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In an insurance case arising out a church fire, a state supreme court held that Reliance National, and other insurance carriers of the church, were not entitled to subrogate against the contractor whose employee allegedly caused the fire, because a waiver of subrogation in the church’s contract with the contractor was enforceable to bar the claim.

The contract between the church and contractor contained the following provision: “”The Owner and Contractor waive all rights against each other, separate contractors, and all other subcontractors for damages caused by fire or other perils to the extent covered by Builder’s Risk or any other property insurance, except such rights as they may have to the proceeds of such insurance.”

The fire was caused when an employee of the contractor, Knowles Industrial Services, Corp. (Knowles),  brought a cigarette or open flame within ten feet of a section of the Church to which large quantities of the paint stripper had been applied earlier that day.  The church was destroyed, with damages totaling almost $15 million.  The church’s insurance carriers paid it about half of those losses.  Those carriers then sought to bring a subrogation suit in the church’s name against Knowles and the manufacturers of the paint stripper that was used.

As to the contractor, Reliance’s complaint alleged willful and wanton misconduct, negligence, breach of contract, and breach of warranty.  As to the chemical defendants, the complaint alleged strict liability, negligence, and breach of warranty.

The lower appellate court granted a motion for summary judgment in favor of Knowles and the chemical defendants, and against the church/Reliance because the court found that the waiver of subrogation barred the claims

On appeal to the state supreme court, Reliance argued that genuine issues of material fact exist with respect to whether Knowles misrepresented its qualifications and intentions to comply with all pertinent federal and state regulations in order to obtain the contract from the Church.  In reviewing this allegation the Supreme Court stated that as subrogee of the Church, Reliance is bound by the Church’s statement of material facts and record references.  Since the church did not argue or prove that Knowles made misrepresentations, the Court said this issue was not genuine and could not be presented by Reliance.
The court next dealt with the question of whether a wavier of subrogation is void as against public policy.  As explained by the court, “ A waiver of subrogation is a provision by which parties to a contract relieve each other of liability to the extent each is covered by insurance, thereby shifting the risk of loss to an insurer.”  The court further explained that it has previously held “waivers of subrogation are encouraged by the law and serve important social goals: encouraging parties to anticipate risks and to procure insurance covering those risks, thereby avoiding future litigation, and facilitating and preserving economic relations and activity.”

In this case, Reliance argued that there must be public policy exception to the general rule that waivers of subrogation are enforceable.  Specifically, Reliance contended that public policy precluded the enforcement of the waiver of subrogation in this case based on Knowles’s willful and wanton misconduct or its violation of a positive statutory duty, or because enforcement will be harmful to the interests of society.

The Supreme Court rejected all these bases.   It acknowledged that exculpatory clauses are unenforceable in the face of claims of gross negligence or willful and wanton misconduct.  But, the Court concluded “that principle is inapposite to waivers of subrogation.”  “The rule exists for exculpatory clauses to ensure that “a party injured by another’s gross negligence will be able to recover its losses. [citations omitted].  In cases involving waivers of subrogation, however, there is no risk that an injured party will be left uncompensated, and it is irrelevant to the injured party whether it is compensated by the grossly negligent party or an insurer.”  The point that the court was making is that there is a major distinction between a party indemnifying another for its own negligence and parties allocating risk to insurers.

What was particularly problematic to the Court with regard to Reliance’s argument was that, “Adopting the approach advocated by Reliance would require us to distinguish between varying degrees of negligence.  We have rejected the concept of gradations of negligence,  [citation omitted] and we decline to change our approach with respect to waivers of subrogation for two reasons.”  The first reason given by the Court is that “waivers of subrogation deter litigation among parties to complicated construction contracts.”

In this case, the Court noted the real injured party in this case—the Church—was not a party to the appeal because the waiver of subrogation did what it was intended to do: it allowed the Church to resolve its claims quickly.  The court further explained that the Church was made whole to the limits of its insurance and it was not divested of a remedy, and, “Were we to hold that parties cannot bar subrogated claims for gross negligence or willful and wanton misconduct, these benefits will evaporate, as the parties will have the incentive to litigate the question of whether a heightened standard of negligence applies.”

The second reason given by the Court was that “waivers of subrogation have a beneficial economic effect that furthers the public interest.  They help parties avoid the higher costs that result from having multiple insurance polices and overlapping coverage.  [citation omitted].  In addition, because insurers can account for such waivers when setting premiums, [citation omitted], there is still an economic incentive for parties to refrain from committing gross negligence or willful and wanton misconduct.”  For these reasons, the Court concluded that “public policy favors enforcement of waivers of subrogation even in the face of claims of gross negligence or willful and wanton misconduct.”

Reliance National Indemnity et al. v. Knowles Industrial Services, Corp. et al. (868 A.2 220, 2005 ME 29).

Comment. This case highlights why project owners routinely seek waivers of subrogation as one of the terms of the construction contract.  It also demonstrates why insurance carriers need to take these waivers seriously during the underwriting process—deciding whether to put limitations on them, or to charge additional premium for permitting the insured to grant a waiver of subrogation.  Some carriers, particularly in professional liability policies, have granted greater leeway to their insureds to waive the right to subrogate.  But the policy language states that such waivers must not be granted after the damage or claim, but may only be granted as part of the initial contract terms and conditions.  Exercise caution before agreeing to any waiver.  Be sure you know what your insurance policy permits.  Discuss this with your insurance broker or carrier as appropriate.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 7, No. 7 (Nov 2005).

Copyright 2005, ConstructionRIsk.com, LLC