An endorsement that has become common in general contractors’ insurance policies can function as a trap for both the policyholder and defense counsel. The “Contractors Special Conditions” endorsement requires that the policyholder must have written contracts with each subcontractor that it uses on a project, and that those agreements must meet certain requirements. If there is a loss involving those subcontractors, and if contract conditions were not met, the insurer may deny coverage. The problem, of course, is that if the policyholder does not read the policy before the loss, and didn’t get the right contracts in place, there may be no way to “cure” the problem. And defense counsel may be put in a bind as well when they are asked to report to the insurer.
The overall purpose behind the “Contractors Special Conditions” endorsement is to shift risk to subcontractors by making the general contractor’s policy excess to the coverage carried by the subcontractors. The endorsement attempts to do this by requiring that, before a job, the contractor have a written agreement with each sub in which the sub agrees to defend and indemnify the contractor, and make the contractor an additional insured on the sub’s liability insurance policy. The endorsement also requires that the contractor have received a certificate showing additional insured status, and maintain those records for a set period. There is no standard ISO form for these endorsements. All of these requirements are usually stated to be a “condition precedent” for coverage under the policy – if the condition was not met, the insurer will deny coverage.
There is nothing necessarily objectionable in these requirements, and they will strike many as simply good risk-management on the contractor’s part. But as anyone who has worked in the construction field knows, record-keeping is not always airtight, particularly for smaller contractors, and in the rush of business some things are done on a handshake. In addition, what of minor-player subcontractors who do not have “blanket” additional insured provisions in their policies, or subs in fields that generally are not able to provide additional insured coverage? The endorsement does not make any allowance for such contingencies.
For a policyholder that does not carefully study its policy, the “Contractors Special Conditions” endorsement can then be a trap, springing itself after it is too late to correct the problem.
The endorsement can also pose problems for defense counsel, as illustrated in an Arizona case, Cosgrove v. National Fire & Marine from spring 2017. The Cosgrove case followed a familiar pattern: a general contractor was sued over faulty workmanship and resulting property damage; the insurer accepted the defense under a reservation of rights and retained counsel to defend. Defense counsel then reviewed the job file and found no written subcontractor agreements, and reported that fact to the insurer in the course of explaining why he was bringing third-party claims against the subs for common-law indemnity only, and not breach of warranty or contractual indemnity, and why he was not tendering the claims to the subcontractors’ insurers.
The parties in the Cosgrove defect litigation began settlement negotiations, but the contractor’s insurer refused to participate, relying on a “Contractors Special Conditions” endorsement. The contractor reached a stipulated settlement with the owner and assigned its rights against the insurer to the owner.
The owner—standing in the shoes of the contractor—argued that the insurer had no right to rely on the exclusion because it learned about the lack of subcontractor agreements as attorney-client privileged information from defense counsel, making it unusable for coverage purposes. The court agreed, and took the defense attorney to task for revealing the information to the insurer in the first place. (The Cosgrove decision was vacated and sealed after the parties settled, but not before it had been picked up by Google Scholar and publicized through reporting by Randy Maniloff – thanks Randy!).
While Arizona law is not quite the same as Oregon, Washington or California law regarding the role and obligations of counsel in a reservation-of-rights defense (and indeed each of those states differ in that regard), this scenario could easily come up in those jurisdictions or others. Particularly where defense counsel regularly receive work from one specific insurance carrier there may be a practice of routinely reporting case developments. That routine needs to be examined (and potentially suspended) any time there are coverage concerns. Due to this endorsement, defense counsel who do not pay attention to coverage land mines (like the “Contractors Special Conditions”)—or who do not seek outside assistance from the contractor’s coverage counsel—and who accede to insurer demands for information could find their conduct called into question. One wonders whether insurers have an obligation to warn its own counsel about this potential ethical trap.
The “Contractors Special Conditions” endorsement will not be enforceable in all circumstances. At least one Oregon federal court has strictly applied this endorsement (that unpublished decision is on appeal), there is a good argument that the endorsement is not applicable at all in states like Oregon, where virtually the full range of claims are made available against subcontractors (even without a written agreement), and where anti-indemnity statutes mean that a subcontractor’s participation in a case accomplishes almost all that could have been achieved by additional-insured and indemnity language in a written contract.
Moreover, the endorsement has been characterized as a disfavored “escape clause” by some courts, including Underwriters of Interest v. ProBuilders Specialty Ins. Co., 241 Cal. App. 4th 721, 729 (2015), in which the court held that the insurer was required to defend the insured contractor even though it appeared that the contractor had not complied with the conditions, because (among other things) there were some claims against the contractor that did not rely on the work on subcontractors. In Oregon and elsewhere, courts may use different nomenclature, referring to endorsements like this one as a “condition of forfeiture” and require the insurer to meet a heavy burden to enforce the clause.
Contractors, their defense counsel, and their insurance brokers should look out for the “Contractors Special Conditions” endorsement and if it ends up being a part of the policy – take great care.