So, where a significant insurance dispute arises, especially one involving defense fees and costs or the number of deductibles/retentions applicable (aspects of which may be discussed in the program agreements), the policyholder’s legal department may face an insurer contending that the entire dispute must be arbitrated — under the law selected in the program agreement, and in a remote jurisdiction no less.  For example, a California-based corporation’s legal department, facing a major insurance dispute, may be confronted with arbitration in New York under New York law – even where the dispute arose in California, and California law and the prospect (or fact) of litigation might provide for a much more favorable outcome.

 While a few Courts of Appeal across the country have confronted arbitrability questions under program agreements, with differing outcomes, a recent decision in the Northern District of California provides a cautionary tale.  In that case, Judge Edward Chen found that the arbitration clause in an agreement Swinerton Builders had entered with AIG regarding the payment of deductibles on five claims under a contractor-controlled insurance program was open-ended enough to require that deductible/defense disputes regarding other claims also had to be arbitrated(https://ecf.cand.uscourts.gov/doc1/035110572568).  One can expect insurers to argue more aggressively for arbitration given the current judicial trend towards broader construction and stricter enforcement of arbitration clauses.  Happily, however,corporate policyholders can take fairly simple action to reduce or eliminate the distraction, expense and/or consequences of program agreement arbitration clauses — primarily by reviewing program agreements before they are entered, and ensuring they contain clear limits, consistent with litigation/forum rights under the policies.  As insurance program renewal time approaches, risk management and legal departments can quickly and effectively nip a potential problem in the bud.

If you would like further information on these topics, please contact Martin Myers at mhmyers@jonesday.com.

Because asbestos bodily injuries are continuous (i.e., after initial exposure, the injury “occurs” year-after-year as part of an ongoing injury process within the claimant’s body), insurance policies spanning decades can be triggered by the alleged injuries.  Earlier in Kaiser Cement’s coverage case, the Court of Appeal ruled that each asbestos bodily injury claim constitutes a separate “occurrence”—and thus each asbestos bodily injury claim is subject to a separate per occurrence limit.  (London Market Insurers v. Superior Court, 146 Cal. App. 4th 648.)  Had Kaiser Cement’s policy limits been provided on an aggregate basis, such a ruling may not have much significance.  For instance, Kaiser Cement had three other primary insurers who have paid their aggregate policy limits and their coverage now is exhausted.  But the fourth, Truck Insurance Exchange, issued policies for a number of years that did not contain an aggregate limit and coverage under those policies for asbestos bodily injury claims are subject only to their per occurrence limits.

To minimize its exposure, Truck argued that the policy that Kaiser Cement selected to respond to asbestos bodily injury claims only required Truck to pay a single occurrence limit from any of its unexhausted primary policies.  In a clause entitled “Limits,” the Truck policy selected by Kaiser Cement states as follows (emphasis added):

The limit of liability stated in this policy as applicable “per occurrence” is the limit of the Company’s liability for each occurrence.

There is no limit to the number of occurrences for which claims may be made hereunder, however, the limit of the Company’s liability as respects any occurrence . . . shall not exceed the per occurrence limit designated in the [policy].

According to Truck, even if other policy years were triggered, this policy language precluded the “stacking” of its multiple, non-aggregate per occurrence limits and Truck only had to pay a single per occurrence limit before Kaiser Cement had to look to its excess insurers to cover any additional liability.

In a June 2011 decision, the Court of Appeal agreed, holding that Truck’s per occurrence limits contained in multiple policies triggered by a single claim could not be stacked.  (Kaiser Cement& Gypsum Corp. v. Ins. Co. of the State of Pennsylvania, 196 Cal. App. 4th 140.)  On review, the Supreme Court stayed the Kaiser Cement case pending its decision in State of California v. Continental Ins. Co., which involved the issue of whether there is a general rule in California barring the stacking of policy limits.  In October 2012, the Supreme Court decided Continental, ruling that there is no general rule in California prohibiting the stacking of insurance policy limits, but at the same time permitting policy language to accomplish the same result.  (State of Calif. v .Continental Ins. Co., 55 Cal. 4th 186.)  Thus, unless there is specific policy language that prohibits stacking, the Court found that stacking would be the norm under standard policy language.

On transfer from the Supreme Court, reconsidering its prior decision in light of Continental, and focusing on the policy language quoted above, the Court of Appeal reached the same conclusion it had before the Supreme Court weighed in and rejected a general “anti-stacking” rule.  The Court of Appeal distinguished Truck’s policy language from that policy language before the Court in Continental, which provided that:  “The limit of the Company’s liability under this policy shall not exceed the applicable amount [listed as the policy limit].”  In other words, the policies in Continental limited the Company’s liability under a specific policy; in contrast, Truck’s policy was read to limit all of Truck’s liability. 

The Kaiser Cement case demonstrates the tension between a general horizontal exhaustion rule and how it may be affected by individual policy language.  Under the horizontal exhaustion rule, absent policy language to the contrary, all of Truck’s primary policies (as well as those of all other primary insurers with triggered policies) would need to be exhausted before any excess layer policy became liable.  But because Truck’s policy language was viewed as a limitation on stacking Truck’s primary policy limits, Truck is required to pay only one per occurrence limit for each claim.  As a result, the remainder of Truck’s primary policies become “unavailable” and not “collectible by the insured,” and a substantial portion of Kaiser Cement’s primary coverage no longer needs to be exhausted before its excess insurers become liable.  Thus, although California still purports to have a horizontal exhaustion rule, and generally permits the stacking of policy limits, specific policy provisions interpreted to be “anti-stacking” provisions can affect which policies need to be exhausted, and how many potentially multiple policy limits must be paid, before excess coverage comes into play.

At bottom, the Kaiser Cement ruling reminds us that insurance law is simply contract law.  And any coverage analysis begins and ends with the language of the policy.

If you would like further information on these topics, please contact Philip Cook at pcook@jonesday.com or Jason Wright at jcwright@jonesday.com.

The essence of the dispute was whether AstraZeneca’s captive insurer (AstraZeneca Ins. Co. Ltd.) could adequately establish the existence of liability on the part of its insureds, which were entities within the AstraZeneca Group.  AstraZeneca had embarked on a strategy of settling claims.  In addition, AstraZeneca had tried one case to judgment, resulting in a defense victory for AstraZeneca.  Thus, there had been no judicial determination of “liability” on the part of AstraZeneca.

The AstraZeneca captive did not attempt to put on a “positive case” in the English court that would establish AstraZeneca’s liability to the standard required under English insurance law.  Under English law, a policyholder seeking indemnity under a policy of insurance must show that, on a balance of probabilities, there was “actual legal liability” to the underlying claimant.

The English court rejected the argument that an “arguable liability” is sufficient to trigger indemnity obligations.  The court also held that this same deficiency of proof doomed AstraZeneca’s request for defense costs, which had totaled $786 million through the time of submissions to the court (not all of these would have been payable from the coverage layer involved in the dispute).  In what is the most surprising part of the judgment, and also obiter dicta, the Court essentially stated that the same result might have been reached under New York law, absent a breached duty to defend.

Two quotes from the judgment should give a policyholder reason for pause, because the Court holds that the Bermuda Form does not cover forms of “liability” that are usually taken as covered, nor does it cover defense costs without actual liability:

104.  The critical words are “[damages] which the Insured shall be obligated to pay by reason of judgment or settlement for liability on account of Personal Injury”. . . .[I]t is not damages payable under any judgment or settlement that qualify under this provision: the judgment or settlement must be “for liability”, in other words there must be a liability.  I do not see how the word “liability” in this context can be interpreted as anything other than actual legal liability.  “For liability” must be qualifying both judgments and settlements in the same sense.  Since you cannot have a judgment for alleged liability, it seems to me you cannot have a settlement for alleged liability under this clause.  In both cases, the liability must be actual. . . .

144. In my judgment [insurers’ counsel] is right that by tacking the words “and shall include Defense Costs” on to the definition of Damages, the parties have expressed the intention that defence costs should only be recoverable in circumstances where what might be described as “traditional” damages are recoverable, not that there should be free-standing coverage for such defence costs. . . . . [I]t is difficult to see how Defense Costs, which are expressly made recoverable as part of Damages (“and shall include Defense Costs”) can be recoverable even where no actual legal liability is established. . . .

The Court in AstraZeneca stated, in obiter dicta, that the New York standard allowing proof of “potential liability” instead of “actual liability” is based on cases in which an insurer has breached its duty to defend the policyholder.  If an insurer were to suggest that New York law requires proof of “actual liability” when there has been no breach of a duty to defend, that would not be correct.  New York jurisprudence on this issue has strong ties to the general law of indemnity, and is not limited to situations in which there is a defense duty.  For example, a recent case from the Eastern District of New York illustrates that, so long as an indemnitor has notice of a claim as to which indemnity is sought, the indemnitee need only show that it made a reasonable, good faith settlement.  See Tokio Marine & Nichido Fire Ins. Co. v. Calabrese, 2013 U.S. Dist. LEXIS 26984 (E.D.N.Y., Feb. 26, 2013). The reasonableness of a settlement involves a consideration of the potential liability faced by the settling party, but not proof of “actual liability.”  The Calabrese court summed up New York law:

“[I]t is well-established under New York law that, where an indemnitor does not receive notice of an action settled by an indemnitee, ‘in order to recover reimbursement [for the settlement], [the indemnitee] must establish that [it] would have been liable and that there was no good defense to the liability.’” [citations omitted]. . . .

If, on the other hand, an indemnitor has notice of the claim against it, “the general rule is that the indemnitor will be bound by any reasonable good faith settlement the indemnitee might thereafter make.”  [emphasis added; citations omitted]

What Can Be Distilled from AstraZeneca for U.S. Policyholders?

It is possible that Insurers might attempt to use AstraZeneca to contend, incorrectly, that the result reached under English law should likewise be reached under New York law. Therefore:

• Policyholders must be on guard against insurer arguments that the Bermuda Form should be interpreted under New York law to require a showing of “actual liability” in order to support payment of settlements or defense costs.
• Policyholders should carefully scrutinize policies at every excess layer for non-concurrencies that might introduce English law.

• Policyholders must be aware that a higher excess insurer might contend that settlements or defense costs actually paid by lower layers nevertheless are not covered by the higher layer, and therefore do not erode underlying coverage.

Policyholders should discuss these issues with an insurance professional such as their inside or outside coverage counsel.  If you would like additional information on the topics addressed in this post, please contact John Iole, a partner in the Insurance Recovery Practice, at jeiole@jonesday.com or (412) 394-7914.  

Where an insurer bears some or all of the cost to defend a lawsuit, the insurer often takes the position that it will pay defense costs only if defense counsel scrupulously follows “defense guidelines” drafted by the insurer, and the insurer refuses to pay defense costs it claims are not consistent with the guidelines, leaving the client and defense counsel at odds.  Although insurers treat compliance with these guidelines as a strict condition to paying defenses costs, as a purely legal matter, they are not:  Most insurance policies do not include or incorporate by reference such defense guidelines (though of course they could), quite plainly making them extra-contractual. 

In some cases, an insurer’s defense guidelines are very specific and stringent, for example stating that the insurer will not pay for conferences between two lawyers or certain types of activities such as legal research or travel time.  In other cases, they are more general, stating (for example) that the insurer will not pay for “administrative” work or certain types of expenses (e.g., expenses it considers to be “overhead”).  Whatever form such guidelines may take, two things are clear:  (1) defense cost guidelines represent an attempt by insurers to impose restrictions on the duty to defend (or to pay defense costs) that are not part of the written contract between the insured and the insurer, and therefore they are of questionable enforceability; and (2) they can be especially harmful to a policyholder if they attempt to restrict, or have the effect of restricting, defense counsel’s zealous representation of its client and are unlikely to be enforced by a court when that is the case.

Somewhat surprisingly, these types of guidelines appear not to have been the subject of many challenges, at least judging from the paucity of reported decisions on this subject.  Perhaps that is because the policyholder’s interests and those of the insurer are often aligned, at least to some degree, in trying to keep defense costs down, and accordingly any disputes that do arise are resolved through discussion and negotiation.  Or perhaps it is because a policyholder for whom the defense is critical does not want to upset the apple cart at peril of having the insurer take a hard line on defense costs.  Whatever the cause, policyholders need to examine carefully whether such guidelines improperly impinge upon counsel’s ability to provide—and the policyholder’s contractual right to receive—a complete and zealous defense consistent with the applicable ethical rules. 

Applying a common-sense view, some courts have recognized that insurers cannot impose restrictions on defense counsel that hamper or restrict counsel’s ability to provide a full and complete defense.  See, e.g., Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999, 1009 (Cal. Ct. App. 1998) (stating that “[i]nsurer-imposed restrictions on discovery or other litigation costs may well violate the insurer’s duty to defend as well as the attorney’s ethical responsibilities to exercise their independent professional judgment in rendering legal services.”); In re Urgin, 2 P.3d 806, 814-15 (Mont. 2000) (examining the requirement for the insurer’s prior approval for defense work and holding “the requirement of prior approval fundamentally interferes with defense counsel’s exercise of their independent judgment, required by Rule 1.8(f), M.R. Prof. Conduct.”).

 Several state ethics boards and similar attorney ethics organizations have expressed similar views.  For example, in an advisory opinion, the Ohio Ethics Board addressed in detail whether it is proper for an insurance defense attorney to abide by an insurer’s litigation guidelines in the representation of the insured.ⁱ  The Board stated that, “the majority view is that certain carrier imposed limitations give rise to ethical problems.”  Among other things, the Board held that it was “improper under DR 5-107(B) for an insurance defense attorney to abide by an insurance company’s litigation management guidelines in the representation of an insured when the guidelines directly interfere with the professional judgment of the attorney.”  The Board then described litigation guidelines that would interfere with the professional judgment of an attorney.  These guidelines include:  (a) guidelines that restrict or require prior approval before performing computerized or other legal research; (b) guidelines that dictate how work is to be allocated among defense team members by designating what tasks are to be performed by a paralegal, associate, or senior attorney; (c) guidelines that require approval before conducting discovery, taking a deposition, or consulting with an expert witness; and (d) guidelines that require an insurer’s approval before filing a motion or other pleading.  The Board further noted that, “[o]ther guidelines may or may not interfere with an attorney’s professional judgment.” 

A similar approach was set forth in ethics opinions, bar association comments, and advisory opinions in, among other states, Pennsylvania, Texas, Utah, Washington, and Indiana.ⁱⁱ  These analyses focus, in large part, on the potential conflict between defense counsel’s duty to zealously represent its client (and the client’s obvious interest is a fulsome defense) and the fact that another party (often, though not always, an insurer) that is paying for the defense may have a legitimate interest in managing the cost of litigation.

By way of example, the Pennsylvania Bar Association on Legal Ethics and Professional Responsibility,ⁱⁱⁱ while noting that insurer-imposed guidelines do not violate ethics rules per se, stated as follows: 

[U]nder the Pennsylvania Rules of Professional Conduct], “an agreement may not be made whose terms might induce the lawyer improperly to curtail services for the client or perform them in a manner contrary to the client’s interests. . . .  Any duties that the lawyer may owe to the Third Party Provider by contract or otherwise cannot prevail over the lawyer’s duties owed to the client under the guise of enabling the Third Party Provider to provide a “cost-effective” defense and indemnity to the client.

Discussing litigation guidelines that require approval of litigation strategy by third party providers (such as insurers), the Committee further stated that, “[l]itigation management guidelines, no matter how well intended, cannot operate to remove the attorney’s independent professional judgment and replace it with that of a Third Party Provider.”  Id. at *5.  In other words, guidelines that have the effect of micromanaging the defense by controlling the activities of defense counsel are likely to be viewed as problematic.

 In summary, while insurer-imposed defense cost guidelines may not be found to be improper or unenforceable per se, they are unlikely to be enforced by a court if they infringe in a material way on defense counsel’s duty to zealously represent its client, the policyholder.  Furthermore, a policyholder likely will have a reasonable basis to instruct counsel to ignore guidelines that arguably are inconsistent with ethical rules and attempt to restrict counsel’s legitimate discretion in running a case (e.g., a rule that two attorneys cannot attend court hearings or a rule that the insurer will not pay for conferences between two attorneys).

 *  *  *

So what actions should a policyholder take? 

• First, if an insurer attempts to impose on defense counsel stringent defense guidelines that the policyholder or defense counsel believes restrict defense counsel’s ability to defend a case with the appropriate level of independence and effort, the policyholder and defense counsel should raise the issue with the insurer in writing at the beginning of the representation, specifically objecting to the problematic portion(s) of the guidelines and citing (if necessary and appropriate) relevant ethics opinions.

•  Second, if an insurer acts overly aggressively in enforcing litigation guidelines (for example, by refusing to reimburse significant amounts of defense costs), the policyholder or its defense counsel should write to the insurer to the effect that the insurer’s guidelines or conduct are improperly restricting counsel’s ability to litigate the case.  At the very least, such communications should cause the insurer to think twice about attempting to enforce litigation guidelines in an overly aggressive manner. 

As noted above, while most courts and ethics organizations have not categorically rejected such guidelines per se, they are likely to come out in favor of the policyholder if they conclude that the guidelines, as written or applied, in effect substitute the judgment of the insurer for the judgment of the lawyer in staffing and litigating a case.

ⁱ  The Supreme Court of Ohio Bd. of Comm’rs on Grievance and Discipline, Op. 2000-3 (2000). 

ⁱⁱ  See, e.g., Tex. Comm. on Prof’l Ethics, Op. 533 (2000); Utah State Bar Ethics Advisory Op. Comm., Op. 02-03 (2002) (2002 WL 340262); Wash. State Bar Assoc., Formal Op. 195 (1999); Ind. State Bar Assoc. Legal Ethics Comm., Op. 3 (1998).  

ⁱⁱⁱ  Pa. Bar Ass’n Comm. on Legal Ethics and Prof’l Responsibility, Formal Op. 2001-200 (2001) (2001 WL 1744775).

 If you would like additional information on the topics addressed in this post, please contact Peter Laun, a partner in the Insurance Recovery Practice, at pdlaun@jonesday.com or (412) 394-7930 .

No airline wants to ground any part of its fleet unless safety considerations require such action.  Likewise, no aviation product manufacturer wants its product to be implicated in a grounding order.  Nevertheless, once the FAA has issued a mandatory grounding order,  there are important implications for insurance coverage.

Groundings are very likely to result in a loss of revenue.  Although safety is the paramount consideration, it would be natural for the affected parties to seek some type of recourse if a design or manufacturing defect is determined to exist.  To protect against the financial consequences of  such claims, aviation manufacturers can purchase aviation products liability insurance.  For purposes of such insurance, it can make a very significant difference whether a grounding is based on voluntary action or mandated by governmental act.

“Grounding Coverage” in an aviation product manufacturer’s policy is third-party liability coverage that can provide quite extensive limits to defend and indemnify a manufacturer against claims for loss of use caused by grounding.  A typical grounding insuring agreement might read as follows:

COVERAGE B – GROUNDING LIABILITY

To pay on behalf of the Insured all sums which the Insured shall become legally obligated to pay as damages for the loss of use of completed aircraft occurring during the policy period after delivery to and acceptance by a purchaser or purchasers or operator or operators of such aircraft, and caused by a grounding arising out of the Products Hazard.

What is necessary for a “Grounding” to occur?

It is immediately obvious that grounding coverage must be triggered by a “grounding arising out of the products hazard.”  Therefore, the definition of “grounding” must be considered.  This term is used loosely in news and other reports, but for purposes of grounding coverage a typical definition is as follows:

“Grounding” means the complete and continuous withdrawal at or about the same time in the interest of safety, of one or more aircraft from flight operation due to a mandatory order by Federal Aviation Administration (FAA) or any other Civil Airworthiness Authority because of a like defect, fault or condition or suspicion thereof in two or more such aircraft whether such aircraft so withdrawn are owned or operated by the same or different persons, firms or corporations.

For purposes of language such as that set forth above, a “mandatory order” is key.  Although some policies might allow an agreed order of grounding also to serve as a trigger, coverage for a purely voluntary “grounding” of aircraft that is not associated with any governmental imprimatur probably would be contested under such provision.

Has there been an “Occurrence”?

Another requirement to trigger grounding coverage is an “occurrence.”  A standard definition of occurrence will require an “accident or event” that results in “bodily injury or property damage.”

What is the period of “Grounding”?

The above-quoted policy deems grounding to occur on the date of the accident or occurrence that discloses the defect, fault or condition.  However, other policies provide for a period of delay between the date of the occurrence and the date of the grounding order.  An example is as follows:

A Grounding shall be deemed to commence from the date on which the first such [mandatory] order becomes effective following an Occurrence during the Policy Period and to continue until the date on which the last such order relating to the same existing, alleged or suspected like defect, fault or condition is withdrawn or becomes ineffective.  Such Grounding shall be deemed to fall in the Policy Period of the Occurrence which exposed such defect, fault or condition.

Under the above definition, the grounding period begins when the first mandatory order becomes effective.  The date of the occurrence must be determined in order to fix the proper policy period applicable to the loss, but (under this definition) is not relevant to the period of grounding itself.

Other definitions start the grounding period with the date of the accident or occurrence:

Grounding shall be deemed to commence on the date of an accident or occurrence which discloses such defect, fault of condition, or on the date an aircraft is first withdrawn from service on account of such defect, fault or condition, whichever first occurs.

Under typical formulations, grounding coverage will end when the grounding order is withdrawn or is ineffective, even if that extends beyond the expiration of the policy.

Grounding Exclusions

Grounding coverage also is subject to a series of exclusions.  For example, if loss of use is determined to have been due to a failure by the policyholder to use reasonable diligence to eliminate the cause of the loss of use, then an exclusion on this topic might be asserted.  Grounding coverage might also contain an exclusion for property damage resulting from “improper or inadequate design or specification.”  In addition, costs incurred to correct or eliminate the cause of the loss of use typically will be excluded.

CONCLUSION

In short, all “groundings” are not alike.  When evaluating insurance coverage for an aviation grounding, it is critical to study the precise terms of the policy.  If a coverage opinion, legal analysis, or a demand for coverage against the insurer is required, a policyholder should seek the input of knowledgeable professionals, including an insurance broker who specializes in this field, the policyholder’s risk manager (if there is one), as well as legal counsel.

If you would like further information on these topics, please contact John Iole at jeiole@jonesday.com, Allison Buckner Parker at abparker@jonesday.com, or Jeffrey DeVore at jsdevore@jonesday.com.

Part 3:  Coverage

Part 1 explained the nature of a unified wrap up insurance program for a construction project, and contrasted it with the more traditional approach to insuring project risks.  Part 2 addressed the pros and cons of using a wrap up program.  Several key coverage issues under a wrap up program are addressed below.

            1.         Who is covered under the wrap up program?

Generally speaking, the greater the number of enrolled participants, the more successful the wrap up program is likely to be.  The owner/developer, the general contractor, and most subcontractors will be covered under the wrap up program.  Certain subcontractors may not be covered, and they may need to furnish appropriate individual coverage suitable to their roles in the project.  For example, wrap up coverage may be limited to operations at the project site and thus may exclude subcontractors or suppliers conducting off-site manufacturing or assembling of building components.  Claims arising from goods or materials in transit may be excluded, preventing haulers from being covered.  Some wrap up policies exclude coverage for crane operators and hoisters. 

In addition to participants who may be excluded from wrap up coverage by the policy itself, owners and general contractors may elect not to enroll certain subcontractors based on such considerations as the subcontractor’s type of work, contract value, or duration of work.  In that event, the subcontractor will have to ensure they have adequate individual coverage.  For example, hazardous material suppliers and handlers may not be enrolled because their services would be excluded by a pollution exclusion; unless the wrap up program also includes pollution liability coverage, they may have to arrange their own coverage.

            2.         To what extent is there coverage for “completed operations” claims?

“Completed operations” coverage – for claims of damage occurring within a specified length of time after a contractor’s work has been completed – is an important consideration under a participant’s individual general liability policy.  It is no less important where that participant’s work is covered by a wrap up policy instead.  The wrap up policy, or the project’s contractual insurance requirements, should be reviewed to assess the sufficiency of “completed operations” coverage.  Where feasible, the wrap up policy should provide “completed operations” coverage for construction defect claims that is as long as the statutory period of repose in the state where the project is located.  (E.g., Cal. Code of Civil Procedure §337.15 [requiring certain latent defect claims to be filed within ten years from substantial completion of the project].)  Otherwise, enrolled participants may not be insured for claims involving damage occurring within the statutory period but after the “completed operations” period. 

            3.         Does the contractor’s individual policy cover work on the wrapped project?

Many individual liability policies expressly exclude coverage for any project covered by wrap up insurance.  In that event, the construction participant would look solely to the wrap up policy for coverage for project related claims.  While that may be sufficient for many claims, it might not be sufficient if the wrap up policy’s coverage is not as broad as the participant’s individual liability policy with regard to that participant’s role on the project. 

Where a construction participant’s individual policy excludes coverage for claims arising out of the wrapped project, and there is a concern about the scope of the wrap up coverage, the participant may consider seeking to have its individual policy endorsed to be excess and difference-in-conditions (DIC) to the wrap up coverage.  This typically means that (a) the wrap up program will be primary as to all risks it covers, and (b) the participant’s individual policy will provide excess coverage on all risks insured under the wrap up program, and primary coverage as to risks not insured under the wrap up program.  While this endorsement is usually associated with a premium, this approach has the benefit of increasing the available limits on claims covered by the wrap up program, and ensuring that the participant has a scope of coverage at least as broad as its own individual policy. 

            4.         How is payment of the deductible handled in the event of a covered claim?

Wrap up policies, like individual liability policies, typically require satisfaction of a deductible or retention.  In theory, giving participants some skin in the game by requiring that they share the cost of responding to a claim promotes better construction and safety practices and thereby lowers the cost of insurance. 

But how is the deductible handled under the wrap up policy?  Assume, for example, that a neighboring business owner is damaged by construction activities on the project site, and the neighbor sues the owner, the general contractor, and a subcontractor.  They give notice to the wrap up insurer, which points out that the policy has a $25,000 deductible.  This raises several questions:

• What types of outlays will count toward satisfying the deductible?  Defense costs?  Repair costs?  Costs incurred before the insurer is given notice of the claim? 
• Who is obligated to pay the deductible?  If the deductible is a shared obligation, in what proportion?
• Can costs incurred by the owner, general contractor, and subcontractor be aggregated to satisfy the deductible? 

It may be helpful for the participants, especially the owner and general contractor, to consider and discuss these issues on the front end, before a claim arises.

            5.         Who will defend the enrolled participants if they are sued?

If a claim is made against multiple construction participants, a dispute can arise as to how they will be defended under the wrap up policy.  If, for example, a roofing subcontractor’s employee is injured on the worksite, he may choose to sue the owner, general contractor, and another subcontractor and have the judicial system determine which entities caused or contributed to his injuries.  (The workers compensation exclusivity rule would bar him from suing his employer, the roofing subcontractor, for civil damages.)  Before the deductible or retention is satisfied, these participants will need to retain defense counsel, and they will continue to need defense counsel after the deductible or retention is satisfied.  This raises several questions:

• Who will represent the three entities before the deductible or retention is satisfied?  Will one defense firm  represent all three entities?  If so, who will select that firm? 
• Once the deductible or retention is satisfied, and the wrap up insurer is bound to pay for defense counsel, can the insurer replace existing defense counsel with one of its panel defense firms? 
• When is the insurer required to provide independent counsel to one or more of the insured defendants? 

These logistical issues are sometimes resolved by agreement among the participants and the wrap up insurer after the claim is brought.  But it can only help if these issues are considered up front.

In sum, for the right projects, wrap up programs present a viable alternative to the traditional approach of having every construction participant bring its own coverage to the party.  Wrap up programs can reduce the cost of insurance, provide coverage more suitable for the nature and risks of the project, improve safety and risk management, and help avoid disputes among the participants.  Early consideration of several key issues that can arise with a wrap up program can help ensure the successful management of risks on a wrapped project.

If you would like further information on these topics, please contact Daven Lowhurst at dlowhurst@jonesday.com

Part 1 explained the nature of a unified wrap up insurance program for a construction project, and contrasted it with the traditional mechanism of having all of the construction participants – including the general contractor and all of the subcontractors – procure their own individual insurance policies to cover project claims.  The next question is whether it is advisable to have the controlling entity – whether the owner/developer on an OCIP or the general contractor on a CCIP – insure the project under a wrap up program.  The decision whether to use a wrap up program for a particular project should be made as part of a feasibility study, since a wrap up program offers several benefits when compared to the traditional approach, but also presents several obstacles.  These factors should be weighed in light of the nature and risks of the project.  Below is a general discussion of some of the key factors relevant to deciding whether to insure a project under a wrap up program.

            1.         The cost of insurance

A wrap up program is intended to reduce the overall cost of insurance for the project by providing what amounts to volume pricing for the whole project.  Further, if the wrap up program is written on a loss-sensitive basis (e.g., where policy premium is adjusted based on claims history), reducing paid claims under the wrap up program will reduce the cost of insurance.  This might be accomplished through a comprehensive project safety program and better claim management.  On the other hand, a higher than anticipated claims history could increase the cost of insurance to the wrap up sponsor. 

            2.         Control over coverage limits 

A wrap up program provides higher per-occurrence or per-claim liability limits than would be provided by a typical subcontractor’s individual liability policy, which frequently carries liability limits of $1-2 million regardless of the size of the project, and often with no excess layer.  By contrast, wrap up policies allow the controlling entity to procure for all participants much higher liability limits appropriate for the size and risk of the project. 

            3.         Control over the scope of coverage  

Under the traditional approach, by which each participant furnishes its own insurance, the owner and general contractor generally have little control over the coverage provided by downstream participants.  Sometimes subcontractors are contractually bound in their subcontracts to procure certain coverages and limits, but even then, there is no guaranty that the subcontractors will actually obtain that coverage.  Even if the subcontractors procure the contractually required coverage, the owner or general contractor has little control over whether (a) the individual policies remain in force, (b) the subcontractors pay any required deductibles or retentions in the event of a covered claim, (c) the individual policies’ limits are eroded due to the payment of claims on other projects, and (d) the owner and contractor have been properly added to the individual policies as additional insureds. 

Individual liability policies may also contain exclusions or limitations not present in a wrap up policy.  For example, individual general liability and professional liability policies may contain exclusions for residential work (such as condominiums) due to historically costly construction defect claims arising out of this work.  In addition, construction participants may not be able to obtain sufficient “completed operations” coverage to protect against claims (such as for latent defects) throughout the applicable statute of limitations or repose.  It may also be difficult for upstream participants to ensure that downstream participants maintain this coverage for a sufficient duration. 

Under a wrap up program, by contrast, the controlling entity should have greater control over the types, scopes, and limits of coverage, and can better tailor the coverage to the particular project.  In this same manner, wrap up policies may present a viable solution to the insurability hurdles that might otherwise confront builders and design professionals, including challenges in obtaining coverage for residential exposures, as well as coverage for “completed operations” that is commensurate with the applicable statute of limitations or repose.  The controlling entity can also ensure that the policy does not lapse by taking responsibility for the payment of premiums, and can readily monitor the erosion of the wrap up policy’s indemnity limits as claims are paid. 

            4.         Wrap up’s impact on a construction participant’s individual liability policy 

With a wrap up program, the insurance limits under the participants’ individual (corporate) liability policies are not at risk, or are at risk only after exhaustion of the underlying wrap up coverage (i.e., where the individual policy has been endorsed to provide excess/difference-in-conditions coverage to the wrap up coverage).  This benefits the owner and other participants by ensuring a certain amount of coverage for the wrapped project regardless of the extent to which certain participants’ individual coverage limits have been eroded by the payment of claims on other jobs.  This also benefits subcontractors by allowing them to preserve their individual policy limits for other jobs without fear of erosion through the payment of claims under the wrap up policy. 

            5.         Ease of administration 

This factor cuts both ways.  On one hand, a wrap up program relieves the controlling entity of the daunting burden of ensuring that all lower-tiered participants (e.g., subcontractors and material suppliers) have obtained appropriate coverage for themselves, as well as “additional insured” coverage for the upstream participants (e.g., owner and general contractor).  Indeed, the need for “additional insured” coverage is significantly reduced under a wrap up program because all of the participants are “named” insureds.  The controlling entity also can more easily track compliance with policy terms and conditions, including satisfaction of any claim reporting requirements and payment of any deductible or retention. 

On the other hand, the controlling entity will face certain administrative hurdles not present under the traditional approach.  For example, the controlling entity may be responsible for educating participants about the wrap up program, enrolling participants into the program, allocating the cost of the program through deductive change orders, overseeing project safety, and managing claims, although controlling entities frequently pass this responsibility down to their insurance broker who acts as the wrap up “administrator.”  Enrolled participants are not free from administrative burden, since they may have to review the sufficiency of the wrap up coverages, enroll in the program, analyze the cost of insurance in bidding for the job, and periodically submit documentation bearing on the cost of insurance (e.g., payroll information) to the administrator.  These administrative burdens may render small construction projects unattractive for wrap up programs, although for multi-residence projects, a wrap up program may be the only game in town.

            6.         Improved safety and risk management 

An owner/developer or general contractor, working in conjunction with the wrap up insurer and administrator, may be better positioned to create and maintain a unified safety and security program, and to set consistent risk management standards for the project.  This centralized risk management may help achieve a higher level of project safety, which could reduce the frequency and severity of bodily injury and property damage claims, thereby reducing the cost of insurance for the project.

            7.         Reduction in disputes among construction participants

Since all construction participants are insured under the same wrap up policy, a wrap up program hopefully has the beneficial effect of reducing finger-pointing and litigation among the participants in the event of a third-party claim, such as a claim against them by an injured passer-by, subcontractor employee, or neighboring property owner.  Indeed, wrap up programs present an opportunity for participants to work cooperatively in resolving such claims.  Further, because all enrolled participants are insured under the same policy, the wrap up insurer typically cannot pursue a subrogation claim against the insured participant that caused the loss. 

            8.         Risk of the wrap up insurer’s insolvency

Unfortunately, wrap up insurers, like other insurers, are not immune from the risk of insolvency.  In the unlikely event that the wrap up insurer becomes insolvent, there may be a gap in coverage and claims administration.  This gap may be partially filled if the wrap up program includes excess or umbrella policies that “drop down” in the case of insolvency, or when a state insurance guaranty fund takes over for an insolvent insurer.  Nonetheless, a primary purpose of insurance is to spread risk, and that purpose might not be advanced under a wrap up program, where one insurer (at least at the primary layer) takes the place of what would otherwise be multiple insurers for the individual participants.

            9.         Lack of legal precedent

There are few judicial decisions interpreting wrap up policies.  This is likely a function of the fact that wrap up insurers frequently use custom (manuscripted) provisions in their policies to address a particular project, and even when standard insurance language (e.g., ISO forms) is used, that language may be modified.  On the other hand, where a wrap up insurer uses standard forms (e.g., ISO’s CG 00 01), judicial decisions in the non-wrap up context may be relevant to interpreting the same language in a wrap up policy.  Nonetheless, parties tend to favor certainty in their business affairs, and the use of untested language in a wrap up policy, and the lack of precedential authority, may increase the risk of differing interpretations and, therefore, the risk of coverage disputes and litigation.

            10.       Limited market for wrap up insurers

Few insurers are underwriting wrap up programs.  If residential exposures are involved, the market shrinks even further.  Depending on the size and nature of the project, the limited market for wrap up underwriting may impact the controlling entity’s ability to bargain for coverage terms and price.

Having addressed the nature of a wrap up program in Part 1, and the pros and cons of using a wrap up program in this Part 2, Part 3 will address several key issues that can arise under a wrap up program and that should be considered by all of the construction participants.

If you would like further information on these topics, please contact Daven Lowhurst at dlowhurst@jonesday.com

Part 1:  The Nature of a Wrap Up Program

The traditional mechanism to insure construction projects is to have the construction participants – such as the general contractor, the subcontractors, and the design professionals – furnish their own corporate or practice insurance to protect against project risks.  Typically, each participant would include the cost of its insurance, plus a mark-up, in its bid.  The breadth of that insurance would be left to each participant to arrange, though generally subject to certain contractual requirements as to the type and amounts of the various coverages.  This traditional approach is not without limitations and risks.

Consequently, large construction or infrastructure projects, typically in excess of $100 million, are more and more frequently insured under a Controlled Insurance Program (“CIP”), colloquially referred to as a “wrap up” program.  Under a CIP, one of the participants in the project controls the procurement of insurance for all or the majority of the construction participants.  If the controlling entity is the project owner, the coverage is referred to as an owner-controlled insurance program or “OCIP.”  If the controlling entity is the general contractor, the coverage is referred to as a contractor-controlled insurance program or “CCIP.”  (The project could be insured in a hybrid manner or “Co-CIP”.)

Whether the wrap up program is carried out through an OCIP or a CCIP, a unified insurance program is wrapped around the entire project, protecting – as insureds – the project owner or developer, the general contractor, and the subcontractors.  Coverage is sometimes extended to construction managers, private inspectors, or key material suppliers, depending on the nature of the project.  The program usually includes commercial general liability, business auto liability, and workers compensation coverages.  Professional liability (errors and omissions) coverage can also be procured on a wrap up basis, insuring the architects, engineers, and other design professionals on the project.  Like the traditional approach, wrap up programs are usually structured with both primary and excess layers.

Whether a project is insured in the traditional manner or with a wrap up program, the owner or developer will typically end up footing the cost of the project insurance.  Where a wrap up is in place, the participants often either submit bids that exclude the cost of insurance, or include the cost of insurance in their bids subject to a later deductive change.  A wrap up “administrator,” frequently the insurance broker, administers the program, which may include educating the participants as to how the wrap up program works, ensuring proper enrollment of the participants into the program, and determining payment adjustments to properly account for the cost of insurance.

There is no standard wrap up policy that can be taken off the shelf and used for every project.  While coverage under a wrap up program may borrow from commonly used insurance forms or provisions (such as ISO’s CG 00 01), the coverage terms and conditions can be as varied as the nature and requirements of the project and its participants, as well as the risk appetite of the wrap up insurer and the entity sponsoring the wrap up.

The wrap up sponsor – whether the owner under an OCIP or the general contractor under a CCIP – has an incentive to obtain the best coverage (that is financially feasible) for the project and its participants, since the sponsor will be insured under that policy and may very well find itself the beneficiary of the coverage it procured.  Despite this incentive, participants frequently review the wrap up policy language or binder to ensure that it affords sufficient protection for their particular needs, since different participants may face different risks based on their respective roles on the project.  For example, the project risks faced by a grading contractor may differ significantly from the risks faced by a crane operator.

A participant concerned about gaps between its individual risk profile on the project and the wrap up coverage could seek to include certain insurance requirements during the contracting phase.  In addition, that concerned participant could, for a premium, seek to have its corporate or individual insurance policy endorsed to provide excess and difference-in-conditions (DIC) coverage for the wrapped project.  If obtained, this would have the effect of (a) adding the policy limits of the participant’s individual policy on top of the wrap up policy’s limits, and (b) providing primary “gap filler” coverage for risks covered by the individual policy but not covered by the wrap up policy.  If this avenue is pursued, the policy should specify that this excess/DIC endorsement governs any coverage exclusion in the individual policy for projects insured under a wrap up program.

Having addressed the nature of a wrap up program, Part 2 will address the pros and cons of using a wrap up program.  Part 3 will address several key issues that can arise under a wrap up program.

If you would like further information on these topics, please contact Daven Lowhurst at dlowhurst@jonesday.com

     The California notice-prejudice rule originated in Campbell v. Allstate Ins. Co., 60 Cal.2d 303 (1963).  There, the court held that while “[a]n insurer may assert defenses based upon a breach of the insured of a condition of the policy . . . , the breach cannot be a valid defense unless the insurer was substantially prejudiced thereby.” Id. at 305.  Campbell was a case involving third party liability insurance.  In the ensuing decades, the notice-prejudice rule has become firmly ensconced in California insurance jurisprudence.  The rule has prevented insurance forfeiture based on strict application of policy notice requirements – at least in the context of “occurrence” policies (though not necessarily “claims made” policies). 

     However, until now, it was unclear if the Campbell “substantial prejudice” standard applied to certain other policy “conditions,” including requirements that first-party policyholders submit a proof of loss within a specified period of time.  The Court of Appeal has answered this question in the affirmative in Henderson.  Reasoning that there is nothing in Campbell to exclude proofs of loss from the notice-prejudice rule, and that the purpose of both requirements is essentially the same – to facilitate the insurance company’s investigation of the loss – the court held that the same standard should apply to both “conditions” of coverage.  The ruling indicates that California courts may well extend the substantial prejudice rule to other contexts.

     The Henderson ruling is welcome news to policyholders whose claims are governed by California law, because  insurance companies will have even greater difficulty denying valid claims on the basis of non-prejudicial technicalities.  Nevertheless, policyholders may rest even easier if they secure a written extension of any filing deadline contained in their first party policies.

ADDENDUM:

     On January 16, 2013, the California Supreme Court granted review of Henderson. The appellate decision is currently depublished pending review.

     If you would like further information on these topics, please contact Amanda Schapel at aschapel@jonesday.com

     (1)      Identify and secure all insurance policies that may respond to the losses.  You may have coverage for losses, such as business interruption losses, even in situations where no physical damage occurs to your property.  Identify other loss payees and determine whether other ancillary documents are relevant (leases, credit agreements, etc. often have provisions for providing insurance and/or payment of insurance proceeds).

     (2)      Analyze the coverage the insured has for each type of potential loss, including exclusions, retentions, and policy conditions.  Identify debris removal coverage and pollution coverage.  Identify business interruption coverage.  There may be coverage for damage to customer or supplier locations, resulting in financial loss to your business, as well as coverage for extra expenses incurred to sustain your business.  There may also be coverage for losses due to an inability to access your property because of governmental order and/or physical damage to the property of others.

     (3)      Identify your loss mitigation duties.  Identify timetables required for reporting and documenting the loss.

     (4)      Identify and document the losses with detail, including photographs and videotape where possible.  Collect and preserve evidence in a form that will be admissible at any trial, if needed.

     (5)      Provide notice to insurers.

     (6)      In any notice of loss and other internal and external communications, avoid ascribing definite “causes” to losses until you have complete and accurate information.  For example, do not conclude there has been definite “flood” damage vs. “wind” damage vs. “water” damage until sufficient information is available.

     (7)      Assess the availability of early interim payments and the policy’s proof-of-loss requirements.  Do not assign damages amounts to losses without adequate information.  If necessary to assign some amounts to losses, then make clear that any estimates are subject to significant revision as the loss is better understood.

     (8)      Institute a system to ensure that the policy requirements are met (e.g., allowing insurers to inspect damaged property or equipment before cleanup or disposal begins and allowing them to have input on recovery strategies and contractors, if appropriate).

     (9)      Develop a communications strategy, involving in-house and/or outside counsel, and key risk department personnel.  Recognize that all communications may become subject to discovery in any resulting litigation or other claims dispute.  Make sure that the broker does not characterize your claim or loss in a manner with which you do not agree.  Try to identify one person to serve as the principal point of contact with insurers, and educate that person on potential coverage issues.

     (10)     Sensitize field personnel to insurance issues that may be involved.

     (11)     Ensure that accounting systems are set up to track expenses related to the loss (e.g., set up separate accounts for expenses and ensure that backup documentation is retained).  Prepare to respond to extensive and ongoing information requests from insurers and develop a system to track what has been requested and provided.  Consider a physical or electronic “data room” available to multiple insurers.

     (12)     Consider immediate retention of consultants, including forensic accountants, to help the company quantify and mitigate its losses. Make sure these consultants fully understand the policy requirements and are answerable to those requirements.  Evaluate their suitability as witnesses in arbitration or trial, if needed.

     (13)     Be aware of statutes of limitation or shorter periods in the applicable policies by which you are required to submit claims or bring a lawsuit.  Insurers generally agree to extend these requirements if requested to do so.

     (14)     Retain experienced legal counsel familiar with insurance policy interpretation and claims.

     If you would like further information on these topics, please contact Peter Laun at pdlaun@jonesday.com or John Iole at jeiole@jonesday.com