC for covered Loss While default of performance under the subcontract dictates coverage, subcontractor is not a party to the insurance transaction Payment 30 days from adequate proof of loss Coverage applies through statutory periods Retro premiums 54

55 Subcontractor Default Insurance Subcontractor Default Insurance vs. Surety Bond -- Pros The insured contractor has greater control Controls subcontractor qualification Controls subcontractor selection Controls which jobs are covered Enhanced protection Coverage for certain Soft Costs ( Indirect Costs subject to limit) Coverage extends to statute of repose 55

56 Subcontractor Default Insurance Subcontractor Default Insurance vs. Surety Bond -- Pros Profit Potential The dual premium structure (a fixed rate plus a variable rate) rewards successful management Good risk management and loss control can result in a return of variable premium. Bond premiums cannot be recaptured. With strong subcontractor pre-qualification and adequate volume, can become self-funding 56

57 Subcontractor Default Insurance Subcontractor Default Insurance vs. Surety Bond -- Cons Contractor will incur additional overhead costs Qualification and risk management Billing and reporting Deductible and co-payment obligations apply where subcontractor defaults Subcontractor pre-qualification program (but should be done in any case.) 57

58 Subcontractor Default Insurance Insured Contractor Responsibilities The insured contractor must qualify all subcontractors covered by the policy The insured contractor is responsible for managing the risk covered by the policy Subcontractor default insurance is best suited to use on negotiated projects where selection of subcontractors is based on qualification rather than the low responsive bid The contractor has a responsibility to report subcontractor enrollment to the broker/carrier The contractor must cooperate with the carrier s Risk Engineers 58

59 Subcontractor Default Insurance Other tips for those considering buying subcontractor default insurance for the first time Careful subcontractor pre-qualification is critical; do not use SDI as a vehicle to cover subs who cannot obtain traditional bonds (and thus are a significant default risk) SDI offers the ability to accumulate retro premiums over time in excess of the cost of the program if sufficient subcontractor volume is run through the program SDI allows for a quicker recovery in the event of a default BUT Care must be taken to timely identify and declare a material default as defined by the Policy 59

60 Subcontractor Default Insurance Other tips for those considering buying subcontractor default insurance for the first time Carefully document damages flowing directly from the default set up separate cost codes SDI insurers require very detailed documentation to justify the reimbursement of costs incurred but it is typically documentation that is available detail and patience 60

61 Subcontractor Default Insurance Other tips for those considering buying subcontractor default insurance for the first time An SDI policy is a reimbursement policy costs must be expended and proven before reimbursed promises to pay or contingent costs will create problems and may go unreimbursed be mindful of how costs are bucketed for purposes of reimbursement direct costs typically subject to overall policy limit Indirect costs are sub-limited Protect SDI insurer s subrogation rights monies recovered by SDI insurer replenish policy limits 61

62 Subcontractor Default Insurance Case study Interplay between SDI and CGL coverage for business risk exclusions: Pavarini Constr. Co. (SE), Inc. v. ACE Am. Ins. Co., 161 F. Supp. 3d 1227 (S.D. Fla. 2015) 62

63 Thank You Questions? Presented by: Michele Leo Hintson Kirk D. Johnston Michael S. McNamara 63