Waiver Of Subrogation In Construction Contracts

By: Werner Sabo, Of Counsel

In a recent article, Who Needs Builder’s Risk Insurance, Geoff Bryce wrote about a recent Illinois case with large damages. This article will expand on the case, with an emphasis on the AIA form documents.

A welder working at a construction site started a fire. He was welding new ductwork to existing ductwork in the kitchen area. The old duct was coated with grease and caught fire. The fire extinguisher that should have been close by was missing. By the time he got back with a fire extinguisher, the fire was out of control and caused more than $83,000,000 in damages. Who pays for this?

This scenario played out at a renovation for the Empress Casino in Joliet, Illinois. Empress had hired O’Neil as the general contractor using standard American Institute of Architects contracts. This is described in Empress Casino Joliet Corp. v. W.E. O’Neil Const. Co., 2016 IL App (1st) 151166 (Nov. 16, 2016), where three insurance carriers were trying to recover more than $81,000,000 that they paid to Empress for the loss, and where Empress was trying to recover more than $2,000,000 in deductibles. The problem for the carriers was that the contract contained a “waiver of subrogation” provision.

The owner of the project, Empress, had three insurance policies in place prior to the fire. One was a “builder’s risk” policy and the other two were general “all-risk” property insurance policies. Usually, when a loss occurs, the insurance company pays the owner to cover the loss, and the insurance company is then “placed in the shoes” of the owner, or “subrogated.” The insurance carrier can then file suit against the party that caused the loss. The forms prepared by the AIA, however, take a different approach by requiring all parties to waive subrogation. This means that, if an insurance carrier pays out on a loss, that carrier cannot then turn around and sue the responsible party. The thinking behind this is that the various parties to a construction project have purchased insurance to cover unknown future losses, and the losses should be paid for by the insurance companies. Otherwise, there is a lot of litigation and the insurance companies never really pay for anything. The waiver of subrogation will bind the insurance carrier, so it cannot sue the responsible party. Hopefully, this reduces the risk of each party, thereby also lowering the cost of construction.

In the Empress case, the trial court granted summary judgment in favor of all the defendants, finding that the plain language of the construction contract (the AIA Document A201-1997) revealed the parties’ intent for Empress to assume the risk of loss for any fire loss and look to its different insurance policies as the single source of recovery. Empress had agreed to waive all rights to subrogation against all possible at-fault parties. One provision of the contract stated that Empress was responsible for its own insurance deductibles. The insurance carriers and Empress appealed.

The plaintiffs raised a series of arguments as to why the trial court was wrong. One argument was that the complaint alleged claims for willful and wanton conduct by the defendants, and a waiver of subrogation provision should be unenforceable. The appellate court, however, agreed with the trial court that the waiver did not violate public policy. A waiver of subrogation is not an exculpatory clause (which might violate public policy). Nothing in the AIA language indicates that the parties intended there to be an exception for fires caused by willful and wanton conduct.

Two of the carriers also argued that the waiver of subrogation applies only to the builders’ risk policy and not the general liability policies. The appellate court carefully reviewed the AIA language and found that the language unambiguously waived all subrogation rights.

The carriers also argued that the waiver of subrogation should be limited to damages caused to the “Work” itself and not to other property damaged at the site. Noting that a majority of other courts considering this argument have rejected this distinction between work and non-work, the appellate court also held that the waiver applied equally to contract claims as well as negligence claims. Finally, the appellate court held that the contract clearly made Empress responsible for the deductibles.

While in this case the contractors (and the architect) benefitted from the waiver of subrogation in the contract, in a different situation it might be an owner who benefits. Each party to a construction project typically obtains various types of insurance policies. If a contractor’s insurance carrier pays out under its policy, it will be happy to sue the owner, the architect, subcontractors, or anyone else who might possibly have contributed to the loss. The waiver of subrogation provision works to protect each of these parties from a lawsuit. If a non-standard contract is offered for a construction project, serious consideration should be given to incorporate the standard AIA waiver of subrogation language.

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