APPORTIONMENT OF LIABILITY BETWEEN INSURERS AND CONTRACTORS Malcolm Stephens, Senior Associate, Allens Arthur Robinson Tuesday 17 May 2004 ymss S0111333001v1 150520 17.5.2004 Page 1
1. Introduction This paper considers issues which arise where: a company involved in a construction project suffers a loss (for example, damage to its property or the incurring of a liability); that company is entitled to be indemnified from an insurer; and that company also has a right to recover its loss from a contractor (whether in a claim for negligence or under a contractual indemnity). The 3 possible outcomes in this situation are that the ultimate loss: (c) lies with the insurer; lies with the contractor; or is shared between the insurer and the contractor. For the reasons explained in this paper, each of the above outcomes is possible, depending on the particular arrangements between the parties. In this paper the company which suffers the loss is referred to as the "owner" and the negligent insured is referred to as the "contractor". The issues considered, however, apply whether it is a principal, operator, contractor or sub-contractor which suffers the loss. In practice, an owner would normally first seek to be indemnified by its insurer. Section 2 of this paper considers the rights which an insurer then has to recover the amount of that indemnity from the contractor. Section 3 deals with the complications which can arise if that contractor is insured under the same policy, as is commonly the case, for example, in project specific policies. Section 4 considers issues which can arise if the parties seek to limit the right of an insurer to bring a subrogated claim whether with or without the insurer's consent. 2. The rights of an insurer against a contractor: Subrogation or Contribution? This section of the paper considers the right of an insurer, which has indemnified an owner, to recover the amount of that indemnity from a contractor. The complications which arise where the contractor is insured under the same policy are considered in section 3. Contractual attempts to vary the rights of the parties are considered in section 4. 2.1 Subrogation If the owner's property was damaged by the negligence of the contractor, it is well established that an insurer is entitled to bring a subrogated action against the contractor. That action is brought in the name of the owner and depends on the rights of the owner against the contractor. If it were not for the doctrine of subrogation, a contractor would be entitled to assert that any liability to the owner must be reduced to the extent that the owner has already been ymss S0111333001v1 150520 17.5.2004 Page 2
compensated for its loss by its insurer. The doctrine of subrogation was introduced because the law takes the view, essentially for policy reasons, that a negligent contractor should not be entitled to the benefit of an insurance policy independently arranged by the owner. 2.2 Contribution The doctrine of contribution applies where parties are under "co-ordinate liabilities" to make good the "one loss". A common example of "co-ordinate liabilities" occurs if 2 insurers are liable to indemnify the same loss. There are also limited rights to contribution under legislation for example, between joint tortfeasors or between marine insurers. The examples are not relevant, however, in determining the rights and obligations of insurers. Two important differences between contribution and subrogation are that: contribution gives a party which is liable for a loss a direct right against another party liable for that loss, whereas subrogation only entitles one party to stand in the shoes of the entity which it indemnified; and claiming contribution results in the liability being shared, whereas claiming subrogation results in a full recovery. 2.3 Contractor's indemnity: contribution or subrogation? As explained above, an insurer is entitled to bring a subrogated action, in the name of an owner, if the owner's property was damaged by the negligence of a contractor. If, however, an owner has a claim against a contractor under a contractual indemnity, rather than in negligence, a highly contentious issue is whether the insurer is entitled to bring a subrogated action against the contractor (in the name of the owner) or whether the insurer only has a right of contribution from the contractor. The two leading cases on this issue are the Elf judgment of the House of Lords 1 and the judgment of the Full Court of the Supreme Court of Western Australia in Speno 2. 2.4 Elf: the facts The Elf litigation arose out of an explosion on an oil platform in the North Sea. Although the litigation involved many different claims, the relevant point of principle can be understood from the following sample facts: (c) (d) one cause of the explosion was negligence by the operator; injured workers therefore had a right to be compensated by the operators; the operators were indemnified by their insurers; and the operators also had a right to be indemnified by the contractors who employed the relevant workers. 1 Caledonia North Sea Limited v British Telecommunications plc (Scotland) & ors [2002] UKHL 4. 2 Speno Rail Maintenance Australia Pty Limited v Hamersley Iron Pty Limited (2000) 23 WAR 291. ymss S0111333001v1 150520 17.5.2004 Page 3
The insurers of the operator brought subrogated claims against the contractors seeking to recover under the indemnities. The contractors argued that the insurers were not entitled to bring subrogated claims against them but were only entitled to bring a claim for contribution. The essence of their reasoning was that the contractors and the insurers were both liable under contractual indemnities and that therefore their liabilities were "co-ordinate". 2.5 Elf: The decision The judge at first instance accepted the contractors' argument. This judgment caused great controversy around the common law world, as it had often been assumed that an insurer would always be entitled to bring a subrogated claim relying on a contractual indemnity. The decision of the trial judge was overturned on appeal. On a further appeal, the House of Lords also disagreed with the trial judge and held that, on the facts in Elf, the liability of the contractors was "primary" and the liability of the insurers was "secondary". The insurers were therefore entitled to bring subrogated claims against the contractors. The decision of the House of Lords has often been cited as authority for the proposition that an insurer is always entitled to bring a subrogated action against a party giving a contractual indemnity. One article even proclaimed, after the House of Lords decision, that "Elf is dead". A closer examination of the decision of the House of Lords, however, shows that it very much rested on the particular facts of that case. Although the novelty of the argument being put by the contractors was clearly an influence on the judgments in the House of Lords, those judgments were primarily based on the presumed intention of the parties. In particular, the House of Lords appears to have been particularly influenced by evidence of industry practice, in off-shore oil platforms, for the parties to indemnify each other against liability to each other's employees. That industry practice was reflected in the contracts under which the claims against the contractors were being brought. The House of Lords accepted that the purpose of this arrangement was to avoid protracted litigation (such as the Elf litigation), and replace it with the simple rule that each company will be liable to its own employees. The House of Lords believed that the position taken by the contractors in the Elf litigation was contrary to this industry practice. The House of Lords also emphasised that the operator was not obliged to take out the insurance which provided indemnity against claims by employees. The House of Lords did not believe that the contractors should be able to take advantage of any insurance contracts which the operator independently chose to take out. It is not clear whether the converse argument could have been made that the insurers should not be able to take advantage of an independent decision made by the operators to obtain contractual indemnities or whether the insurers were in fact aware of these indemnities. The judgments of the House of Lords therefore ultimately depended on the presumed intention of the parties that the contractors would be "primarily liable" and that the insurers would only be "secondarily liable". There will be many factual situations where such an ymss S0111333001v1 150520 17.5.2004 Page 4
intention cannot be presumed and where an insurer, consequently, would not be able to bring a subrogated action relying on a contractual indemnity provided to its insured. 2.6 Speno In Speno, unlike in Elf, it was the insurer which asserted that any claim it had against a third party which provided a contractual indemnity should be a claim for contribution, rather than a subrogated claim. The insurer in that case was unable to bring a subrogated action as it had not indemnified its insured. The judgment of the Full Court of the Western Australian Supreme Court was delivered after the first appeal in Elf (which found in favour of the insurers) but before the judgments in the House of Lords were delivered (which were also in favour of the insurers). The Full Court of the Western Australian Supreme Court agreed that, on the facts in Speno, the liability of the insurer was "secondary" rather than being "co-ordinate" with the contractors' obligation to indemnify, and that therefore contribution could not be claimed. In comparison with the judgments of the House of Lords in Elf, the judgments in Speno gave less weight to the factual background and more weight to the inherent differences between insurers and other parties providing contractual indemnities. The facts of Speno, however, did not provide the same opportunity for a detailed factual investigation as the facts of Elf. 2.7 Other Australian authorities The relationship between insurance indemnities and other contractual indemnities has been considered in the following factual situation: negligent driving by one employee injures another employee; the injured employee recovers from the employer; the employer has three sources of recovery: its workers' compensation insurer; its motor vehicle liability insurer; and the negligent employee. In Commercial and General Insurance Co Ltd v GIO (NSW) (1973) 129 CLR 374 the High Court assumed, although the matter was not argued before it, that a motor vehicle liability insurer could bring a subrogated claim against a negligent employee. A leading text 3 makes the following comment on this assumption. There is difficulty in accepting this [assumption], for it assumes that the insurer had available to it [the employer's] claim to indemnity by its employee but if the principle in Sydney Turf Club v Crowley (1971) 1 NSWLR 724 is correct it follows that, the obligation of the employee being a secondary one of indemnification, the employee, in an action brought by the employer on its own behalf, would have a good defence that the loss had already been met by the first insurer 3 Meagher RP, Heydon JD & Leeming MJ, Meagher, Gummow and Lehane's Equity: Doctrines and Remedies (4 th edition, 2002) at 414-415. ymss S0111333001v1 150520 17.5.2004 Page 5
Therefore, did not [the insurers and the negligent employee] bear a co-ordinate liability to make good the one loss, so that each by contribution should bear one-third of the loss? This would be an application of that doctrine consistent with the formulation by Kitto J in Albion Insurance Co Ltd v GIO (NSW) (1969) 121 CLR 342 at 349-50 These comments are relevant in determining rights between insurers and contractors, as the obligation of an employee to indemnify its employer is an implied term of the employment contract. The authors of this text therefore, assume that a contractual obligation to indemnify: is a secondary liability; and is "co-ordinate" with an insurer's liability to indemnify. An Australian court is likely to give the comments in this text similar weight to the Elf judgment, given the high regard of its current and former authors. It is, therefore, still very much an open question under Australian law whether, and in what circumstances, an insurer is entitled to bring a subrogated claim against a contractor providing an indemnity. 3. The rights of an insurer against a contractor insured under the same policy 3.1 The issues which arise A feature of project specific policies is that many entities involved in the project are insured under the same policy. It is frequently the case that, where one party suffers property damage indemnified by the insurer, that damage was caused by the negligence of another party insured under the same policy. There has been much litigation as to whether an insurer, in that situation, has a right to bring a subrogated claim against the negligent contractor. Sometimes the rights of an insurer in this situation are expressly dealt with by the policy. For example by a "waiver of subrogation" clause. These clauses are discussed in the next section, as are clauses under which the parties to the construction project attempt, between themselves, to impose ultimate liability on the insurer. There have been many cases in which it has been argued that, even in the absence of an express clause preventing an insurer bringing a subrogated action, an insurer is not entitled to bring a claim against a negligent insured. The main reasons discussed in the cases are: the principle of "circuity"; the notion that each contractor has an "insurable interest" in the entire contract works; an implied term in the insurance policy; or an implied term of the contract between the insureds. ymss S0111333001v1 150520 17.5.2004 Page 6
A further possible reason would be to assert that the presumed intention of the parties is that the insurance liability be primary (by analogy with the reasoning in Elf discussed above), which would prevent a subrogated claim being brought. 3.2 Circuity Some early English cases on this issue held that an insurer could not bring a subrogated action against a negligent insured because of the principle of "circuity" 4. In its narrow form, the argument was that the insured would in turn be indemnified by the insurer, and so the proceedings should therefore not be allowed. It has subsequently been pointed out on a number of occasions that relying on "circuity" in this narrow sense is inaccurate 5. The two main reasons are as follows. This is not an example of the legal defence of "circuity". That defence only operates where there is circuity between the parties to the litigation. In a subrogated action the insurer is not a party to the litigation (as the claim against the defendant is brought in the name of the insured). There is therefore no circuity in this technical sense. In these cases the negligent party has not in fact had a right to be indemnified by the insurer. There has therefore not in fact been any circuity. In addition to these two reasons, there is a practical consideration that an insurer is not going to bring a subrogated action against another insured if it is going to end up indemnifying that insured. It is therefore doubtful that notions of "circuity", in the narrow sense, can ever be of any assistance. There is, however, more support for a broader principle preventing subrogated claims relying on an "insurable interest" argument. This is considered in the next section. 3.3 Insurable interest A number of cases have held that each party involved in a construction project has an "insurable interest" in the entire construction project 6. The rationale for giving each party an insurable interest in the entire construction project is that the interests of each party could be affected by damage to the property of another party. The consequence of giving an each party an insurable interest in the entire project is that, in respect of any property damage, each party has a right to recover the entire loss from the insurers. In so far as property owned by entities other than the insured making the 4 See the judgments of Lloyd J in The Yasin [1979] 2 Lloyd's Rep 45 and in Petrofina (UK) Limited v Magnaload Limited [1984] QB 127 (the latter slightly qualified the former's reliance on circuity). 5 See the decisions of the English Court of Appeal and House of Lords in Co-operative Retail Services Limited and ors v Taylor Young Partnership & ors [2001] LRIR 122 (Court of Appeal) and [2002] UKHL 17 (House of Lords). 6 See for example the decision of the Supreme Court of Canada in Commonwealth Construction Co Ltd v Imperial Oil [1977] 69 DLR (3d) 558 and the decisions of Lloyd J referred to above. This reasoning was followed by Franklyn J in Co-operative Bulk Handling Limited v Jennings Industries Ltd (1986) 17WAR 257 (Full Court of the Supreme Court of Western Australia). ymss S0111333001v1 150520 17.5.2004 Page 7
claim has been damaged, then the insured making the claim will hold the insurance proceeds on trust for those other insureds. If one follows this line of reasoning, the insured whose negligence caused the damage would have been entitled to recover from the insurer the loss resulting from that property damage (holding the proceeds on trust for the entities whose property was damaged). It may therefore be inappropriate to allow an insurer to bring a subrogated claim against the negligent insured if that insured would itself have been entitled to recover that loss from the insurer (thus negating any possibility of a subrogated action a party cannot sue itself). This reasoning is referred to in some cases as "circuity". This reasoning is commercially quite sensible, although it does involve a slightly artificial application of the principle of "insurable interest". The reasoning in these cases is arguably inconsistent with authorities on the meaning of "insurable interest" and may not by itself suffice to prevent a subrogated action. The reasoning has also been restricted to the particular circumstances of the parties insured under project specific policies. It does not apply, for example, in so far as a supplier of equipment asserts that it has an insurable interest in that equipment because it might be liable for its failure. 7 3.4 Implied term of an insurance policy It has alternatively been suggested that a term should be implied into an insurance policy preventing an insurer bringing a subrogated action against a negligent insured 8. Part of the justification for implying such a term is the reasoning set out above concerning "insurable interest". It is unlikely, however, that the strict requirements under Australian law for implying a term into a contract justify implying such a term into a project specific policy. For example, it is not necessary to imply such a term to give the policy commercial efficacy. Furthermore, the fact that express terms to this effect are frequently included in project specific policies makes it very unlikely that a court would imply such a term where the parties had, presumably intentionally, not included such an express term. 3.5 Implied term of contract between insureds An insurer bringing a subrogated claim against a negligent insured is exercising the rights of the insured which it has indemnified. It has been held that a term should be implied into the contract between the insureds preventing claims where one insured has been indemnified for its loss. It could be argued that such a term is implicit from the agreement between the two insureds requiring one insurance policy for the benefit of both. Even though there are much better prospects of implying such a term into a contract between insureds, than into an insurance contract, it will still be difficult to meet the strict requirements for implying a term into a contract. Once again, it is not necessary to imply such a term to give those contracts business efficacy. Nevertheless, the House of Lords 7 Maxitherm Boilers Pty Ltd v Pacific Dunlop Ltd & anor [1998] 4 VR 559. 8 See the judgments of Colman J in Stone Vickers Ltd v Appledore Ferguson Ship Builders Ltd [1991] 2 Lloyd's Rep 288 and National Oilwell (UK) Ltd v Davy Off-Shore Ltd [1983] 2 Lloyd's Rep 582. ymss S0111333001v1 150520 17.5.2004 Page 8
has held that, depending on the particular contractual arrangements between the insureds, an obligation to take out insurance cover for the benefit of both parties may justify implying a term preventing claims between them in respect of insured losses 9. 3.6 Presumed Intention of the parties The most promising ground for a negligent insured to resist a subrogated claim may be to rely on the reasoning of the House of Lords in the Elf judgment. A contractual obligation to take out insurance for the benefit of both parties might well support an argument that the liability of the insurer was intended to be "primary". Although such an argument does not appear to have been raised before, it may represent the best chance for a negligent insured. 3.7 Conclusion The right under Australian law of an insurer to bring a subrogated action against a negligent insured is still very much an open issue. There has been little judicial consideration of the arguments referred to above. 4. Express Clauses Limiting Rights of Subrogation 4.1 Overview There are two means by which parties might seek to limit an insurer's right to bring a subrogated action against an insured: including a waiver of subrogation clause in the insurance policy; or including a clause in the agreements between the insureds which indirectly prevents a subrogated action being brought. Each of these is considered in turn. 4.2 Waiver of Subrogation Clauses An insurer might be willing to include a term in the insurance policy preventing it from bringing subrogated claims against other insureds. The courts will not read down such clauses. For example, a waiver of subrogation clause which simply prevents an insurer bringing claims against an insured will be effective to prevent a subrogated action even if: the cause of the insured's liability (eg professional negligence) is expressly excluded from the policy cover: GPS Power Pty Ltd v Gardiner Willis Associates Pty Ltd (Queensland Court of Appeal, 8 December 2001); and the subrogated claim does not relate to the incident which gave rise to the insurer's obligation to provide indemnity: Larson-Juhl Australia LLC v JayWest International Pty Limited (2000) 11 ANZ Ins Cas 61-499 (New South Wales Court of Appeal the putative subrogated claim concerned alleged misleading conduct by the vendor 9 Co-operative Retail Services Limited and ors v Taylor Young Partnership & ors [2002] UKHL 17(25 April 2002) ymss S0111333001v1 150520 17.5.2004 Page 9
of unsafe premises, where that vendor also owned property stored at the premises and was therefore insured under the policy). If an insurer wishes to preserve a right to bring a subrogated claim against an insured for example in relation to conduct unrelated to the project then it will need to ensure that the waiver of subrogation clause is drafted accordingly. An insurer faced with a waiver of subrogation clause might consider bringing a claim for contribution, relying on the reasoning accepted at first instance in Elf. Although this would not breach a waiver of subrogation clause, it is likely that a court would not allow such a claim because the liabilities are not "co-ordinate", given the apparent intention that the insurers should be primarily liable for any loss (and, presumably, that the contractor's liability would be secondary). 4.3 Agreements between insureds: existing rights It is reasonably well established that an insured may not, as against its insurer, release or compromise existing rights in a manner which prejudices its insurer's right to subrogation. In the leading judgment on this issue 10, Barwick CJ stated (at 241): It is also settled law that an insured may not release, diminish, compromise or divert the benefit of any right to which the insurer is or will be entitled to succeed and enjoy under his right of subrogation. On occasions an attempt by the insured to do so will be ineffective against the insurer because of the knowledge of the circumstances which the person under obligation to the insured may have. On other occasions when the insured's act has become effective as against the insurer, the insured will be liable to the insurer in damages, or possibly, on some occasions for money had and received. But such conduct on the part of the insured will not in general avoid the insurer's liability to indemnify, though in some circumstances the insurer may be entitled to set off the amount of the damages against the amount otherwise payable under the indemnity. In a subsequent New South Wales Court of Appeal case it was stated that, in so far as the above passage suggests that any such release would be "ineffective" (particularly if the contractor was aware of the insurer's rights of subrogation), then that is incorrect 11. It was suggested in that case that the correct remedy for an insurer was probably a claim in damages for breach of an implied term of the insurance contract. If the contractor was aware of the insurer's rights of subrogation, there may also be a tortious claim against the contractor for inducing a breach of contract by the insured. There is therefore currently some doubt as to whether, if an insured releases a third party to the prejudice of its insurer, that release will be ineffective or whether the insurer will only have a claim in damages. 4.4 Agreements between insureds: future rights A further and more important issue is whether the parties can effectively diminish the rights of an insurer before those rights come into existence. In particular, can the parties agree 10 State Government Insurance Office (Old) v Brisbane Stevedoring Pty Limited (1969) 12 123 CLR 228 11 Sola Basic Australia Ltd v Morganite Ceramic Fibres Pty Ltd (Unreported, NSW CA, 11 May 1989, BC8902186) per Meagher J ymss S0111333001v1 150520 17.5.2004 Page 10
that, in so far as any future losses may occur, they will not be liable to each other to the extent that those losses are covered by insurance? Such clauses are now quite common. The common law on this issue is unclear, but it appears that the parties may limit the rights of an insurer in this manner. In the High Court case referred to above 12, the parties under a crane hire agreement agreed to exclude any rights of contribution that might rise against each other as joint tortfeasors. Following a subsequent injury, it was held that both parties were liable in negligence for that injury. The insurer of one of the parties (the employer of the injured worker) sought to reduce its liability to the extent that it was unable to obtain contribution from the other party. The High Court held that the insurer was not entitled to reduce its liability in this manner as the agreement between the parties "precluded rights arising" which, according to the High Court, "is quite a different matter" from a release, compromise or derogation from rights. The decision of the High Court depended, to an extent, on the particular facts of that case. There is therefore still some uncertainty at common law as to the extent to which such agreements might entitle an insurer to reduce its liability. In order to clarify this uncertainty, section 68 of the Insurance Contracts Act 1984 was introduced 13. This section, however, really addresses a slightly different issue. It provides that provisions in insurance policies limiting an insurer's liability, where its insured has entered into such an agreement, will be ineffective, unless the insurer clearly informed the insured in writing of the effect of the provision. The indirect consequence of this provision, however, is to make it extremely difficult for an insurer to seek to reduce its liability where the insurance policy contains no such provision. The existence of section 68 will make it almost impossible to imply a term into an insurance policy which prevents insureds entering into such agreements. 5. Recommendations The issues and cases discussed above demonstrate the importance of the parties involved in a construction project, together with their insurers, expressly specifying what rights, if any, the insurers will have to bring claims against other insureds. In the absence of express agreement, there is still considerable uncertainty as to the circumstances in which an insurer can bring a subrogated action against either: a contractor which has provided an indemnity to its insured; or a negligent contractor which is also insured under the policy. The following points should be considered when negotiating policies and agreements. Excluding waiver of subrogation clauses will not necessarily permit insurers to bring subrogated claims. For example, an insurer might be prevented from bringing subrogated claims by an express or implied term in the contract between its insured and another party. Insurers should therefore consider imposing an obligation on their insureds not to enter into agreements which have the effect of 12 State Government Insurance Office (Old) v Brisbane Stevedoring Pty Limited (1969) 12 123 CLR 228 13 ALRC 20, para 308. ymss S0111333001v1 150520 17.5.2004 Page 11
reducing rights of subrogation or contribution. The insured must be clearly informed of such a clause before it enters into the policy. (c) Parties involved in construction projects need to be careful, when negotiating their contracts, that they obtain their insurers' approval to any clauses which might have the effect of reducing rights of subrogation. This is obviously of particular importance where there is an express obligation in the policy not to enter into such agreements. It would, however, be prudent to adopt this course in any case. When drafting waiver of subrogation clauses, both parties should clarify whether there are any circumstances in which an insurer might bring a claim against an insured for example, whether an insurer might bring subrogated claims in respect of conduct that is unconnected with either the project or the risks covered by the insurer. Malcolm Stephens Senior Associate Allens Arthur Robinson 17 May 2004 ymss S0111333001v1 150520 17.5.2004 Page 12