‘Additional Insured" endorsements have been one of the most contested aspects of liability insurance in recent years, particularly with regard to construction defect claims. In New York, the priority of coverage afforded by additional insured endorsements in subcontractors’ excess policies vis-à-vis general contractors’ primary policies is often disputed. This article analyzes current New York law concerning the priority and allocation of coverage between a subcontractor’s excess policy and the primary coverage of its additional insured general contractor.

Until recently, New York law was clear that an allocation between a subcontractor’s excess policy and the primary coverage of its additional insured general contractor was determined without regard to the indemnification agreements in trade contracts. Instead, the courts compared the terms and intended purposes of each policy to ascertain the priority of coverage. Such priority of coverage determinations almost always resulted in horizontal exhaustion of the parties’ primary commercial general liability (CGL) policies prior to the triggering of excess or umbrella coverage.

Horizontal Exhaustion

It is well settled under New York law that, when a trade subcontractor’s work on a construction site results in injury or property damage, the trade subcontractor’s primary CGL insurer will defend and indemnify those upstream parties added as an additional insured for liability arising out of the subcontractor’s work.1 Often, however, the limits of the subcontractor’s primary CGL policy are insufficient to cover the loss to the insured party. It is in these instances when disputes arise as to who pays when.

In 1985, the Court of Appeals in State Farm Fire & Casualty v. LiMauro2 held that insurers have the right to rely upon the terms of their contracts with their insureds, and, as such, the terms of the insurance contracts dictate the priority of coverage.3 Since LiMauro, a number of Appellate Division cases have held that the priority of insurance coverage in construction cases is determined by the terms and conditions of the applicable insurance policies without reference to the underlying trade contracts.4 When such determinations have involved primary and excess insurance, the result has been horizontal exhaustion of primary policies prior to the triggering of excess policies.

For instance, in the 2008 case of Bovis Lend Lease LMB v. Great American Insurance,5 the First Department relied on the reasoning of LiMauro to hold that the upstream owner’s and construction manager’s primary policies were triggered prior to the subcontractor’s umbrella policy.6 The coverage dispute arose out of losses sustained from a wrongful death action resulting from a construction accident.

The decedent was employed by a subcontractor on the site and it was undisputed that the subcontractor’s primary policy provided additional insured coverage to the owner and construction manager up to the policy’s $1 million limits. At issue in the case was the priority of coverage upon exhaustion of the subcontractor’s primary policy. The owner and construction manager (the Bovis plaintiffs) argued that the priority of coverage should be determined by the terms of the underlying trade contracts, which required the subcontractor to obtain $5 million of additional insured coverage that would be primary to any other insurance maintained by the owner and construction manager.

The First Department disagreed with the Bovis plaintiffs. Relying on LiMauro for support, the court held that "[a]n insurance policy is a contract between the insurer and the insured. Thus, the extent of coverage (including a given policy’s priority vis-à-vis other policies) is controlled by the relevant policy terms, not by the terms of the underlying trade contract that required the named insured to purchase coverage."7 In considering the policies at issue, the court took into consideration the purpose each policy was intended to serve as evidenced by both its stated coverage and the premium paid for it, as well as the wording of the provisions concerning excess insurance. Because the subcontractor’s umbrella policy contained language making it a "true excess" policy and had a reduced premium, the court held that the umbrella policy was intended to constitute a final tier of insurance over and above the Bovis plaintiffs’ primary policies.8

The Second, Third, and Fourth departments have similarly held that a priority of insurance coverage determination must be made based upon the terms and conditions of the applicable policies without regard to the underlying trade contracts.9

‘St. Paul Mercury’: Exception

The First Department’s 2010 decision in Indemnity Insurance of North America v. St. Paul Mercury Insurance10 provides a significant exception to New York’s established rule of horizontal exhaustion. In St. Paul Mercury, a coverage dispute arose out of an injury sustained by the general contractor’s employee caused by the subcontractor’s failure to remove a cable from the work site. The injured employee sued both the owner and the subcontractor for his injuries. The owner tendered defense to the general contractor’s primary insurer who accepted the defense of the owner. Upon request, the subcontractor’s primary insurer agreed to defend and indemnify the owner without reservation or qualification. The subcontractor’s primary insurer later tendered defense of the owner to the subcontractor’s excess carrier because it looked as though the claim would exceed the primary insurer’s policy limits. The excess carrier also accepted tender without reservation or qualification.

A directed verdict was entered against the owner as to liability on the "scaffold law" claim, finding the owner vicariously liable as the owner of the construction site. The subcontractor’s excess insurer then settled the remaining claims within policy limits. The general release stated that the settlement was made with respect to the claims against the owner and subcontractor. The general contractor’s insurer did not participate in either the defense or settlement of the action, having determined that the subcontractor was ultimately liable as a result of its agreement to indemnify the owner.

The subcontractor’s excess carrier subsequently commenced a coverage action against the general contractor’s primary insurer seeking to recoup the amounts it paid to settle the underlying action. In its first cause of action, the excess carrier maintained that the general contractor’s primary policy was the primary insurance covering the loss and sought a declaration that its policy was excess to the general contractor’s primary policy. In its second cause of action sounding in subrogation, the excess carrier argued that it was entitled to reimbursement from the general contractor. The Supreme Court granted summary judgment to the general contractor and its primary insurer. An appeal followed.

With regard to the excess carrier’s first claim concerning the priority of coverage, the First Department held the priority of coverage to be irrelevant under the circumstances.11 The First Department relied upon the fact that the court in the underlying action had determined that the owner’s liability was strictly vicarious of the subcontractor’s liability. Thus, the court held, the subcontractor was required to indemnify the owner under the trade contract.12 In addition, the court stated, the fact that the subcontractor’s insurers, including its excess insurer, agreed to defend and indemnify the owner without any qualifications or reservations further supported its decision.13

The court also pointed out that the excess insurer settled the action without the consent of the general contractor’s participation or consent and held that, where an insurer rightfully does not take part in settlement negotiations or agree to the settlement of an underlying personal injury action, it is not required to contribute to that settlement.14

On the excess insurer’s second claim sounding in subrogation, the court held that, because the general contractor was an additional insured under the excess policy, the court stated, antisubrogation prohibits the excess carrier from seeking subrogation from the general contractor.15

Lessons and Tools

Strict Vicarious Liability Can Alter Results. The decision in St. Paul Mercury has important ramifications for insurers insuring owners, general contractors, and subcontractors in New York. According to St. Paul Mercury, the horizontal exhaustion analysis does not apply in a construction case if (1) a court has found that the upstream additional insured’s, i.e., the owner’s or general contractor’s, liability is strictly vicarious to that of the named insured subcontractor and (2) the subcontractor’s insurers agreed to defend and indemnify the upstream party without reservation or qualification.

Insurers for Subcontractors. Insurers for subcontractors should rely on LiMauro and its progeny, including Bovis and Tishman, to argue that the policy terms control coverage priority and that those terms establish horizontal exhaustion. Such insurers for subcontractors should seriously consider filing a declaratory action promptly upon the filing of the underlying action in order to increase the chances of obtaining a decision on the priority of coverage prior to a finding of liability in the underlying action.

But, because a priority of coverage determination may not always be possible prior to a liability determination, it is also important for such insurers to reserve their rights to a priority of coverage determination when agreeing to defend and indemnify upstream insureds. Moreover, if the upstream insurers are aware, via a reservation of rights, that they may be called upon to contribute to payment of the loss, such insurers should participate in any settlement negotiations, negating another basis for the decision to apply vertical exhaustion in St. Paul Mercury.16

General Contractors and Owners and Their Insurers. In light of St. Paul Mercury, general contractors and owners with contractual indemnity rights against trade subcontractors should want to establish as quickly as possible their right to contractual indemnity from a trade subcontractor in the event of injuries or property damage from an accident. This may be accomplished via a third-party claim in the underlying action. The feasibility of establishing the right to indemnity will depend, however, on the claims in the underlying action.

If the owner’s and/or general contractor’s liability is premised solely on the strict liability afforded by New York’s "scaffold laws," establishing the right to contractual indemnity by summary judgment will be easier than if the injured party also alleges active negligence against these parties. If a right to contractual indemnity is established prior to a determination regarding the priority of coverage, the upstream insurers should argue that, pursuant to St. Paul Mercury, the upstream parties’ liability passes to the subcontractors and its insurer, and thus the priority of coverage is irrelevant. Whether a New York court will extend the St. Paul Mercury reasoning beyond the specific circumstances in that case, however, is yet untested.

Conclusion

Although horizontal exhaustion remains generally the law in New York, the First Department’s decision in St. Paul Mercury shows that insurance coverage law is ever changing and provides insurers with the ammunition to argue for greater use of vertical exhaustion in certain circumstances.

Richard B. Friedman is a partner at McKenna Long & Aldridge and can be reached at rfriedman@mlalaw.com. Kristin Landis, a senior associate at the firm, assisted in the preparation of this article.

Endnotes:

1. Pecker Iron Works of New York v. Traveler’s Ins., 99 NY2d 391, 393-394 (2003) (holding that when a subcontractor agrees to provide additional insured coverage, the subcontractor’s policy is primary coverage for that additional insured.).

2. 65 NY2d 369 (1985).

3. Id. at 373.

4. See, e.g., Bovis Lend Lease LMB v. Great Am. Ins., 53 AD3d 140 (1st Dept. 2008); Tishman Constr. v. Great Am. Ins., 53 AD3d 416 (1st Dept. 2008); Harleysville Ins. v. Travelers Ins., 38 AD3d 1364 (4th Dept. 2007); United States Fid. & Guar. v. CNA Ins., 208 AD2d 1163 (3d Dept. 1994); Travelers Indem. v. American & Foreign Ins., 286 AD2d 626 (1st Dept. 2001).

5. 53 AD3d 140 (1st Dept. 2008).

6. Id. at 155.

7. Id. at 145.

8. Id. at 155. Also at issue was the Bovis plaintiffs’ primary policies vis-à-vis the downstream general contractor’s primary policy. Based upon the language contained in the general contractor’s policy and the Bovis plaintiffs’ policies, the general contractor’s primary policy was required to respond prior to the Bovis plaintiffs’ primary policies. Id.

9. See, e.g., Harleysville Ins. v. Travelers Ins., 38 AD3d 1364 (4th Dept. 2007); United States Fid. & Guar. v. CNA Ins., 208 AD2d 1163 (3d Dept. 1994); Stout v. 1 E. 66th St., 90 AD3d 898, 904-05 (2d Dept. 2011).

10. 74 AD3d 21 (1st Dept. 2010).

11. Id. at 26.

12. Id. at 25-26.

13. Id. at 26.

14. Id. at 25.

15. Id. at 26-27.

16. Id.