Second Circuit Holds That a Waiver of Subrogation Provision Applies to Breach of Contract and Gross Negligence Claims
April, 2005
Clausen Miller P.C. has been very successful in recent years convincing various courts, arbitrators, mediators and adversaries that a waiver of subrogation provision does not apply to breach of contract and/or gross negligence claims. In fact, as previously reported in the New York Clausen Miller Report Volume 1 & 2, 2004, we obtained a written decision from the U.S. District Court for the Southern District of New York specifically holding that a waiver of subrogation provision will not apply to a gross negligence claim. See American Motorist Ins. Co. v. Morris Goldman Real Estate Corp., 277 F.Supp.2d 304 (S.D.N.Y. 2003). Unfortunately for the subrogation bar, not all law firms have been as successful as Clausen Miller. In St. Paul Fire & Marine Ins. Co. v. Universal Builders Supply, 2005 WL 1220473 (2d Cir. 5|24|05), the Second Circuit, applying New York law, held that a waiver of subrogation provision applies to a gross negligence claim.
Facts
Durst (owner) retained UBS to serve as its head contractor for the construction of Four Times Square, New York, New York. The construction contract required Durst to acquire a builder's risk policy, which would “insure against risks of physical loss or damage to buildings and structures to be incorporated into the project,” and cover Durst, UBS and all subcontractors as insured parties; the policy was to waive the carrier's subrogation rights against all contractors/subcontractors. The contract also provided that Durst waive all rights against contractors/subcontractors for damages caused by fire or other perils, “to the extent covered by insurance obtained pursuant to” the contract. Finally, the contract required that all contractors/subcontractors acquire waivers of rights against all parties and all certificates of insurance shall indicate “that waiver of subrogation has been endorsed to the insurance policies.” 2005 WL at 1220473, *1.
Durst acquired a builder's risk policy from St. Paul, which policy also named UBS and all contractors/subcontractors working on the project. St. Paul's policy allowed an insured to waive subrogation rights, in writing, prior to a loss. Durst also acquired an excess liability policy from TIG Ins. Co., which also named UBS. TIG's policy provided that it is subrogated to all of Durst's rights of recovery and Durst shall do nothing after a loss to prejudice the subrogation rights.
UBS acquired a CGL policy from AIU Ins. Co. and an excess liability policy from Royal Ins. Co. These policies also provided the carriers with subrogation rights and stated that UBS must not do anything after a loss to affect these rights.
“In 1998, the 49-story temporary scaffolding in use for construction of the building collapsed, resulting in one fatality and causing extensive damage to the site and surrounding area. As a result, Durst . . . had some $20 million in property losses....” Id. at 2. St. Paul paid approximately $19 million and this litigation was commenced. The complaint alleged that UBS was liable on the following theories: negligence, gross negligence, breach of contract, breach of warranty and strict liability. UBS answered the complaint and raised an affirmative defense that the claims were prohibited by the waiver of subrogation provision. UBS also commenced a third-party action against TIG, AIU and Royal seeking a declaration that they owed it defense and indemnity against St. Paul's claims.
Various motions to dismiss were filed, including a motion to dismiss St. Paul/Durst's complaint on the basis that St. Paul's right to subrogation was waived and Durst waived its right to recovery. Plaintiffs asserted that the waiver of subrogation provision did not apply because: (a) UBS breached the contract by not acquiring insurance policies that permitted waivers of subrogation, and (b) UBS engaged in gross negligence. The trial court rejected both of plaintiffs' arguments, dismissed the complaint, and held that TIG, AIU and Royal did not owe defense and/or indemnity to UBS. The remainder of this article will focus on the waiver of subrogation issue.
Analysis
On appeal, the Second Circuit observed that a “builder's risk policy is a form of property insurance that covers the interests of owner, contractor, subcontractors, and others involved in the construction project, insuring them against risks of property damage to the project.” Id. at 9. The Court noted that “in connection with such a policy, ‘[a] waiver of subrogation is useful . . . because it avoids a disruption and disputes among the parties to the project. It thus eliminates the need for lawsuits, and yet protects the contracting parties from loss by bringing all property damage under the all risks builder's risk property insurance.’” Id. On the other hand, a “liability policy covers ‘damage to third parties . . . such as injuries to passersby or damage to adjoining property.'” Id. at 10. The Court concluded that the mutual waiver provision in the contract did not apply to liability policies but was intended to apply to property policies. Therefore, UBS did not breach the contract by not acquiring a waiver of subrogation provision in its liability policies.
The Second Circuit next addressed the gross negligence claim and its relation to the waiver of subrogation provision. The Court noted “that New York ‘[p]ublic policy . . . forbids a party's attempt to escape liability, through a contractual clause, for damages occasioned by grossly negligent conduct.' This prohibition applies to bar so-called ‘exculpatory clauses,’ which ‘typically deprive a contracting party of the right to recover for damages suffered as the result of the exonerated party's tortious act.’” Id. at 11. “Thus, ‘[t]o the extent that agreements purport to grant exemption for liability for willful or grossly negligent acts they have been viewed as wholly void.’” Id. The Court continued:
It is important, however, to “distinguish between [such] exculpatory clauses” and “indemnity contracts that simply shift the source of compensation without restricting the injured party's ability to recover.” The later agreements are not contrary to public policy unless they purport to indemnify a party for damages flowing from an injury that was intentional. The New York Court of Appeals has held that a party may obtain insurance as protection against its own gross negligence.
Id. The Court reviewed the New York Court of Appeals' decision in Board of Education v. Valden Associates, Inc., 46 N.Y.2d 653, 416 N.Y.S.2d 202 (1979). Valden involved a fire causing damage to the construction project and the owner's carrier commencing a subrogation suit against the contractor/subcontractor alleging ordinary negligence. The Valden court stated:
‘[a] distinction must be drawn between contractual provisions which seek to exempt a party from liability to persons who have been injured or whose property has been damaged,' and ‘contractual provisions, such as those involved in this suit, which in effect simply require one of the parties to the contract to provide insurance for all of the parties' involved in the construction project, and thereby shift to an insurance company the risk of damage to the construction property. ‘Absent any indication of overreaching or unconscionability,' the latter type of provision ‘violate[s] neither section 5-323 of the General Obligations Law nor any other public policy.'
Id.
The Second Circuit ultimately held that since insurance coverage for gross negligence is not contrary to public policy, there should be no distinction between ordinary and gross negligence with reference to a waiver of subrogation provision. Therefore, the Court found no merit to St. Paul's contentions and affirmed dismissal of the complaint.
Learning Point:
Although Universal Builders held that a waiver of subrogation provision will apply to gross negligence claims under New York law, thus making it much harder for certain subrogation actions that were going to rely upon a gross negligence claim to get around a waiver of subrogation provision under New York law, there are still some loop holes which may apply to your case. It is still important to discuss your case with a competent and qualified subrogation attorney to determine whether there is subrogation potential, do not merely close the file because there is a waiver of subrogation provision.
If you would like to learn more about subrogation or any of the issues discussed above, please feel free to e-mail Robert A. Stern (rstern@clausen.com) or call him at (212) 805-3900. •
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