Priority of Insurance in Construction Accidents

Kevin G. Faley and Andrea M. Alonso, New York Law Journal

February 18, 2016

It is a common occurrence for multiple insurance policies to be applicable in a personal injury suit resulting from an accident on a construction site. Often both primary and excess policies contain conflicting language, have similar priority designations and provide coverage to several parties. Litigation arises when conflicting or similarly worded policies are used by a carrier in an attempt to gain "upstream" status to avoid paying out under its policy. Further, most construction contracts require a "downstream" party, such as a subcontractor, to indemnify or insure "upstream" parties, usually the general contractor or owner. This can make determining the priority of insurance coverage a complicated yet important task.

Where to Begin

When determining the priority of insurance in construction accident cases, a good starting point is B.P. Air Conditioning. v. One Beacon Ins.,1 where the Court of Appeals held that "[i]n order to determine the priority of coverage among different policies, a court must review and consider all of the relevant policies at issue."2 A review of the underlying policies consists of a comparative analysis of the expectations of the parties when contracting, the premium paid, the stated coverage and the wording of "other insurance" clauses.

In Harleysville Ins. v. Travelers Ins.,3 the court, in comparing both policies, determined that "[p]ursuant to the other insurance clauses, the policies both provided primary coverage except that the coverage was excess where any other primary insurance was available to the insured for which the insured had been added as an additional insured by attachment of an endorsement."4

Accordingly, if a party was held to be an "additional insured" under a second policy, then the first policy became excess coverage pursuant to the language contained in the "other insurance" clause of the first policy. This allowed the court to hold that the primary policy of the general contractor was excess insurance to the primary policy of the subcontractor. The holding also reflected the intent of the general contractor when it contracted with the subcontractor to be covered as an "additional insured" under its primary policy.

In both cases the goal of the respective insurers of the upstream parties was to obtain coverage from the primary policy of the downstream party before their policies were reached. However, depending on the applied method of policy exhaustion, this result is not always achieved.

Horizontal Exhaustion

Horizontal exhaustion is the principle that all primary policies must be exhausted, regardless of the holder, before an excess policy may be reached. This is in contrast to vertical exhaustion which mandates that the policies of the downstream parties must be completely exhausted, whether primary or excess, before the policies of the upstream parties may be touched.

New York declared itself a horizontal exhaustion state in Bovis Lend Lease v. Great Am. Ins.5 The Appellate Division, First Department, found that the order of insurance coverage was the subcontractor's primary policy, followed by the general contractor's primary policy, the owner's primary policy and, after the exhaustion of those, the subcontractor's and contractor's umbrella policies sharing ratably.

The court stated that an umbrella or excess policy is exactly what the title indicates, an underlying safety net to any primary policies. Thus, if the review of a policy reveals a reference to "insurance specifically purchased to apply in excess of the subject policy (or similar phraseology) [it indicates] a higher-level policy that specifically designates the subject policy as underlying insurance."6

To rule any other way would distort the terms of the policies and the expectations of the parties, and cause uncertainty in the insurance market. The application of horizontal exhaustion has been reaffirmed in several important cases.

Default Rule

In Tishman v. Great Amer. Ins.7 the First Department held that a policy issued to the subcontractor was an excess policy which provided the final tier of coverage and should not be invoked prior to the complete exhaustion of the primary policy issued to the construction manager

The court weighed several factors when making this determination including the stated coverage, the premium paid and the "other insurance" provisions of the policies at issue. In addition to the policy language of the subcontractors' excess policy establishing itself as such, the premium for the excess policy was $60,000 for coverage of up to $25 million while the premium on the contractors' primary policy for up to $2 million was significantly higher. This was a direct reflection of the underwriter's evaluation that the excess policy was a secondary policy that had a significantly less chance of being invoked. Tishman illustrated the full gamut of factors that are considered when determining a policy's place in the insurance pecking order.

In Liberty Ins. Underwriters. v. Utica Natl. Assur.8 a subcontractor's excess policy was held to be "true excess" and above a contractor's primary policy even though the "follow form" provision contained in the excess policy might have indicated otherwise. The Supreme Court, Suffolk County, reasoned that an "other insurance" clause, similar to the "follow form" clause at issue, could not render a primary policy excess to a "true excess" or umbrella policy which was sold to provide a higher

tier of coverage. The "follow form" provision in the excess policy was worded such that the terms of the underlying primary policy, including its "other insured" clause, were incorporated only if there were no inconsistencies between the two policies.

However, since the excess policy had language that specifically designated it as excess to any underlying policies and stated it would not be required to pay unless the underlying policies were exhausted, it managed to establish itself as a "true excess" policy to the upstream party's primary policy.

Conversely, in Central Park Studios v. Slosberg9 a provision in the general contractor's primary policy was able to convert it into an excess policy above the subcontractor's primary policy and in the same tier as the subcontractor's excess policy. The general contractor's primary policy insurer also attempted to gain excess status above the subcontractor's excess policy by arguing that the "follow form" provision in the excess policy also made it a primary policy.

The subcontractor claimed that the general contractor's primary policy should pay out before the subcontractor's excess policy was reached. The trial court, Supreme Court, New York County, then applied the rule that "where two policies each state that they are excess, the excess clauses cancel each other out and the policies apply together as co-insurance."10 Since both policies were deemed to be excess to the subcontractor's primary policy, the trial court decided that the two should contribute equally, pursuant to the terms of the general contractor's now excess policy. When affirming the lower court's decision, the First Department relied heavily upon the language of the two policies as well as the intent of the parties when contracting. The premium paid did not factor into this case because the subcontractor's excess policy failed to disclose how much its premium was.

In contrast, the Southern District of New York in Certain Underwriters v. Illinois Nat. Ins.11 relied heavily on the premium

when determining the priority of coverage. Two policies, one claiming to be umbrella and above any excess policies and one excess policy, were found to be on the same tier when applying horizontal exhaustion. The court reached this conclusion by considering the language of the policies, specifically the "other insured" clauses, as well as the premium paid for them.

One policy received a premium of $425,826 for $25 million worth of coverage while the other received $3,362,500 for the same amount. Both were ruled to be in the same tier because the policy with the lesser premium lasted only 15 months while the greater premium reflected that policy duration of five years. The difference in the two premiums was further explained by the fact that the policy with the greater premium was covering multiple contractors and subcontractors on a large job site, while the policy with the lesser premium only covered trucking companies in their general work. This led the court to conclude that the disparity in premium rates reflected the difference in degree of risk covered rather than the difference in tier of coverage.

Since the two policies were ruled to be in the same tier, the priority of coverage was determined by comparing their respective "other insurance" clauses. The court found that the only difference between the two clauses was the wording of their exceptions. The two policies' "other insurance" clauses both attempted to establish their policy as excess-over-excess and were ruled to cancel each other out.

Accordingly, since the court determined that both policies provided the same level of coverage, the policies had to ratably divide any cost remaining after the primary policy was exhausted. Since both policies provided a $25 million limit, the two policies had to contribute equally to any remaining costs after the exhaustion of the primary policy.

Vertical Exhaustion

The policy of horizontal exhaustion has been consistently reaffirmed as the default rule in New York cases involving accidents on construction sites. However, courts will also consider the language of the underlying trade contracts to determine whether an indemnification clause will result in vertical rather than horizontal exhaustion.

Although the default rule in New York is horizontal exhaustion, the language of underlying contracts can mandate vertical exhaustion instead. Vertical exhaustion requires that all of the policies of a downstream party be exhausted before those of an upstream party can be reached, regardless of the tier of coverage (primary, excess, or umbrella). An example of contract language that may be used to shift the applied method of exhaustion from horizontal to vertical is the requirement that the downstream party "indemnify and hold harmless" the upstream party.

In Indemnity Ins. v. St. Paul Mercury Ins.12 the First Department's review of the underlying trade contracts determined that vertical exhaustion applied rather than horizontal. The wording of the underlying contract between the general contractor and subcontractor stated that the subcontractor agreed to "(1) indemnify and hold harmless [the owner] and [general contractor] from any claims arising from or in connection with any acts or omissions in the performance of [the subcontractor's] work."13 This wording resulted in the vertical exhaustion of the subcontractor's policies before considering the general contractor's insurance. It was held that the language "indemnify and hold harmless" entitled the general contractor to "contractual indemnification from [the subcontractor] and a complete pass-through of liability to [the subcontractor] and its insurers."14St. Paul was the first of several instances of breaks from the norm that was established by Bovis.

Liberty Surplus Ins. v. Burlington Ins.15 is one of several cases that reaffirm the St. Paul ruling.16 In Liberty, the Supreme Court, New York County, applied vertical exhaustion based on the language contained in underlying trade contracts which required the subcontractor "to defend and indemnify [the owner] for all 'claims losses, liabilities, suits, judgments, actions, and expenses…arising out of' [the subcontractor's] work."

Both Liberty and St. Paul find that contractual indemnification provision will result in a break from the rule that "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."17 The fact that the upstream parties did not participate in the settlement agreements at issue also weighed heavily in both decisions.

Where the Law Stands Today

When determining the priority of insurance in construction accident cases, attorneys must always start their analysis by examining the underlying language of the policies, as dictated by B.P. They must then consider the default rule of horizontal exhaustion as stated in Bovis by weighing such factors as the stated coverage of the policy, the premium paid for it, and the effect that "other insured" clauses may have.

Finally, as seen in St. Paul, courts will also look at the wording of the underlying trade contract to determine if an upstream party is entitled to a complete pass-through and indemnification from downstream parties' insurers. In summary, the default rule is to apply horizontal exhaustion, but certain underlying contract language can convert the applied method into one of vertical exhaustion.

Endnotes:

1. 8 N.Y.3d 708 (2007).

2. Id. at 711.

3. 38 A.D.3d 1364, 1366 (4th Dept. 2007).

4. Id. at 1367.

5. 53 A.D.3d 140 (1st Dept. 2008).

6. Id. at 152.

7. 53 A.D.3d 416, 417 (1st Dept. 2008).

8. 2014 N.Y. Misc. LEXIS 2155, *1 (N.Y. Sup. Ct. Suffolk Co. May 6, 2014). 9. 121 A.D.3d 562 (1st Dept. 2014).

10. Central Park Studios v. Slosberg, 2014 N.Y. Misc. LEXIS 199, *8 (Sup. Ct. N.Y. Co. Jan. 13, 2014). 11. No. 09 CIV. 04418 LAP, 2015 WL 1623822, at *4 (SDNY March 13, 2015).

12. 74 A.D.3d 21 (1st Dept. 2010).

13. Id. at 23.
14. Id. at 25.

15. 2015 N.Y. Misc. LEXIS 1234, *1, *2 (N.Y. Sup. Ct. April 14, 2015).

See also White v. Newmark Constr. Servs., 2011 N.Y. Misc. LEXIS 3699, *28 (Sup. Ct., N.Y. Co. July 25, 2011).
Bovis Lend Lease LMB v. Great Am. Ins. Co., 53 A.D.3d 140, 145 (1st Dept. 2008).

Kevin G. Faley and Andrea M. Alonso are partners at Morris Duffy Alonso & Faley. Anthony Riverso, a paralegal, assisted in the preparation of this article.

Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 - reprints@alm.com.