Inside this Issue

A1 - Pollution Exclusion in Well Driller’s CGL Policy Barred Coverage for Damages Allegedly Caused by Hydraulic Fracturing
A2 - Engineer Owes No Duty to Developer Who Claim Third Party Beneficiary Rights to Services Engineer Performed as Subdivision Inspector for Town
A3 - Indemnification Clauses: Uninsurable Contractual Liability
A4 - Analyzing Additional Insured Endorsements
A5 - Nationwide Mutual Insurance Company Announces it Will Not Insure Damages from Fracking
A6 - Workers Compensation Experience Rating Formula To Change

Article 1

Pollution Exclusion in Well Driller’s CGL Policy Barred Coverage for Damages Allegedly Caused by Hydraulic Fracturing

See similar articles: Fracking | Hydraulic fracturing | Insurance-Pollution Coverage | Pollution Exclusion

J. Kent Holland, Jr., J.D.

Where a hydraulic fracturing well driller was sued by a homeowner who alleged his drinking water was contaminated by the release and discharge of pollutants and contaminants due to improper cement casing of the gas wells and other activities involving the gas wells, the driller tendered the claim to its commercial general liability (CGL) insurance carrier to defend the claim and indemnify against any damages awarded. The carrier, ACE Insurance, denied coverage based on a pollution endorsement that limited coverage to only sudden and accidental incidents. After settling the case with the homeowner, the well driller filed suit against ACE, alleging that the failure to provide a defense constituted bad faith. The case is Warren Drilling Co., Inc. v. ACE American Insurance Company and Equitable Production Company, (Court of Common Pleas – Noble County, OH – Case No. 212-0088).

As of the date when this article was written, the suit is currently pending. The driller seeks to recover under its policy for over $100,000 in legal fees and expert witness fees incurred in the underlying case, as well as $40,000 incurred in reaching a settlement with the homeowner. It is likely that the carrier will respond to the suit with a motion to dismiss or motion for summary judgment, asserting that the case must be dismissed as a matter of law based on what it will argue is clear and unambiguous language of the policy.

The Homeowner’s Complaint of Bodily Injury and Property Damage

In the underlying homeowner’s suit, the plaintiffs alleged that pollutants and industrial waste, including “fracking fluid”, was discharged into the ground water or onto the waters near the plaintiffs’ home and into the ground water wells, which contaminated the water supply plaintiffs consumed and relied on as their water supply. As set forth in the Homeowner’s Complaint:

“Plaintiffs complain of environmental contamination and polluting events caused by the conduct and activities of the Defendants herein, who caused the releases, spills, and discharges of gases, hazardous chemicals and industrial wastes from its oil and gas drilling facilities and/or drilling activities. These releases, spills and discharges caused the Plaintiffs and their property to be exposed to such hazardous gases, chemicals and industrial wastes and caused damage to the natural resources of the environment in and around the Plaintiffs’ property, causing Plaintiffs to incur health injuries, loss of use and enjoyment of their property, loss of quality of life, emotional distress, and other damages.”

The Homeowner’s Complaint names as a defendant the Equitable Production Company (EPC), who apparently owned and operated the gas wells in question. It also named Warren Drilling Company and Halliburton Energy Services, Inc. for their roles in conducting drilling operations on the gas wells located in Jackson County, West Virginia. The complaint states that the defendants “used a drilling process known as hydraulic fracturing and horizontal drilling, a process that “requires the discharge of enormous volumes of hydraulic fracturing fluids, otherwise known as ‘fracking fluid’ or ‘drilling mud,’ into the ground water under extreme pressure in order to dislodge and discharge the gas contained under the ground.”

As a result of the hydraulic fracturing process used for drilling the gas wells, the homeowner sought remediation costs, property damages, personal injury damages, costs of future health monitoring, and an injunction to stop further drilling.

ACE Denies Coverage Under the Driller’s Policy

ACE Insurance, the CGL carrier for Warren Drilling, denied any obligation to either defend or indemnify the driller under the policy. This denial was based on language in the Energy Pollution Liability Extension Endorsement of the policy that provides insurance will not apply to injuries and damages arising out of, or in any way related to a “pollution incident” from the discharge of “pollutants” except where the following five conditions are satisfied:

“1. the discharge is both unexpected or unintended from the standpoint of the ‘insured’; and

2. the discharge commenced abruptly and instantaneously and can be clearly identified as having commenced entirely at a specific time on a specific date during the policy period; and

3. the discharge commenced, at or from, a site location or premises….; and

4. the discharge was known by any ‘insured’ within 30 days of the commencement of the discharge of ‘pollutants’; and

5. the discharge was reported to us within 60 days of the commencement of the discharge of ‘pollutants’.”

In a letter to the well driller denying coverage, ACE stated that the driller failed to satisfy all five conditions that are the prerequisites for coverage. In response to the coverage denial, the driller’s attorney wrote to ACE acknowledging that the carrier “correctly characterized the claim as alleging that the drilling activities of Warren Drilling and other defendants contaminated the Plaintiffs’ property and ground water.” But the attorney explains that the driller’s position is that (1) “ACE may not require slavish adherence to the terms of that coverage; (2) even if the pollution liability coverage does not apply, Warren is entitled to a defense and indemnification of any property damage under [another section of the policy].”

The attorney’s letter goes on to argue that since the driller did not learn of the pollution until a couple years after it first occurred, it was impossible for the driller to notify the carrier with the time periods established in the policy, and that the there is no evidence that ACE has been prejudiced by the inability of the driller to give the notice within the 60 days of the commencement of the gas well drilling.

In response to Warren Drilling’s attorney’s letter, coverage counsel for ACE responded, “You admit that Warren Drilling did not know of the discharge of pollutants within 30 days of the commencement and did not report the discharge to ACE within 60 days of the commencement. Accordingly, Warren Drilling has not met its burden of establishing the conditions to create an exception to the absolute pollution exclusion.”

Comment on Policy Intent

When a policy, such as the ACE policy, states it is to cover a pollution incident that “commenced entirely at a specific time on a specific date during the policy period” this is understood to mean that the policy is intended to cover only events such as a quickly occurring spill or a sudden discharge that occurs at a specific point in time that can be promptly discovered and reported to the carrier. It is not generally understood to encompass pollution events that occur out of sight, underground, and perhaps gradually over time.

To be covered, the policy states that the pollution “discharge [must have] commenced abruptly and instantaneously and can be clearly identified as having commenced entirely at a specific time on a specific date during the policy period.” This limits coverage to sudden and accidental events that “commenced entirely” at a specific moment in time.

There was a time when CGL policies used the terms “sudden” and “accidental” in an effort to limit pollution incidents that would be covered under the policy. Because so many courts, however, interpreted those words to include gradual releases of pollution that were not immediately known at a specific time and place, the standard insurance policies were revised in an effort to avoid potential ambiguity or confusion over the intended limitation on coverage.

Instead of using words like “sudden”, a policy such as the ACE policy at issue here specifies that the pollution discharge must commence “abruptly and instantaneously” and be known by the Insured within 30 days of the date the discharge commenced and must be reported to the carrier within 60 days of the date it commenced.

In the coverage dispute case with Warren Drilling, ACE asserts that the effect of the above-quoted language is to exclude coverage for damages that are alleged to have been caused by a “pollutants” discharge from hydraulic fracturing that are not caused “abruptly and instantaneously” and that that are not known quickly enough to be known by the ‘insured’ within 30 days of the commencement of the discharge of “pollutants” and be reported to the insurance carrier within 60 days of the commencement of the discharge.

Risk Management Comment:

Seeking pollution coverage under the limited pollution coverage of a CGL policy for allegations of gradual, long-term pollution that is not capable of quick discovery and reporting, is not a realistic insurance/risk management practice. The limited pollution coverage available by endorsement to a CGL policy is not sufficient to manage the risk of the types of pollution or environmental impairments that may occur from the hydraulic fracturing gas well drilling process. Consequently, firms involved in this process may choose to obtain a policy specifically intended to cover such risks. A contractor’s pollution liability (CPL) policy, for example, can cover a well driller on a broad basis for pollution caused by their work without regard to whether it occurs suddenly at a specific point in time or occurs gradually over a long period of time and is not discovered until long after the construction activities that caused it to first commence.

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. 14, No. 7 (July 2012).

Article 2

Engineer Owes No Duty to Developer Who Claim Third Party Beneficiary Rights to Services Engineer Performed as Subdivision Inspector for Town

J. Kent Holland

A professional employed by a town to inspect the construction of a subdivision does not owe a duty of care to a developer or its contractor with whom the professional has no contractual relationship where it was not foreseeable and reasonable for the developer to rely on the services provided by the professional to the town, and the professional had no knowledge that the developer or contractor were relying on its services, since its contract with the town expressly stated the services were for the sole benefit of the town.

In this case, an engineering firm was hired by the town as a consultant to conduct subdivision reviews and inspections. This entailed inspecting the work performed by a contractor on a developer’s housing project. The developer filed suit against the engineer, alleging that the engineer was negligent in failing to identify deficiencies in the contractor’s work and that this resulted in the developer having to correct the work and considerable additional cost. The developer was not a party to the contract between the town and engineer, but was required pursuant to town rules and regulations to reimburse the town for the entire cost that the town paid to the engineer.

Evidence was presented at trial showing that although the engineer was only required to give its inspection reports to the town, it actually provided copies of the reports to the developer as well. There was also evidence that the engineer interacted regularly with the developer and developed a close working relationship, and was the only engineering firm on site that was carrying out inspections during approximately two years of construction.

It turned out that the contractor improperly installed water lines, fire hydrants, granite curbing, manhole covers, and other features of the infrastructure. There was evidence presented that the engineer in some cases did not identify shortcomings and deficiencies in the contractor’s work.

Both the trial court and appellate court concluded that the engineer owed no duty to the developer and that summary judgment for the engineer was properly granted. In arguing that the engineer was liable, the developer sought to have the court apply what is known in Massachusetts as the “Craig principle of foreseeable reliance” that was established in a previous court decision. That case held that where an engineer working for a town knew that “offset stakes” it laid down would be used by a third-party contractor, the contractor to sue the engineer based on its justifiable reliance on those stakes. In the current case, however, the court stated that the key is not whether the contractor thought the engineer was aware the contractor was relying on its services but rather whether the engineer had “actual knowledge” of the plaintiff’s reliance on its services.

Among the reasons given by the court for why the developer could not have reasonably relied on the services of the engineer were the following: (1) The contract stated the engineer would have no “authority or responsibility for the methods and procedures of construction selected by the Contractor,” (2) At the outset of the project the engineer issued a memorandum to the developer stating that any deviation from the approved subdivision plans without prior approval of the engineer would be performed at the contractor’s risk, and (3) the developer hired its own engineer for the project and “The fact that the project engineer may have failed to honor its contractual obligations to [the developer] does not, standing alone, justify [Developer’s] reliance on the work performed by the [town’s engineer]”.

For these reasons, the court held the engineering firm owed no duty of care to the developer. Meridian at Windchime v. Earth Tech, Inc., 960 N.E. 2d 344 (Mass. 2011).

Article 3

Indemnification Clauses: Uninsurable Contractual Liability

See similar articles: duty to defend | Indemnification clause

Professional consultants are judged by whether or not they satisfied the professional standard of care (i.e., were not negligent in the performance of their services). That is what is covered under a professional liability policy; therefore, it is critical that the indemnification obligations be limited to damages to the extent caused by the consultant’s negligence. Anything more is barred from coverage pursuant to the contractual liability exclusion of the professional policy. By agreeing to more than that, the consultant effectively agrees to a higher standard of care that is uninsurable. Under the common law of the states, the professional consultant is not held to a standard of perfection, but instead is required only to meet the generally accepted standard of care. Language is sometimes buried deep within the insurance article of a contract that states the consultant must provide insurance with contractual liability coverage for the indemnity agreement. This is not acceptable for professional liability, as those policies do not provide such contractual liability coverage for defense costs. Additionally, they will not cover damages within the indemnity costs other than what would have been incurred in the absence of the contractual indemnity provision.

Strike Any “Duty to Defend” Language

There is no common law duty of a consultant to defend its client against third-party actions. That duty can only arise as a result of a contractual liability created through the indemnification clause of the contract. Since this is a contractual liability, it is excluded from coverage pursuant to the contractual liability exclusion of the errors and omissions policy.

Courts interpreting indemnification provisions that include “duty to defend” language have explained that this means the consultant must defend its client (i.e., pay legal fees on behalf of) as the litigation is ongoing. It cannot wait until the conclusion of the litigation to determine whether the consultant is found to have negligently performed services and therefore owe a separate duty to indemnify. The courts see the duty to defend and the duty to indemnify as two separate and unique duties. The professional liability insurance policy only covers damages to the extent they are caused by the consultant’s negligence — and that determination can only be reached at the conclusion of the case or by settlement to which the carrier agrees.

Although it is theoretically possible that the damages awarded by a court might include some attorney’s fees if there is a statute that requires the same, attorney’s fees are generally not awarded as part of a judgment in the American system of justice. Therefore, a clause stating that the consultant will defend (pay on behalf of) or indemnify (pay attorney’s fees after judgment is rendered) may create uninsurable liability. Agreeing to defend on behalf of a client, however, is the far worse situation. The consultant would be paying out of its own pocket its client’s attorney’s fees as they are incurred to defend against a third-party claim. Ultimately, that claim might not even be found to have been caused by the consultant’s negligence.

Typical advice to professional consultants from risk managers and insurance professionals is that any duty to defend the client pursuant to an indemnification clause, or other provision of the contract, is uninsurable pursuant to the contractual liability provision of the contract. Therefore, it should be struck from the contract language accordingly.

It is not good enough that the contract states that the duty to defend and indemnify is limited to damages resulting from the negligent performance of professional services. Even where the trigger is limited to “negligent performance,” a court could reasonably interpret the duty to defend to be such a broad duty that the consultant could be expected to begin defending a claim on behalf of its client (paying attorney’s fees as they are incurred) as soon as any allegations of negligence are made. This could be true regardless of whether those allegations are frivolous and ultimately disproved.

Although the results vary by state, it is generally the case that the duty to defend that is agreed to as part of an indemnification clause is comparable to the duty to defend that an insurance carrier has pursuant to an insurance company. An insurance company doesn’t wait to see if you are negligent before defending you. Rather, the company defends you as the battle is being waged in the hope of proving you are not negligent. Waiting until negligence has already been proven before starting the defense would be like waiting until the war has been lost before deciding to join the battle. The same principle applies to defense duties assumed by a consultant in an indemnity clause.

For a more detailed commentary, see the newsletter I wrote for publication in the most recent Zurich A/E Briefings, spring 2012.

http://www.zurichna.com/internet/zna/sitecollectiondocuments/en/products/construction/designprofessional/aebriefings/aebriefing_2012_spring.pdf#page=1

Article 4

Analyzing Additional Insured Endorsements

See similar articles: Additional Insured

M. Claire Juliana J.D

Additional insured endorsements are a routine request for policyholders having to satisfy contractual obligations to their clients and other parties. But, there is a seemingly limitless variety of endorsements and an equally impressive amount of case law out there interpreting these various additional insured provisions – quite often with unexpectedly expansive results (from the perspective of the party extending such coverage whether it be the insured or its insurer).

Take, for example, a recent case from the New Jersey Appellate Division. In Marshall v. Raritan Valley Disposal, 2012 N.J. Super. Unpub. LEXIS 544 (3/13/2012), the court was confronted with a dispute between two insurance companies concerning their respective monetary contributions, if any, towards the settlement of a personal injury lawsuit. The underlying lawsuit involved a tragic and fatal accident involving a garbage truck. The town of West Amwell (the “Town”) had contracted with Raritan Valley Disposal (“RVD”) to place a garbage truck on a site one day a week for residents to empty their garbage. The contract only required that RVD bring the truck to the site, park it where told by a municipal employee and then remove it at the end of the day. Additionally, for purposes of the dispute herein, the contract required that RVD add the Town as an additional insured under the policy as well as to indemnify and hold it harmless from and against, among other things, claims resulting directly or indirectly from the performance of the contract.

On May 12, 2001, a resident backed his pickup truck pinning another resident against the stationary truck causing her fatal injuries. Her estate sued the Town for its failure to maintain the premises in a safe condition and failure to warn of unsafe and dangerous conditions at the facility. The Town’s general liability insurer undertook the defense of the suit and also filed a third party complaint against RVD’s insurer seeking coverage under the additional insured endorsement to its Business Auto policy.

Endorsement #10 to that policy defined “insured” as follows:

WHO IS AN INSURED

A. The “Named Insured” for any covered “Auto” and

B. At the option of the Named Insured, any entity or individual prior to or after an “Accident” for any

covered “Auto”.

The lower court held that the Town was an insured pursuant to the terms of RVD’s policy. The court found the provision to be “not ambiguous” but even if it were, the court concluded that the contract required RVD to obtain primary additional insured coverage for the Town. The court added that the Town was specifically insured for the accident because it resulted from the use of the garbage truck.

The matter was appealed and the New Jersey Appellate Division affirmed the lower court’s finding of coverage for the Town under the RVD policy. The court rejected RVD’s insurer’s argument that the terms of the waste collection contract were intended to limit the scope of the Town’s status by excluding liability coverage for the Town’s own negligence. The court found the endorsement on its face to be unambiguous - the Named Insured could (and did) designate any entity “without regard to a reason”. Because the language of the endorsement was plain and unambiguous on its face, the court did not need to resort to review of any extrinsic information (such as the underlying contract) to distill its meaning. That said, the court did look at these collateral documents and found no support for the claimed limitation regarding negligence. The court also addressed the carrier’s argument that the accident did not “result from the use of the garbage truck” as to implicate the auto policy. The court quickly dispatched with that argument finding that the activities at the Town facility involved the proper use of the garbage truck within the reasonable intendment of all concerned. The victim had been using the truck to dispose of trash; the Town was using the truck as a means of affording a public service to its residents; and the truck was used to fulfill the Town’s provision of such services. The court was therefore satisfied that the policy’s employment of the word use “fully embraced the circumstances of this tragic accident”.

Maybe the court’s conclusion was one you would expect or maybe not. But at the very least, this case, like those preceding and (likely) succeeding it should serve as a reminder that while these endorsements can be an effective risk management tool, policyholders and their advisors should make sure that the wording of the additional insured endorsement is reviewed carefully and clearly articulates the parties’ expectations and obligations.

About the Author

M. Claire Juliana J.D. is Director - Environmental Claims; Aon Risk Solutions; Specialty- Environmental; 199 Water St., 8th Floor, New York, NY 10038; Telephone: 212.441.2392;

E-mail: claire.juliana@aon.com.

Article 5

Nationwide Mutual Insurance Company Announces it Will Not Insure Damages from Fracking

J. Kent Holland Jr., J.D.

A Wall Street Journal article (Associated Press) states that Nationwide Mutual Insurance Co. has become the first major insurance company to announce that it will not issue policies to cover damage related to hydraulic fracturing. According to the Wall Street Journal article, the Nationwide policy came to light when an internal memo detailing underwriting guidelines was posted on websites of anti-fracking groups in up-state New York, and the memo reads:

"After months of research and discussion, we have determined that the exposures presented by hydraulic fracturing are too great to ignore. Risks involved with hydraulic fracturing are now prohibited for General Liability, Commercial Auto, Motor Truck Cargo, Auto Physical Damage and Public Auto (insurance) coverage."

It said "prohibited risks" apply to landowners who lease land for shale gas drilling and contractors involved in fracking operations, including those who haul water to and from drill sites; pipe and lumber haulers; and operators of bulldozers, dump trucks and other vehicles used in drill site preparation.

It appears that the insurance carrier is going beyond inserting a pollution exclusion in their policies and is instead deciding not to write policies of any nature for any of the ancillary service providers involved with fracking.

In view of the significant negative press about fracking and the threats by environmental groups to do what they can to stop, or at least slow down, fracking, it seems likely that there could be a litigation explosion against all firms involved, even in an ancillary manner, with fracking. Since a recurring theme in such claims will likely be property damage and personal injury caused by air and ground water pollution, it is not difficult to see what insurance carriers would exclude environmental or pollution damages asserted against their insureds arising out of hydraulic fracturing. The solution for those in need to this coverage may well be to purchase a stand-alone environmental policy to specifically provide coverage for such damages or alleged damages.

Article 6

Workers Compensation Experience Rating Formula To Change

See similar articles: Workers compensation

Phil Galbraith

The National Council on Compensation Insurance (NCCI) has announced changes in the formula that is used to calculate experience modifiers for employers in most states. Specifically, the primary/excess split point will be incrementally increased from the current $5,000 to $10,000 in 2013 and $13,500 in 2014. Thereafter, the split point will be tied to an inflationary index that will start at $15,000. NCCI cites medical inflation as the reason for the changes, and a need to make premiums more reflective of an employer's loss experience. For example, in the first year of these changes, contractors with no losses greater than $5,000 should see a drop in their experience modification rating (EMR) factor, while those with a relatively large number of losses approaching or exceeding $10,000 will see an increase in EMR. There is no cap on how much an employer's EMR can increase in a given policy year.

These changes will impact all industries but perhaps the construction industry more than most due to minimum EMR requirements imposed on contractors by many project owners just to qualify to bid on a project. Furthermore, it could affect eligibility for the contractors credit premium adjustment program (CCPAP), which provides discounts to contractors who pay higher than the state average hourly wage for employees in certain construction classifications. In some states, contractors must have an EMR of 1.0 or lower to be eligible for the CCPAP discount.

Unfortunately, because the experience rating period covers prior years' losses, contractors will not have the opportunity to implement strategies that could reduce the impact of the changes before they become effective. However, contractors do need to prepare for the changes by calculating an estimate of their new EMR and account for the difference in premium in their 2013 budget. Contractors can ask their insurance agent or broker to calculate a rough estimate of their new mod by using current loss data and using $10,000 instead of $5,000 as a split point, but these estimates will not reflect expected changes in other rating factors. (The actual rating factors that will be needed to calculate the new mod with certainty will not be available until late summer or early fall.) Contractors should also discuss these changes with key clients to make them aware of coming changes in the EMR and make it clear that these changes are the result of a formula change rather than an increase in losses or a relaxation in safety protocols.

These changes will become effective in 2013 for all states that follow the NCCI rating system. A few independent bureau states have made comparable changes. Changes to the primary/excess split point have not been proposed in the monopolistic states (North Dakota, Ohio, Washington, and Wyoming) or in most independent bureau states, including California, Delaware, Massachusetts, Michigan, New Jersey, New York, Pennsylvania, and Texas.

Reprint from International Risk Management Institute, Inc. (IRMI)

For more information contact:

Phil Galbraith, CPCU

President

Capitol Risk Solutions, Inc.

phil@capitolrisksolutions.com

301-233-2427

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ConstructionRisk.com Report (July 2012)