Limiting Third-Party Claims through Controlled Insurance Programs

Brian M. Stork | Kane Russell Coleman Logan PC | May 4, 2018

All owners and general contractors are familiar with the scenario where the employee of a subcontractor is injured while working on a large construction project. The subcontractor is generally a workers’ compensation subscriber and, therefore, immune from any direct claims asserted by the injured employee. In other words, the injured employee’s sole remedy against his employer is to seek workers’ compensation benefits – often referred to as the workers’ compensation bar.

The workers’ compensation bar would not, however, extend to claims against the owner, general contractor and other parties working on the project. As a result, the subcontractor employee often sues these parties in an effort to obtain additional funds beyond the workers’ compensation benefits, regardless of how attenuated the claims may be against these other parties. In effect, the workers’ compensation bar may actually encourage litigation against parties beyond an injured employee’s employer in an effort to attempt to be made whole. This process frequently shifts the risk of loss to parties on the project that bear little or no responsibility for the underlying incident, e.g., the owner or general contractor.

In an effort to address this issue, in 1983, the Texas Legislature enacted what is now Section 406.123 of the Texas Labor Code, which permits a general contractor and a subcontractor to enter into a written agreement under which the general contractor provides workers’ compensation insurance to the subcontractor and its employees. In return, the general contractor is treated as the “employer” of the subcontractor’s employees for purposes of the application of the workers’ compensation system and is entitled to protection under the workers’ compensation bar. This means the employee is no longer permitted to pursue a third-party claim against the general contractor but, instead, is limited to receiving workers’ compensation benefits.

Section 406.123 protections unfortunately were not made specifically available by statute to other parties involved in the construction process, most notably project owners, which is why Controlled Insurance Programs, often referred to as “CIPs” or “Wraps,” were developed. These are specific insurance programs modeled on the mechanism provided under Section 406.123 that allow an owner (in an Owner Control Insurance Program or “OCIP”) to purchase insurance (of all types, including workers’ compensation insurance) for all parties working on a given construction project.[1] An OCIP provides a project owner several advantages, including: (i) cost savings in negotiating the purchase of insurance; (ii) uniformity of coverage for all claims; and (iii) less animosity between the parties on the construction project, in particular in reference to indemnity claims, which can generate significant legal expenses. However, perhaps the most significant benefit afforded an owner under an OCIP is the potential extension of immunity under the workers’ compensation bar to the owner (and other contractors participating in the insurance program).

Although Section 406.123 applies by its terms only to general contractors, the Texas Supreme Court has recognized the Section 406.123 protections in the form of the workers’ compensation bar can be extended to project owners and other participants in an OCIP. In Entergy Gulf States, Inc. v. Summers, 282 S.W.3d 433 (Tex. 2009), the Texas Supreme Court held an owner that provides an OCIP to all contractors qualifies as a “general contractor” as defined under the Texas Labor Code. A “general contractor” is defined as “person who undertakes to procure the performance of work or a service, either separately or through the use of subcontractors.” Tex. Labor Code § 406.121(1). The Texas Supreme Court found that, so long as an owner hires a general contractor or subcontractors to perform work on the project, it constitutes a “general contractor” under this definition. The Entergy Gulf States ruling means that a project owner can enter into a written agreement to provide workers’ compensation coverage (i.e., an OCIP) that meets the requirements of Section 406.123 and will therefore become entitled to immunity under the workers’ compensation bar in connection with any third-party claims asserted by any general contractor or subcontractor employees insured under the program.

Importantly, the extension of the workers’ compensation bar not only applies to the owner that has obtained the OCIP, but it also applies to bar direct claims asserted against a general contractor who is insured under the program. In HCBeck, Ltd. v. Rice, 284 S.W.3d 349 (Tex. 2009), the Texas Supreme Court held that even though the applicable general contractor did not specifically purchase workers’ compensation insurance on behalf of a subcontractor, so long as the subcontractor participated in an OCIP offered by the project owner, the general contractor was considered to have “provided” the workers’ compensation insurance coverage necessary to qualify for protection under the workers’ compensation bar of Section 406.123. Indeed, at the appellate court level, this workers’ compensation bar has even been applied to claims made by a participating subcontractor’s employee against another participating subcontractor. See e.g.Etie v. Walsh Albert Co.Ltd., 135 S.W.3d 764 (Tex. App.—Houston [1st Dist.] 2004, pet. denied).

The favorable treatment of OCIP programs was most recently endorsed on May 3, 2018, when the First Court of Appeals in Houston overturned a more than $17 million judgment obtained as a result of an accident that occurred during construction of the new Baylor University Football Stadium. Austin Bridge & Road LP v. Raquel Suarez et al., Case Number 01-16-00682-CV. Baylor implemented an OCIP on the project. As part of the OCIP, Baylor required its general contractor and all subcontractors to participate in the program. Baylor hired Austin Commercial LP as the general contractor on the project. Austin Commercial then entered into a subcontract with its subsidiary Austin Bridge & Road LP (ABR). ABR hired Derr & Isbell Construction, LLC (D&I) to perform certain work on the project. An employee of D&I, Jose Dario Suarez, was killed in an on the job accident. His family brought wrongful death claims against ABR and obtained a verdict in excess of $17 million. ABR argued that this verdict was in error because ABR was entitled to protection under the workers’ compensation bar as a result of its participation in the OCIP. Essentially, ABR claimed that Suarez’s remedy was limited to receiving workers’ compensation benefits and he (and his heirs) had no right to assert a direct claim against ABR. The First Court of Appeals agreed and overturned the verdict. This is an important illustration of how an OCIP program can help mitigate risk on large construction projects.

Texas courts have clearly favored a broad application of the Section 406.123 protections to all parties working on a construction project so long as the OCIP is properly structured. Accordingly, when owners are evaluating potential insurance programs and safeguards to put in place, in particular in reference to large commercial projects, they should closely examine the utility of obtaining an OCIP. The program can result in significant cost savings and greatly reduce the administrative time and expense of the inevitable jobsite injury claim.

Insureds Still Cannot Obtain Insurer’s Claim File

Marie Laur | Property Insurance Coverage Law Blog | May 6, 2018

Whether an insured can access an insurer’s claim file has often been addressed by Florida courts. Recently, a Florida appellate court followed other courts’ rulings in holding that an insured cannot obtain its insurer’s claim file.

In Homeowners Choice Property and Casualty Ins. Co. v. Avila,1 the insureds, Raul and Doxanne Avila (“the Avilas”), filed a claim for damage to their property with their insurance company, Homeowners Choice Property and Casualty Insurance Company (“Homeowners”). Homeowners made some payments on the claim, which the Avilas found to be insufficient to cover the damage to their property. The Avilas sued Homeowners for breach of contract.

During the litigation process, counsel for the Avilas served a request for production on Homeowners, seeking various documents related to the claim. While Homeowners produced some of the requested documents, it objected to others as work product privilege or “claim file privilege” and submitted a corresponding privilege log.

The trial court reviewed the withheld documents in camera and ordered that some documents be produced, as they did not fall under either of the listed privileges. The documents ordered to be produced were created prior to the date that the Avilas contested Homeowners’s payment on the claim.

The appellate court ruled that in first party breach of contract actions, such as the one at hand, an insurer’s claim file is not discoverable. However, the appellate court noted that no “claim file privilege” exists under Florida law.

The court’s decision mirrors many other prior rulings in Florida courts on the matter.
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1 Homeowners Choice Property and Casualty Ins. Co. v. Avila, No. 3D17-465 (Fla. 3d DCA April 25, 2018).

Policyholder Must Pay Deductible When Insurance Company Invokes Right to Repair a Partial Loss

Ashley Harris | Property Insurance Coverage Law Blog | May 1, 2018

Recently, the Second District Court of Appeal affirmed the dismissal of a class action against Omega Insurance Company in which the policyholders asserted that Omega improperly required them to pay a deductible when Omega invoked its right to repair the property.

In Ganzemullers v. Omega Insurance Company,1 the policyholders suffered hail damage in March 2016 and filed a claim with their insurance carrier. Omega acknowledged coverage and invoked its right to repair the property under the policy. The policyholder was required to pay their $1000 deductible to the contractor. The policyholders then filed a class action contending that Florida law precludes the insurance carrier from requiring the payment of the deductible when the insurance carrier elects to repair a partial loss.

The policyholder argued that even though the policy may require payment of a deductible, once the insurance carrier elects to repair damaged property, whether the loss is total or partial, Florida Statute §§ 627.702(7) and 627.7011(5)(e) preclude the insurance carrier from requiring payment of the deductible.

Subsection 627.702(1) specifically deals with total losses, and subsection (7) addresses the insurance carrier’s right to repair without contribution by the insured “in lieu of any liability created by subsection (1).” These subsections preclude the insurance carrier from requiring the policyholder to make any contribution when the insurance carrier elects to make repairs in total loss situations. The parties did not dispute that deductibles are covered by the “without contribution” language.

Ultimately, the appellate court found that nothing in the statutory language suggested a statutory intent to eliminate policy deductibles for partial losses as well as total losses where the insurance carrier elects to make repairs. For this reason, the court affirmed the dismissal of the policyholders’ class action.
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1 Ganzemullers v. Omega Ins. Co., No. 2D17-1284, 43 Fla. L. Weekly D948e (Fla. 2d DCA April 27, 2018).

Choosing a Damages Methodology for Certain Construction Claims

Daniel B. Swaja | Kilpatrick Townsend & Stockton LLP | April 18, 2018

In any construction dispute resolution process, not only does a claimant have to prove liability of the other party, but the claimant must also prove damages to prevail on its claim.  The proof of damages element to prevailing on a claim is often overlooked and its importance can be underestimated.  Many times a claimant will focus its case on the facts supporting entitlement, but fail to take the time to meet all requirements establishing a particular damages claim.  While a jury may be more forgiving of such an approach, a court on a bench trial or an experienced construction arbitrator may not be so forgiving.

A common example of a construction claim requiring specific elements of proof occurs when a party seeks recovery of extended, or unabsorbed, home office overhead costs for a delay claim.  Delays are common in the construction industry and will impact home office overhead costs. Extended home office overhead costs can include management salaries, administrative staff salaries, rent, supplies, home office equipment, and insurance, among others.  Construction delay claims are regarded as being among the most difficult types of claims in the industry and often times require the engagement of an expert.  This can be due in large part to the difficulty in analyzing the home office overhead costs associated with a specific project in conjunction with the percentage of the total amount of these costs for the company.  Typically, home office overhead costs are not directly allocable to a specific construction project. As a result, it is important for a contractor to select a recognized methodology for calculating allocable home office overhead costs and ensure all elements tied to such damages methodology are satisfied.

A common methodology for determining the extended home office overhead attributable to a specific project delay is the Eichleay Formula.  The Eichleay Formula’s foundation is in the government contracting arena and more specifically in the Armed Services Board of Contract Appeals case, Eichleay Corporation, ASBCA No. 5183, 60-2 BCA 2688.  The methodology can be summarized as requiring the following steps to prove an extended home office overheard claim:

  1. (Total billings for the contract/Total billing for the Company during the original contract period) X Company Total Overhead During Contract Period = Home Office Overhead Allocable to the Contract.
  2. (Overhead Allocable to the Contract)/(Days of Contract Performance) = Daily Home Office Overhead Rate
  3. (Daily Contract Overhead Rate) X (Days of Compensable Delay) = Recoverable Home Office Overhead

In doing this calculation, there are certain other legal thresholds that may be required in order to prove the claim.  For example, in Ohio, these elements include (1) proof that the contractor was on standby; and (2) the contractor must prove that it was unable to take on other work while on standby. The Court of Appeals of Ohio recently addressed whether these elements must be met on a claim for extended home office overhead costs, using a slight variation of the Eichleay Formula, in Wood Electric, Inc. v. Ohio Facilities Construction Commission, 90 N.E.3d 371 (10th Dist. 2017).

In Wood Electric, Inc., an electrical contractor on a multi-prime school construction project run by a construction manager brought suit against the Ohio Facilities Construction Commission (“Owner”). Among other issues in dispute were the damages suffered by the electrical contractor as a result of delays in the construction allegedly caused by the Owner and other contractors. The electrical contractor sought a claim for extended home office overhead and, instead of using the Eichleay Formula, it used a variant called the HOOP formula. The HOOP formula is a methodology adopted by the Ohio Department of Transportation, and essentially involved the use of elements two and three of the EichleayFormula. Thus, it was a similar, but not identical methodology. The electrical subcontractor prevailed on this claim in the Court of Claims, but the Owner appealed arguing that the trial court’s decision was contrary to Ohio Supreme Court precedent requiring a prima facie showing of two elements for a home office overhead claim: (1) the contractor was on standby; and (2) the contractor was unable to take on work while on standby. Id. at 379-380 (citing Complete Gen. Constr. Co. v. Ohio Dept. of Transp., 760 N.E.2d 264 (Oh. 2002). Specifically, the Owner argued that the electrical contractor was not entitled to recovery on this claim because it failed to establish these two additional elements.

In evaluating this argument, the Court of Appeals stated that the electrical contractor never sought to use the Eichleay Formula, but instead expressly relied on the ODOT adopted HOOP formula. The Court noted that the parties’ contract neither forbade the HOOP formula nor mandated the use of the Eichleay Formula. Further, and importantly, the Court noted that Complete Gen. Constr. Co. expressly stated that “we do not find that the Eichleay Formula is the exclusive manner of determining unabsorbed home office overhead.” Id. at 381 (citing the similar case J&H Reinforcing & Structural Erectors, Inc. v. Ohio School Facilities Comm., 2013 WL 4779008 (Ohio 2013). Because the Court concluded that the two elements of prima facie proof do not necessarily apply to other formulas for calculations of home office and adhered to the recent J&H ruling, the Court of Appeals concluded that the trial court did not err in failing to require proof of the Complete Gen. Constr. Co. elements. Based on this ruling, and there are other factors that may come into play, it appears contractors – at least in Ohio – seeking extended home office overhead claims may want to consider using a formula other than Eichleay to potentially lessen their burden in proving such a claim.

Claim Handling Requirements by State – Washington

Julitza Perez | Property Insurance Coverage Law Blog | April 18, 2018

Washington State is not only known as the “Evergreen State” and the only state named after a United States President, but it is also the home of many innovative Internet companies and where the biggest coffee chain in the world was founded: Starbucks. Besides these facts it is also important to know how a claim should be handled in Washington.

First an insured may bring an action in the superior court of this state to recover the actual damages sustained, together with the costs of the action, including reasonable attorneys’ fees and litigation costs.1 The court may increase the total award of damages to an amount not to exceed three times the actual damages2 or make any other determination regarding an action for an unfair or deceptive practice of an insurer or provide for any other remedy available at law.3

It is important for the first party claimant to provide a written notice of the basis for the cause of action to the insurer and office of the insurance commissioner twenty (20) days prior to filing.4The notice may be provided by regular mail, registered mail, or certified mail with return requested and the insurer and insurance commissioner are deemed to have received notice three (3) business days after the notice is mailed. If a written notice of a claim is served under the time prescribed for filing an action, the statute of limitations for the action is tolled during the twenty (20) day period.5

Washington’s Administrative Code (WAC) defines “Specific Unfair Claims Settlement Practices.”6This definition provides nineteen (19) specific deceptive acts or practices considered as unfair methods of competition and practices of the insurer in the business of insurance. Many of these acts and methods are common to those defined by statutes in other states such as misrepresenting pertinent facts,7 failing to acknowledge and act reasonably promptly upon communication,8 refusing to pay claims without conducting a reasonable investigation,9 and not attempting in good faith to effectuate prompt, fair and equitable settlements.10 WAC also included other specific acts or unfair methods in the business of insurance such as failing to adopt and implement reasonable standards for the processing and payment of claims after the obligation to pay has been established11 and negotiating or settling a claim directly with any claimant known to be represented by an attorney without the attorney’s knowledge and consent.12

Both Washington codes provide a wide list for protection against unreasonable denials, payment or unfair settlements of insurance claims. It is important for Washington insureds to know of their rights under these codes and for insurers to comply.
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1 RCWA 48.30.015 (1)
2 RCWA 48.30.015 (2)
3 RCWA 48.30.015 (6)
4 RCWA 48.30.015 (8) (a)
5 RCWA 48.30.015 (8) (d)
6 WAC 284-30-330
7 WAC 284-30-330 (1)
8 WAC 284-30-330 (2)
9 WAC 284-30-330 (4)
10 WAC 284-30-330 (6)
11 WAC 284-30-330 (16)
12 WAC 284-30-330 (19)