Published October 25, 2018 • 2 minute read
Example: Cristoff the Contractor purchases a commercial liability insurance policy from Fairweather Insurance Company. He then outsources a portion of a construction project to a third-party subcontractor, aptly called Clumsy Crew.
Before beginning work, Clumsy Crew presents Cristoff with a service contract, and included within the contract is a waiver of subrogation provision. Cristoff never informs Fairweather Insurance Company of the waiver of subrogation clause in the contract, and Fairweather Insurance Company never reviews the details of the third-party’s contract adequately enough to notice the consequential language in the policy.
During construction, Clumsy Crew causes $1,000,000 in damages. By law, Fairweather Insurance Company is liable to pay for the damages. When Fairweather moves to sue Clumsy Crew, they are blocked by a waiver of subrogation, which cancels out any rights that Fairweather Insurance Company has to such a claim.
Subrogation is an insurance term defined as the substitution of one person or group by another in respect of a debt or insurance claim, accompanied by the transfer of any associated rights and duties.
And another, possibly clearer, definition:
The principle under which an insurer that has paid a loss under an insurance policy is entitled to all the rights and remedies belonging to the insured against a third party with respect to any loss covered by the policy. (Source: Lee R. Rugg, Couch On Insurance § 222.2, at 222-14 (3d ed.2000)
Effectively, subrogation means an insurer may step into the position of the insured after a claim has been paid to reclaim the cost of damages from the party responsible in a court of law.
Many subcontractors—especially in construction contracts—will include a waiver of subrogation in their contracts simply to protect their own liability, without malicious intent. It is not the responsibility of the subcontractor to inform the insurance company of the waiver.
In an alternate universe, Fairweather Insurance Company performs due diligence prior to work beginning on Cristoff the Contractor's construction project. Fairweather then notices there's a waiver of subrogation involved and, in this case, responds by raising Cristoff the Contractor's insurance premium, thus shrinking the amount of risk for their own bottom line in the event of damages incurred by Clumsy Crew.
In the original case of Fairweather vs. Clumsy Crew, a court of law would likely rule in favor of Clumsy Crew because, in theory, Fairweather was in the most favorable position to protect itself from paying for damages.
In most cases, there will be language in commercial or general liability policies that explicitly prohibits the insured from signing any contracts which revoke or alter the insurer's rights to subrogation.
If the waiver-prohibiting language is present in Cristoff's policy, but he still goes ahead and signs the contract with Clumsy Crew that includes a waiver of subrogation, Cristoff is now in breach of contract, and in the event of damages incurred, may be dropped from coverage by Fairweather and also become liable for resulting losses.
Hot Tip: Instead of playing roulette with contract and policy provisions, maintain total transparency regarding contract language, and hire professionals to track, review and improve your insurance documents in real-time.