Where agreement between a contractor and its client contained an agreement to insured but also a waiver of subrogation, the client and its insurance carrier had no right to file suit against the contractor to recover losses paid to third parties. Court also held that the contractor had no duty to third parties for property damage because they lacked privity of contract.  U.S. Automatic Sprinkler Corp. v. Erie Insurance Exchange, 204 N.E.3d 215 (Indiana 2023).

The question before the court was whether commercial tenants could recover their property damages from a contractor who had a contract with one of the tenants to perform work on a sprinkler system, and it is alleged that the work was performed negligently causing the system to flood, causing property damage to all tenants in the building.  Only one of the tenants had a contract with the contractor.

The tenant who had the contract with the contractor (we will call it the “Company”) reported the damage to its insurance carrier who paid for the damages as an insured loss.  That carrier then sued the contractor under a subrogation theory to recover the damages paid.  The other tenants also sued the contractor to recover their damages as well.

In seeking summary judgment to dismiss the lawsuits, the contract argued that all parties were barred from recovery as a matter of law.  The trial judge declined to grant summary judgment.  This was reversed on appeal, with the court holding that contractor owed no duty of care to the tenants with whom it had no contractual relationship.  The court also held that the summary judgment should have been granted against the insurance carrier on the subrogation claim.

The contractor argued that the subrogation waiver contained in its contract precluded the insurance carriers attempt to recover what it had paid in damages from the contractor or its carrier.  The appellate court found that the agreement had an unambiguously broad subrogation waiver showing the parties intent to shift all risk of loss – irrespective of its source – to its insurance.  This barred the tenant’s carrier, therefore, from recovering against the contractor.

With regard to the suit by all other tenants against the contractor, the court held that because the allegedly negligent work posed a risk only to property and bodily injury, the tenants’ negligence claims failed as a matter of law.  In explaining its reasoning, the court stated:

“Like an agreement to insure, a subrogation waiver signifies the contracting parties’ intent to recover damages “through insurance claims, not lawsuits”—but perhaps more explicitly.”

“Overall, when a contract contains an agreement to insure or a waiver of subrogation, the parties demonstrate their intent to avoid liability by allocating it to an insurer….”

“Because the Inspection Agreement contains both an agreement to insure and a waiver of subrogation, the question is not whether Surgery Center agreed to waive its insurer’s subrogation rights—it did. Instead, the question is whether these provisions were limited to or conditioned on Surgery Center’s damages arising in a particular manner.”

“The agreement to insure provides that Surgery Center “will be responsible for maintaining all liability and property insurance.” This provision, by its plain language, is not conditioned on Surgery Center’s loss arising in any particular way. Further, by agreeing to purchase insurance for Automatic Sprinkler’s benefit, Surgery Center effectively agreed to waive Automatic Sprinkler’s liability in the event of loss (citation omitted). And because “the rights of a subrogated insurer can rise no higher than the rights of its insured,” the agreement to insure forecloses Travelers from pursuing this subrogation action. (citation omitted).”

“We reach the same conclusion based on the plain, unambiguous language of the subrogation waiver. That clause, which immediately precedes the agreement to insure, states, “No insurer or other third party will have any subrogation rights against [Automatic Sprinkler].” This provision captures the understanding that “no” party—including Surgery Center’s insurer, Travelers—would have “any” subrogation rights against Automatic Sprinkler. Travelers, however, insists that this waiver applies only to losses sustained through work completed within the scope of the agreement. But, by its plain language, the subrogation waiver is not conditioned on Surgery Center’s loss arising in any particular way. Instead, given its use of the word “any,” the waiver unambiguously forecloses the availability of a subrogation action against Automatic Sprinkler irrespective of the circumstances giving rise to the loss.”

Contractor Owed no Duty to the non-contract tenants

Under the applicable common law in the state of Indiana, the court found that:

“Under our common law, the availability of recovery in a negligence claim varies depending on the damages sustained and whether the parties share a contractual relationship (citation omitted). In the context of contractor liability, we traditionally followed the “acceptance rule” to assess whether a contractor could be liable to a third party (citation omitted). Under this rule, which has various exceptions, contractors are generally shielded from third-party liability once the work is completed and then accepted by the owner.”

The court explained that it subsequently adopted what is known as the “foreseeability doctrine” that would allow recovery by a party not in contract for   personal injury damages.  “But the absence of privity continued to insulate contractors and builders from third-party liability unless the work was so “dangerously defective, inherently dangerous, or imminently dangerous” such that it produced a “risk of imminent personal injury (citation omitted).”

In this case the court stated that first, “the foreseeability doctrine applies when a third party seeks recovery for personal injury that was a foreseeable consequence of a contractor’s allegedly negligent work.” And, second, “the doctrine applies when a third party seeks recovery for property damage if personal injury—though not sustained—is a foreseeable consequence of a contractor’s allegedly negligent work.”

In the instant case the court stated that the alleged negligence didn’t pose a risk of personal injury to the non-contract tenants, but only endangered their property.  The lack of privity of contract, therefore, barred their recovering property damages from the contractor.  Importantly, the court explained that:

“Under these circumstances, imposing third-party liability on companies—like Automatic Sprinkler—would force them to “insure against a risk the amount of which they may not know and cannot control.” (citation omitted). We find no reason to reallocate this risk and abandon the privity requirement when, as here, the allegedly negligent work created a risk to only property and the third parties suffered only property damage. We therefore hold that Automatic Sprinkler, as a matter of law, owed no duty to the Non-Contract Tenants.”


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 ConstructionRisk 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 Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk Report, Vol. 25, No. 6 (August 2023).

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