10 Subrogation Mistakes Insurance Companies Keep Making

Gary Wickert | Claims Journal | July 6, 2017

“Show me the money.” – Rod Tidwell in Jerry Maguire

This year is the 20th anniversary of the 1996 romantic comedy Jerry Maguire. Its director, Cameron Crowe, just published the entire 5,000-word mission statement he wrote for his crisis-hit sports agent played by Tom Cruise. The memo, entitled The Things We Think and Do Not Say laments some of the dysfunctions within the world of sports agents and endeavored to improve the profession. In many ways, this article is also a mission statement revealing critical mistakes we see with some frequency within the industry and providing suggestions as to how to avoid repeating them. Subrogation is the necessary evil of recovering as much of our insureds’ claim dollars as possible in order to help hold down insurance premiums and soften the blow a claim event might otherwise have on them. No industry is perfect, and insurance is no exception. Thirty-three years of subrogation litigation experience has distilled ten of the most common mistakes which we see clients continuing to make when it comes to recognizing and acting on subrogation potential. I divulge and discuss them in this article, much like Jerry Maguire did, not as a criticism of the clients to whom we owe the living we make, but as a healthy reminder to those who do not wish to repeat them. The following are the ten most common mistakes we see repeated within our industry in order of the frequency with which we see them made.

(1) DELAY OF GAME PENALTY: Waiting too Long to Involve Subrogation Counsel

The dollars lost because claims with subrogation potential are referred to subrogation counsel mere weeks, days, or even hours before a statute of limitations or other deadline is about to expire, is almost incalculable. I refer not to cases in which subrogation potential is discovered late or notice of a pending third-party action filed by the insured or claimant is received late in the game. Rather, I refer to files in which subrogation potential is obvious, but a conscious decision is made to avoid incurring subrogation attorneys’ fees or costs resulting in the wholesale avoidance of referring the file. Claims deteriorate with age and we see far too many files entrusted to us at the very last moment which contain literally dozens of identical demand letters – with little or no substance or subrogation “proof” to support them – sent to the third-party carrier every six weeks like clockwork for years, each a carbon copy of the one which preceded it. When the file is submitted to subrogation counsel with very little time left on the clock, there is frequently no opportunity to conduct a thorough investigation. Evidence has disappeared or been destroyed. Deadlines have passed. Lawsuits have been settled. Releases have been signed. Witnesses have vanished or been “reached” by the other side. Money has been lost. It is the number one subrogation-killer we have seen over the years, in terms of the volume of dollars lost and the number of claim files.

The most surprising aspect of this particular insurance practice is it appears to transcend file size. It is one thing to sit on a $3,500 med pay claim – quite another on a $350,000 workers’ compensation claim. Trial lawyers have developed a well-known body of law in almost every state which allows them to take tremendous advantage of carriers who protect their interests either passively or not at all. Subrogation is a serious investment that deserves both respect and a dedication of time and resources. A successful subrogation program is never an accident and it cannot be developed as an after-thought or a last resort. It is always the result of a commitment to excellence, informed decision-making and planning, subrogation knowledge, an investment of time and money, and an intensely-focused effort and perseverance.

(2) A HOT CUP OF MCDONALD’S COFFEE: Failure to Recognize Third-Party Liability

The biggest obstacle to larger and quicker subrogation recoveries is us. We are our own worst enemy. Our industry is, by design, steeped in the mind-set of limiting liability. Even the most experienced claims adjusters see the comparative fault of their insured before they see the liability exposure of the tortfeasor. Your defense lawyers see a myriad of ways to defend a claim, but very few ways to aggressively prosecute one. It is what makes them good at what they do. Our industry shares a defense myopia that has served us well in the defense of claims of all types and sizes. Human nature dictates that we sing for life the song we learn in our youth. As stated so poignantly in the Suzzy Kassem anthology, Rise Up and Salute the Sun:

If the Creator stood before a million men with the light of a million lamps, only a few would truly see him because the truth is already alive in their hearts. Truth can only be seen by those with truth in them. He who does not have Truth in his heart, will always be blind to it.

Claims professionals are often blind to liability. Your greatest strength is also your greatest weakness. As subrogation counsel, we are plaintiffs’ trial lawyers for the insured industry; hired guns that push your subrogation claims to the maximum – the only way to achieve maximum recovery in each file. It is what makes us good at what we do. Claims professionals reminisce at the water cooler about the ridiculous verdict in the McDonald’s hot coffee case – a case which has become the poster child for tort reform across America. Yet, the true facts of the case reveal a well-litigated claim, an aggressive trial lawyer and a brash, cavalier defense in which the defense witnesses gave off an air of indifference to the 700 serious burn cases which preceded those of the 79-year-old grandmother named Stella Liebeck, whose full thickness third-degree burns over 6 percent of her body, including her inner thighs, perineum, buttocks and genital and groin areas, put her in the hospital for eight days while she underwent skin grafting and burn debridement treatment. They looked past the fact that Lieback lost 20 pounds (nearly 20 percent of her body weight), reducing her down to 83 pounds. They ignored the fact that her grandson was driving and he had pulled over in a McDonald’s parking spot while attempting to pull the far side of the lid toward her to add sweetener, when the cup exploded in her hands. Two years of medical treatment and extensive medical bills followed. The creativity and aggressive pursuit of that infamous case should be the poster child for aggressive subrogation programs rather than a case to be ridiculed as emblematic of an out-of-control civil justice system.

Subrogation opportunities are most frequently disguised as hard work, so it is no wonder they are often not recognized. Our industry is no stranger to hard work. But, human nature is such that the over-worked claims professional with a full plate simply adjusting claims will rationalize away subrogation opportunities because it means willingly accepting more work and more responsibility. Compound this with the fact that recognizing third-party liability often requires thinking like a plaintiff’s attorney and having a working knowledge of tort law from premises liability to product liability. It requires in-depth knowledge of statute of limitations and repose, and an ability to make quick and accurate decisions regarding engaging experts, putting the right people on notice, and taking steps to preserve rights which could easily be lost. Wearing two hats is never easy, but subrogation requires exactly that. Dedicated subrogation staff makes overcoming the fatal mistake of not recognizing recovery potential from day one. Irony is a word often misused. But, it is truly ironic that the four largest subrogation recoveries our firm has ever made were all made in cases in which the insurer or their designated TPA had indicated in the file that there was no subrogation potential.

The best way to overcome an innate inability to recognize third-party tort liability is training. A claims handler doesn’t have to agree with enforcing third-party product strict liability, but they do have to take every reasonable effort to produce a recovery on behalf of their insured employer. Our firm presents a series of webinars and training programs dedicated to immersing the claims professional in a thorough overview of tort law and tort opportunities. Graduates recognize opportunity and know how and why the fact that simply because your insured does the rear-ending in a rear-end collision doesn’t necessarily foreclose the potential for third-party subrogation. Understanding and being familiar with statutory and case law in all jurisdictions gives them the tools to recognize and take appropriate action on subrogation potential that the average claims professional might otherwise overlook. Hard work doesn’t guarantee success – but, a lack of hard work almost always leaves significant claim dollars unrecovered.

(3) THE PARABLE OF THE PEBBLES: Lack of Timely/Thorough Subrogation Investigation

Whether a claim is large or small – the burden is the same. The subrogated carrier has the burden of proving: (1) that the defendant was negligent (or that a product was defective); (2) that this negligence proximately caused the damages which the carrier paid for; and (3) the amount and nature of those damages. If it fails with regard to any one of these elements, there will be no subrogation recovery. Liability carriers are quick to latch on to weaknesses in subrogation files and often deny claims simply because the demand letter doesn’t address these three elements satisfactorily. Like a chain, a subrogation claim is only as strong as its weakest link and that weakest link is almost always created early in the claim, when memories are fresh and evidence is available. The first few days after a loss are critical – the first and often only chance anyone may have to identify, retain, document, investigate, and record valuable information on which a future subrogation lawsuit will depend. Things which may seem to have little or no meaning or importance may turn out to be the lynchpin of an entire subrogation action. An ancient parable is relevant here and goes something like this:

A group of traveling nomads was preparing to make camp for the evening, when suddenly they were surrounded by a great light. They knew instantly they were in the presence of a celestial being. A loud voice spoke from the heavens, “Gather as many pebbles as you can. Put them in your saddle bags. Travel a day’s journey. Tomorrow night you will be both glad and sad.” Then, as quickly as it had appeared, the voice and the light disappeared. The nomads looked at one another in disbelief. They had expected the revelation of a great universal truth – the key to great wealth or happiness. But instead, they were given a menial task that made no sense. Dejected, each one did pick up a few pebbles and put them in their saddle bags. The following morning they broke camp and traveled a day’s journey. That evening, while making camp once again, they reached into their saddle bags and discovered that the few pebbles they had gathered the night before had turned into beautiful and brilliant diamonds! Indeed, they were both glad and sad, just as the voice had promised. They were glad they now had beautiful and valuable diamonds. But, they were very sad they had not gathered and filled their saddlebags with pebbles when they had the opportunity.

Subrogation investigation is much like the opportunity the nomads had to gather pebbles. You don’t know which pebbles might turn out to be valuable, so you conduct your investigation promptly as though they are all valuable. It is important to lock witnesses into positions and testimony favorable to your subrogation case, before the other side gets a hold of them. It is sometimes urgent and legally necessary to place government entities on notice of your claim. Early and thorough investigation often uncovers additional third parties and sources of recovery, including the occasional existence of other insurance which may be available to contribute to the loss.

Some cases are virtually worthless – even with the best of liability facts – unless some investigation and preservation of evidence is undertaken almost immediately. Premises liability cases involving slip and falls, ice and snow, or dangerous conditions on property require some sort of preservation or recording of the conditions existing at the time of the fall. Such cases depend entirely on whether the condition was “unreasonably dangerous” and “open and obvious.” In most cases, relying on the claimant’s or insured’s memory in order to meet our burden of proof guts such files of virtually all value. Cases involving livestock which escape a fenced-in area and wander onto a busy highway almost always require the subrogated carrier to prove that the livestock owner was negligent. This means proving in court that a broken fence or gate that wasn’t repaired or other negligence on the part of the owner caused the accident. This type of evidence can only be preserved at or near the time of the loss and before repairs or spoliation take place.

If a product is involved in a subrogation claim, it is our burden to prove a defect or that there was negligence by a third party in maintaining the product. We also have to prove that the condition of the product was unchanged at the time of the injury or damage from the date it was manufactured. These are impossible burdens to meet if the product is not preserved and the chain of custody is not carefully documented and protected. When an appliance which causes a fire is still under warranty and the repair technician (often an “authorized service company”) takes the appliance or the faulty part, this evidence is often misplaced in the shuffle. Sometimes we are able to argue spoliation by the manufacturer, but it much easier and cheaper to simply preserve the part.

When the cause of a loss seems apparent, don’t stop with simply securing only the product or evidence bearing most directly on the case. Bear in mind that the targets of your investigation will almost always find alternate causes and persons to blame and will quickly cry spoliation if evidence, which they claim may exonerate them, is gone or damaged. Think like the defendant. Take efforts to disprove and eliminate the alternate theories your subrogation counsel will ultimately face. If the claim is significant, engage subrogation counsel or an investigator to conduct the investigation and take thorough statements of all witnesses and, if called for, timely engage experts who are qualified and experienced. The extra work of properly investigating a claim often deters claims handlers from stuffing their saddlebags full of pebbles, but every case is different, and it is often the pebble you leave behind that turns out to hold the key to a full recovery. The pebbles might not turn into brilliant diamonds as in the parable, but they literally can and often do translate into subrogation dollars realized.

Even in inspecting the loss, the client (and sometimes even the expert) doesn’t keep any of the evidence. This is especially true when insurance clients try to cut corners by not having an expert out to the loss scene, but instead rely on plumbers or technicians to tell them what failed. The plumbers or technicians may uncover what failed, but they are not qualified to testify to that in court. Unless they preserve the product and other possible suspects the defendant is sure to blame the loss on, an expert retained at a later date will not be able to offer an opinion and the case will be rendered worthless.

Spoliation – the defense that a party to a suit has somehow damaged or lost evidence which is crucial to the defense of a case – is becoming a very popular claim today, even if it doesn’t exist. Creative theories which blame products located across the room from a point of origin are frequently used to create doubt in the mind of jurors – often with great success.

Investigate cases early and thoroughly. Choose the right expert and insist on reports which pinpoint a cause and an origin of a fire or a water loss. Ben Franklin’s aphorism, “An ounce of prevention is worth a pound of cure” is very accurate when it comes to describing the value of investing early in subrogation potential. Kicking the can down the road frequently leads to significant recovery potential being lost or seriously compromised. As Ayn Rand famously said, “We can ignore reality, but we cannot ignore the consequences of ignoring reality.”

(4) GETTING WHAT YOU PAY FOR: Using Cut-Rate Vendors and Low Bidders is More Expensive

Many corporate decisions made with the best of intentions can be some of the most detrimental to subrogation performance. This is irony at its purest. When making decisions on ways to “save” money when it comes to subrogation, the real, total cost often looks very different. This “mistake” must be assessed when taking into consideration total costs of out-sourcing subrogation. John Glenn was often asked what he was thinking as he was about to be launched into orbit in the nose of a giant rocket. His reply is instructive: “Well, the answer to that one is easy. I felt exactly how you would feel if you were getting ready to launch and knew you were sitting on top of two million parts – all built by the lowest bidder.” The trend today is seemingly to fall victim to slick marketing promotions by third-party adjusting companies and subrogation vendors – often owned by larger law firms with control over the employees.

Litigation is rarely cheap, but it is often necessary. Nowhere is this truer than in the area of insurance subrogation, where those who resist paying subrogation claims assume that insurance companies are loath to pull the trigger and file suit. As a result, liability insurers almost never pay full value on subrogation claims with even the clearest liability facts. For decades, the insurance industry have paid special attention to the attorneys’ fee line item in their claim department budgets and have gone to great lengths to find the perfect balance between keeping litigation fees and costs in check and maintaining high quality representation. Insurers have turned to litigation budgets, in-house counsel, litigation management guidelines, litigation vendor databases, and law firms with lower hourly rates. An entire litigation cost management cottage industry has sprung up and some insurers have even turned over the distasteful task of disallowing certain lawyer time entries and expenses to cost management vendors whose very existence is justified by cutting as much as possible from fee bills.

The problem of runaway fees began and remains primarily within insurance defense litigation, but the mindset of cutting costs has quickly spread to other areas of litigation, including subrogation, where cost-effectiveness is a built-in requirement. It is difficult to assess whether a large hourly attorney’s fee in a defense case resulting in a defense verdict is justified, because it is an open-ended evaluation. Defense lawyers must react to and defend against the case asserted by the plaintiff, whether it has merit or not. A fee of $100,000 which saves $1 million on a defense file is worth it in hindsight. In subrogation cases, however, cost-efficiency must be built into the handling of every file because subrogation is only as successful as it is profitable. If you spend $5,000 to recover a $5,000 subrogation claim, the only winner is your lawyer.

Subrogation files are most frequently handled on a contingency fee basis, which makes the cost containment goal less elusive, but limits the litigation management options available to the insurer. As a result, one illusion which the insurance industry seems to be operating under is the specious notion that lower contingent fee percentages translate into higher net recoveries and, therefore, a more successful subrogation program. If 33 years of subrogation litigation experience has taught us anything, it is the fallacy behind that premise. The only path to true subrogation success is a genuine partnership between an insurer and a law firm it trusts.

A new generation of opportunistic subrogation and claims vendors, often owned by lawyers who have experienced firsthand the cost-conscious insurance industry’s attraction to low rates, have had great success by offering contingent fee rates too good to be true. Idioms which have weathered the test of time usually have a basis in fact and the pejorative phrase “built by the lowest bidder” is no exception. The lowest contingent fees guarantee that many files will be settled for less than their true value and that larger files that should see the inside of a courtroom in order to get top dollar never will. Like insurance catnip, however, the low contingent fees serve up the mirage of fee containment while simultaneously devaluing an entire book of business. The only winner here is the short-lived vendor, who profits by selling short the wheat and leaving the client with the devalued chaff.

The infamous businessman John Ruskin once said, “It’s unwise to pay too much, but its worse to pay too little. When you pay too much, you lose a little money – that’s all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do. The common law of business balance prohibits paying a little and getting a lot – it can’t be done. If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that you will have enough to pay for something better.

We know the above to be true because we are approached weekly by vendors desperate to find lawyers capable of accepting the files that won’t settle on an even lower percentage contingency fee basis. We regularly hear from frustrated claims professionals who are being told that files which did not settle quickly and without litigation suddenly have no subrogation potential and should be closed. Decision makers are sold on a PowerPoint presentation and the lure of quick results at bargain basement prices. Without exception, they are later universally disappointed and must scramble to salvage what they can. It is similar to the unfortunate phenomenon of “sign and settle” trial lawyers who advertise using celebrities or sports figures, but try no cases. If a case doesn’t settle, they must try to refer the case out and retain a percentage, all but ensuring the further devaluation of the poor victim’s case.

A $75,000 recovery in a $90,000 subrogation claim litigated on a 1/3 contingency fee is preferable to a $30,000 recovery on a 15 percent contingency fee. The subjective nature of subrogation success allows a good file to be easily misrepresented as a bad file in order to justify a quick settlement. Unfortunately, it is often easier for subrogation claims managers to sell an 18 percent contingent fee than to assess the true recovery potential of a large case which is settling for little or nothing at all. Far too many in our industry go for the quick buck – skimming the cream while leaving behind a treasure trove of subrogation potential to slowly decay until statutes of limitations are mere weeks from running. Taking the road less traveled means that the bulk of files referred by such vendors have less than 30 days left before being time-barred. Lawyers know the number of hours necessary in order to ready a file for trial and, if that number exceeds the potential profitability of success based on a reduced contingency, they won’t stay in business long. The subrogation vendor working on cut-rate contingency fees is faced with that stark truth when they try to assign to counsel the majority of files that do not settle quickly at discounted value. When even lower rate vendors undercut the cut-rate vendors, the result is disaster. For these entrepreneurial opportunists it is not about getting good results across a wide spectrum of files for their client – it’s about making any promise necessary to get the business in the door and milking the files for settlements the client could have achieved with just a phone call. Unlike law firms, subrogation vendors don’t have to follow attorney ethics rules and obligations and owe no fiduciary duty to ensure that the client’s best interests are being served. Time and time again we see independent audits revealing millions of dollars unrecovered and left on the table and, by then, it’s often too late.

The argument against entrusting your subrogation files to a vendor who will only be paid 22 percent as opposed to one-third is counter-intuitive. But, intuitive isn’t always right. For example, if a bat and a ball together cost $1.10, and the bat costs $1.00 more than the ball, how much does the ball cost? Most people’s quick answer – ten cents – like most people’s instinct on the value of sending off your valuable subrogation files to the lowest bidder – is wrong.

Cheaper is rarely better. My favorite ice cream store has a sign: “You can find cheaper ice cream somewhere else; if you want cheap ice cream, go there.” Litigation is not a “commodity”. It is a professional service like brain surgery and engineering. When you need it, you have to get it right. If your adversaries win by paying significantly less than what they owe, the entire industry suffers. You cannot lose when subrogating on a contingency fee, but those who fall for the idea that this isn’t enough, can lose everything to cut-rate percentages. As a law firm, we sell expertise, value, and proven results. The three go hand-in-hand. Clients who think they want cheap rates occasionally go elsewhere, but we inevitably see them back again – wiser and more determined to understand what it means to win. It takes hundreds of hours to properly develop a case for trial and to try it. Law firms know their margins and, try as they might to avoid doing so, the 22% file is rarely worked aggressively enough to give the client a fighting chance at trial. All parties end up relying on reducing a subrogation demand deep enough to resolve a file. In the end, money is lost – not saved.

Successful subrogation requires that the pointy end of the subrogation sword – a genuine threat of litigation – must always be hanging over your adversary’s head. Value, experience, legal knowledge, availability, prompt and thorough reporting, and the willingness to strong-arm top dollar recoveries in every matter entrusted to it are the trademarks of a good litigation law firm and a good subrogation department. Everything else is smoke and mirrors. Successful subrogation requires the best – not the cheapest. Recall the story of the engineering consultant who was called to repair a broken machine that had brought a factory to a stand-still. He tightened a single screw and within about five minutes the whole factory was back on line. When a $1,000 bill was received, the factory owner was outraged, “You spent just five minutes here, tightened one screw, and we received a bill for $1,000!” The consultant smiled, “The tightening of the screw was free. The $1,000 was for knowing which screw to tighten!”

There are no short cuts in life, and that includes subrogation. Fast food is popular because it’s convenient, it’s cheap, and it tastes good. But, the real cost of eating fast food never appears on the menu and is rarely discovered until it is too late.

(5) SLEEPING WITH THE ENEMY: Relying on Plaintiff’s Counsel to Protect You

“From a place you will not see comes a sound you will not hear”, is the famous line dealing with special forces snipers. It describes the inevitable when insurers think they have “teamed up” with plaintiff’s counsel for protection of their lien. The illusion which many insurers operate under is the perceived “savings” which result from not engaging counsel and relying instead on the plaintiff’s or insured’s attorney to protect and safeguard their subrogation interests. Trial lawyers are shrewd and suggest such arrangements because they know their victims. The idea of a plaintiff’s attorney protecting your valuable subrogation interests runs contrary to the ethical duty these lawyers have. They are ethics-bound to zealously and aggressively represent their client’s interests, not yours. Their number one mission is to make sure you take as little of your subrogation interest home with you as possible, and then bill you for the privilege of succeeding. When relying on plaintiff’s counsel for their “take” on litigation, it is almost always dismal, and trial lawyers know that when the hen comes to the fox for advice, the result is never pretty. One of the most common type of file we see is one in which our client thought they had an “understanding” with the plaintiff’s attorney that he or she would protect their interests. Everything goes well right up to the point where it doesn’t. Frequently, motions to eliminate the lien or subrogation interests are filed just a few days before a hearing date. Scrambling to protect interests this late in the game almost always result in lost recoveries.
If your claim is small enough that entrusting plaintiff’s counsel with your interests, despite the above, is still the more cost-effective course of action, make sure that you have, in writing, an agreement which spells out that you are a “client” of the attorney just like the claimant or your insured. This will go a long way toward deterring the attorney from not keeping your best interests protected.

(6) DETECTING AND CURING SUBROGATION CANCER: Failure to Discover Indemnity/Waiver of Subrogation

A frequently-seen obstacle to successful subrogation is the waiver of subrogation. Waivers of Subrogation are a necessary evil of underwriting, but their application and effect on subrogation are rarely understood. One of the ways to avoid subrogation is through the implementation and enforcement of waivers of subrogation. Just as the insurer has a legal right to pursue subrogation, so too does a party to a commercial transaction have a right to structure the transaction so that the party’s legal rights of recovery against another party are abrogated or somewhat limited. Such clauses, known as exculpatory clauses, have as their intent and effect, to limit a party or that party’s insurer from subrogating against another party to a transaction. Obviously, the existence of contractual limitations to subrogation must be discovered during the due diligence investigation of subrogation potential and should be revealed to subrogation counsel as soon as possible. Spending significant time and money on recovering large subrogation dollars only to discover that a waiver of subrogation endorsement to an insurance policy cuts us off at the knees is worse than if subrogation had not been pursued at all.

A “waiver of subrogation” actually involves two separate provisions:

  1. A waiver of subrogation clause contained in the contract between the parties; and
  2. A provision in the insurance policy, or an endorsement to that policy, granting permission to the insured to waive in writing, recovery rights against the others prior to loss.

Waivers can be found in commercial general liability (CGL) policies, commercial auto policies, workers’ compensation policies, and commercial property, builders’ risk, and inland marine policies, to name a few. In the workers’ compensation context, however, even if a waiver of subrogation exists, a sin worse than not discovering the waiver in the first place is giving up on subrogation because of a waiver which technically would not bar you from seeking a subrogation recovery or a future credit. The first mistake might be issuing a waiver of subrogation endorsement without adequate consideration or premiums charged. However, once issued, it is important to understand what a waiver does and doesn’t do. We see far too many companies giving up on subrogation because of a waiver which will not prevent them from subrogating, seeking reimbursement, and/or, at least in the area of workers’ compensation, obtaining a significant future credit.

Typical waiver of subrogation endorsement language reads as follows:

We have the right to recover our payments from anyone liable for an injury covered by this policy. We will not enforce our right against a person or organization named in the Schedule, but this waiver applies only with respect to bodily injury arising out of the operations described in the Schedule where you are required by a written contract to obtain this waiver from us.

As you can see, there are lots of conditions which must be in place for the waiver to be applicable. Even if it is applicable, clients routinely think that their right to reimbursement and their right to a future credit are also waived. This is not always the case, and failure to act on subrogation due to a misunderstanding of when rights are waived and when they aren’t continues to be a problem we see costing the industry a lot of money.

(7) SHARING THE GOOD NEWS: Giving Notice to Carriers, Government Entities and Product Manufacturers

Refraining from doing some of the simplest acts can result in some of the largest subrogation potential being lost. Notice requirements necessary to preserve and protect subrogation claims are very common, and vary from state to state. They present a procedural trap and a pitfall for the unwary subrogation claims handler. We frequently see significant claims lost because notice requirements with short fuses receive a back seat to the busy activity of adjusting a new loss – especially early in the claim. Notice is required in many states in as short a time as thirty (30) days. A notice of claim against the city of Austin must be filed within forty-five (45) days or be lost forever. An intervention for workers’ compensation subrogation must be filed within thirty (30) days of the carrier having notice of a third-party complaint being filed, or it can recover nothing. If our insured settles a personal injury claim with a tortfeasor prior to us giving notice of our subrogation interest to the liability carrier, no matter how quickly the settlement occurs, our subrogation rights as against the tortfeasor are lost forever. In almost every state, if the claimant settles a third-party bodily injury action before we have placed the claimant’s attorney on notice, our right of reimbursement may be jeopardized and the ability to pursue the only entity with money left in the bank – the attorney – might be barred.

Notice to governmental entities must strictly conform to statutory guidelines and contain specific items of information in order to be valid. Frequently, we see “form” notice letters being sent to such entities, and only months or years later do we receive the file, and by then it is too late. Notice to a plaintiff’s attorney that we will not need his services and do not want to contribute toward common fund attorneys’ fees is necessary in order to avoid significant portions of our subrogation interest going into the bank account of the insured’s attorney. Yet, we often see notice – or notice in the incorrect form and with insufficient information – not given in a timely manner. These become expensive letters that we didn’t bother to write, and quite often, there is nothing subrogation counsel can do to turn back the hands of time and fix the problem.

In the workers’ compensation arena, notice is frequently required in order for the carrier to file suit, intervene, or settle a subrogation claim. Notice against the federal government must be filed on a government-prescribed form, or, in the alternative, it must contain precisely the same information as requested on the form.

The failure of clients to give adequate notice to the property party in a timely manner remains a common mistake leading to the elimination of subrogation potential across all lines of insurance. Unless our client knows that notice required, how to file it, what must be included, and who to serve it on, the notice is often simply overlooked.

(8) CROSSING STATE LINES FOR MORAL PURPOSES: Multi-Jurisdictional Opportunities and Pitfalls

Under the U.S. Constitution, each state is still considered sovereign and each state controls the laws within its boundaries. Things get complicated, however, when a vehicle insured and garaged in one state is involved in an accident in another state. The legal issues involving conflicts of law, at least with respect to subrogation rights, concern themselves with one question: “Which state’s subrogation law should be applied to a particular lawsuit?” The actual process by which a court determines which state’s law to apply is sometimes referred to as “characterization” or “classification.” The actual determination of which state’s law is to apply must be made in accordance with the law of the state in which the court is sitting, which is most often the state in which the accident occurred.
Courts have used a variety of approaches to determine which state’s law applies to an auto insurance carrier’s subrogation interest in a lawsuit filed in a state other than the state in which a vehicle is insured and garaged. This area of law is known as Conflict of Laws. The three main approaches used to determine which state’s law applies in situations such as these are the following:

(1) Lex loci delecti – applying the law of the forum state in which the tort or accident occurs;
(2) Larson Rule – (workers’ compensation) applying the law of the state where the benefits are paid (enabling state) to a recovery made in a different state in which the third-party action was filed (forum state). This is the same as the Restatement (Second) of Conflicts of Law § 185; and
(3) Most significant contacts – applying the law of the state with the most significant contacts to the incident.

Some states have not declared what their rule is, and handle extra-territorial situations on a case-by-case basis. In fact, some states which apply rule number (3) above must look at the facts and circumstances of each case to determine which law applies.

Opportunities to game the subrogation system frequently present themselves in the area of workers’ compensation insurance. In today’s national and global economy, employees are routinely traveling in the course and scope of their employment throughout the country, and are getting injured in states other than the state where the employer is based. Employers with multi-state operations are regularly encountering workers who are being injured and claiming benefits in states other than the state where their home office is located. When attempting to subrogate for workers’ compensation benefits, this can lead to a wide array of confusing results. Most state workers’ compensation laws are extra-territorial. This means that an employee in the enabling state (the state in which he was hired and under whose laws he recovers benefits) who suffers an occupational injury or disease while outside of its boundaries in a forum state (the state in which the worker is injured and files a third-party action), is still eligible for workers’ compensation benefits under the laws of the enabling state. In some circumstances, the employee who is injured in another state may choose to collect benefits either in the enabling state or in the forum state.

We frequently see clients who have the ability to select the payment of benefits under one jurisdiction picking a different jurisdiction even though the selection forecloses any possibility of future subrogation. For example, one state may give an employer and its workers’ compensation carrier first money rights of recovery (such as Texas) while another state may disallow your subrogation interest unless and until the worker is “made whole” (such as Georgia). Knowing which state’s subrogation law to apply is critical in evaluating your subrogation potential and recovering your subrogation interest. If Texas benefits are selected relative to a Georgia accident and a Georgia third-party lawsuit, however, subrogation is destroyed because Georgia only allows subrogation when benefits are paid under Georgia law. Therefore, the littlest decision – often the very first decision made – can have devastating consequences and cost literally millions of dollars in subrogation dollars, all because the necessary homework with an eye toward subrogating was not performed ahead of time.

(9) STEPPING OVER DOLLARS TO PICK UP DIMES: Waiver of Lien to Settle Comp Claims or EL Claims

Whether it’s a case of the tail wagging the dog or the simple fact that insurance companies see their primary responsibility as that of adjusting and concluding “claims”, we all too often see a client with significant subrogation potential waive a $500,000 workers’ compensation lien in order to take down $75,000 in reserves on a pending claim. It is simple and quick, and because they do not yet have the $500,000 in hand, it becomes Monopoly money. The importance placed on closing a file often clouds the more economically sensible decision to wait until the subrogation claim settles and take a large future credit which will have the effect of closing the workers’ compensation claim without having to waive half a million dollars in potential recovery.

Sadly, decisions such as these are often made at levels far above those of the front-line subrogation professional, who learns after-the-fact, that despite significant efforts spent to effect a large recovery, the lien is waived and subrogation is gutted. Left holding the bag, of course, is the employer, who has a vested interest in seeing a large subrogation recovery and a reserve takedown, so that its risk modifier is favorably affected and future workers’ compensation premiums do not go through the roof.

States which allow employer liability (EL) claims, including contribution claims (e.g., Illinois and Minnesota), also present “opportunities” for a carrier to waive a significant lien in order to settle an EL claim worth considerably less. While there are other considerations at play, such as attorneys’ fees for the defense of the EL claim, large liens are often abandoned for the settlement of much smaller contribution claims without much financial analysis. Defense counsel’s job is to resolve the EL claim or the compensation claim, so their recommendation to the client usually consists of waiving subrogation – without regard to the net effective gain or loss.

(10) SUBROGATION AND THE FLAT EARTH SOCIETY: Hiring the Right Expert

In modern litigation – especially subrogation litigation involving defective products, premises liability, negligent maintenance, or medical negligence – expert testimony may be necessary to prevail. The first rule of subrogation is “Do no harm.” This rule is violated when experts who are not qualified to support a subrogation claim area are engaged. Experts represent an expense of litigation – a necessary evil for subrogating carriers. However, in an effort to minimize costs, many carriers rush into broad agreements with “expert” vendors who offer “cut-rate” fees and a sliding menu of services. All too often, we see “expert” reports authored by investigators and technicians who are not qualified to offer testimony in court. It is human nature to tend toward the path of least resistance, and engaging the same company over and over, regardless of their areas of expertise and credential, to author a report which does nothing more than state “the fire started somewhere under the hood”, has become quite common. Unfortunately, the failure to hire the right expert is often worse than hiring no expert at all. At the same time, subrogation professionals cannot afford to hire the best available expert in smaller cases. Compromises must be made. All too often we see our clients settling for experts who are not experts and who author reports which say little or nothing at all. Such an effort is a complete waste of time and money. More importantly, it damages recovery potential.

Manufacturers of defective products know their products much better than you do, and they have a routine of responding to a defective product allegation down to an art. They are familiar with their electrical schematics and engineering diagrams, while our expert may have to learn from scratch. It is said that an expert is one who knows more and more about less and less. Every state has specific requirements about what is necessary in order to allow an expert to testify.

Subrogation counsel should be prepared to provide you with a number of potential experts immediately after a loss occurs. They should be able to walk you through the process of setting up an inspection and destructive testing of a potentially-defective product. In the right case, choosing the best available expert means the difference between a large recovery and no recovery at all.

HONORABLE MENTIONS
  • Signing Releases With Indemnity
  • Ignoring the Subrogation Duty we Owe to Our Insured
  • Ignoring the Small Files
  • Giving Up too Early Once Indemnity or Waiver Agreement Discovered
  • Get Appraisal in Residential/Dwelling/Building Total Losses
  • Grading on a Curve: Giving Yourself an “A” for “D” Work

The above ten areas are areas in which we most commonly see costly mistakes being made. Over the years, we have learned that good decisions come from experience, and experience comes from bad decisions. That may sound like making bad decisions is a good thing, which isn’t true. However, bad decisions permeate every industry and every profession. Making the most of those bad decisions – learning from them and taking steps to avoid remaking them – is the hallmark of a progressive company. They can be expensive lessons to learn. “Experience is simply the name we give our mistakes,” Oscar Wilde famously said. Quite frequently, the subrogation mistakes we see from even the most experienced claims professionals are actually disguised as corporate efforts to save money, streamline, or consolidate. We understand that they are not made in a vacuum and they often begin with the best of intentions. The mistakes we see repeated are sometimes benign. Quite often, however, they turn into very expensive lessons. Whether we learn from these lessons is the true test of both our desire to optimize the recoveries we make and the lengths we will go to in order to fulfill the service – and in some states the “duty” – we owe to our insureds and our clients, for it is often our insured which pays the price for missed subrogation opportunities. As the industry becomes wiser to the significant savings, aggressive, cost-effective subrogation can provide, we can no longer ignore the best subrogation practices and techniques available to us. We can only take advantage of our mistakes if we recognize them and strive to avoid repeating them.

Damages Proof in Subrogation Cases

DON’T TAKE IT FOR GRANTED

Hobart M. Hind, Jr., JD | Claims Magazine | January 2017

In the past few years, savvy defense lawyers have taken a more inquisitive approach on the valuation of subrogation damages across all lines of insurance.

Gone are the days of assuming the damages must be right because no carrier wants to pay more than they should. Recently, a more laser-like Daubert level analysis has been used to attack the expert proof issues that apply to damages just as they would to a liability claim. A subrogating carrier or outside counsel that takes damages proof for granted may regret it.

Structural Damages

The basic rule of proof for damages to buildings or structures involves the ability to recover the fair market value of the structure or the cost to repair it, whichever is less. Sometimes the decision early on in the claim might be agreed to by the adjuster and insured before different valuations are undertaken.

Later, the defense may attempt to show that under the “other analysis” the result would have been much less, and that lower number should be your provable damages amount. Just as worrisome would be if your damages experts were not allowed to testify because their analysis was not based on the proper measure of damage.

An expert appraiser may be engaged to inspect the property to provide a valuation of the building later on if the original valuation is challenged. While a company may not want to spend $20,000 on a full- blown analysis, it can be worthwhile to invest $2,500 to document the building before it was torn down or altered.

For residential claims, a similar analysis applies. Remember that online residential valuation tools typically include the value of the land, so to establish an accurate damages number, one must factor that out. It is not uncommon to see very large “deltas” between the insured value of a house and its fair market value minus the value of the land. To properly value a structural damages claim, subrogation professionals must consider everything.

Business personal property/ contents damages

In property subrogation, one of the most difficult damages situations to handle involves a commercial loss where older equipment that is integral to the operation of a facility is destroyed.  Oftentimes, the business decision is made to replace used equipment with new equipment to minimize the downtime and associated business income loss. A recent Texas case shows why persistence can pay off.

In Factory Mutual Ins. Co. a/s/o Veolia v. Alon USA L.P., WL 257134 (5th Cir. 2013), Factory Mutual Insurance Company (“FM”), was awarded damages stemming from an industrial accident that destroyed a waste treatment plant at an oil refinery plant owned by Alon.  It relied on the equipment and services of a third party, Veolia North America–West (“Veolia”), for on-site water treatment and waste management. The equipment located in the waste treatment facility (known in the lawsuit as the “the Scalfuel facility”) was owned and operated by Veolia and insured by FM. One day, a cloud of vapor exploded at the Scalfuel facility, destroying it. Veolia filed a claim with FM in the amount of $6,106,880, which FM paid. Thereafter, FM filed a subrogation claim against Alon to recover damages stemming from the explosion.

Before the bench trial began, Alon stipulated to liability, leaving only the issue of damages to be determined. At trial, the parties agreed that damages would be determined by the fair market value of the Scalfuel plant before the explosion, but they disagreed as to how fair market value should be calculated. FM contended that it was entitled to the Scalfuel plant’s replacement cost, i.e., the cost of new parts and labor adjusted downward to account for the original plant’s depreciation at the time of the explosion. Alon argued that FM was only entitled to the fair market value of the Scalfuel plant’s component parts. FM sought $6,106,880, whereas Alon claimed FM could only recover $877,882.

The district court found that even though there was a market for specific used components, there was no market for used Scalfuel systems. Since the sum price of a Scalfuel system’s components does not reflect the full value of an operational Scalfuel plant, the district court found that the fair market value is determined by the replacement cost adjusted for improvements in value beyond the destroyed plant and depreciation reflecting the remaining useful life of the plant before its destruction.

Accordingly, the district court found Alon liable for $3,790,391.96, plus interest. To reach this figure, the district court started with an estimate for new equipment, including taxes and shipping, of $2,356,110. Ten percent was added to this amount as a contingency. The combined sum was then multiplied by 2.25 to account for the costs of installation, testing and startup, and the result was then multiplied by 0.65 to account for the original Scalfuel plant’s 35 percent depreciation.

Business interruption damages

Probably no area of damages proof is subject to attack as much as the business loss analysis. The analysis can vary depending on the nature of the business:   a mom and pop hardware store involves a much more simplistic analysis than a biofuel producer who has operations affected in one location, causing derivative problems in other locations, but still having “make-up capacity” in yet other locations.

Oftentimes, subrogation counsel also represents the insured (subrogor) for their uninsured damages. This could be simply the deductible or it could include elements of the claim for which the insured was underinsured. It could also include business damages that extend well beyond the period of restoration, which the policy may use to trigger the cut-off of business interruption damages. Counsel must assess these damages too, and if supportable, add them to the claim as uninsured damages.

We have also seen claims where the business interruption claim is calculated using less than a company’s full financial documentation, and if the claim is sizable, the defense will ask for all relevant documents to show the actual lost profits is far less than claimed.

To mitigate claims expenses, some companies are using in-house accountants to assess the business losses. This may work out favorably, however no one should be surprised by a request to retain an outside forensic accountant to re-calculate the numbers later on in litigation.

Also, an accountant is a more traditional expert who may be more readily scrutinized by a court than other potential damages experts. For this reason, it is crucial that the plan for business damages proof is mapped out early, preferably with the expert using a Daubert-like analysis based upon the full complement of damages support materials from the insured.

Why does this matter?

Effective subrogation is far more than simply getting as much money back as possible, it involves the return on investment. When a loss happens, there are a set of facts that will play out in a percentage range of liability success (or failure). The range may be 20-30 percent or it may be 65-70 percent, but there will always be a range.

Applied against that range is the cost to get to that point. If the insurer applies the cost of recovery against a total paid claim of $750,000, an investment of $50,000 for experts and anticipated litigation costs might make sense. However, failure to analyze the damages properly may result in a recoverable claim of $475,000, and suddenly, the $50,000 investment starts to feel a bit bloated.

There are a host of issues that can plague any case, so don’t let poor damage assessments be another one. Doing this well will speed up the case as a whole, and will ease the decision-making for everyone concerned.

 

Waivers of Subrogation: When a Waiver is not a Waiver

Robert M. Flannery and Douglas Glombarrese | International Law Office | October 25, 2016

Introduction

Subrogation – an insurer’s right to ‘step into the shoes’ of its insured and assert the rights of the substituted party – is a fundamental principle in insurance law that allows an insurer to sue an at-fault third party after reimbursing its insured. Despite its importance, courts have upheld contractual waivers of this right under various rationales, including freedom of contract and public policy. Waivers of subrogation are essentially agreements between parties whereby an insured waives the recovery rights of its insurer when allowed under the policy. Therefore, they technically involve two separate contracts:

  • a waiver clause that is part of the agreement between the insured and a third party; and
  • a provision in the insurance policy in which the insurer permits the insured to waive its recovery rights against the third party.

Most of the litigation surrounding waivers of subrogation is focused on the specific language in either of these clauses. However, there have been interesting developments in the law regarding the context of these waivers outside of the specific language contained in them. Courts have struck down waivers that contravened existing statutes or went against other aspects of public policy. Two rulings this year have addressed these issues; this update considers their import and the broader context, which should give insurers and insured alike more to think about when considering waivers of subrogation.

Statutory bars to enforcement

In a March 2016 ruling New York’s Appellate Division, First Department, held that a waiver of subrogation was unenforceable as it contravened the Uniform Commercial Code, which was generally adopted by New York in December 2014 as part of Assembly Bill 9933.(1) In doing so, the court revived a lawsuit brought by the insurer of a fine art gallery whose artwork was destroyed during Superstorm Sandy. The decision will likely also affect two nearly identical lawsuits whose cases were dismissed in New York Supreme Court earlier this year. Together, the three cases allege more than $12.3 million in damages against Christie’s Fine Art Storage Services, a subsidiary of the celebrated auction house which owned and operated the warehouse in Red Hook, Brooklyn, where the damage occurred.

The case, XL Specialty Insurance Co v Christie’s Fine Art Storage Services,(2) dealt with a 2011 agreement between Chowaiki & Co Fine Art Ltd and Christie’s, under which Christie’s stored Chowaiki’s artwork in its Red Hook warehouse. Pursuant to the agreement, Chowaiki was required to obtain an “against All Risks of loss or physical damage” insurance policy covering the goods, which was provided by XL. Chowaiki further elected to sign a waiver absolving Christie’s of all liability for loss or damage to the artwork, and to “arrange for [XL] to waive any rights of subrogation” against Christie’s regarding any damage to the artwork.(3) This differs slightly from another common waiver of subrogation in which the insured’s contract with the third party includes an express waiver of the insurer’s right to subrogation.(4)Nonetheless, courts have upheld waivers of subrogation which required the insured to purchase insurance for the benefit of a third party.(5)

When Superstorm Sandy struck New York in 2011, the facility – which was located a block away from the waterfront – was flooded. Despite specific reassurances from Christie’s that Chowaiki’s first-floor artwork would be “checked to ensure that all items are raised off the floor” or moved to safer areas of the warehouse, Chowaiki’s goods were damaged – apparently because they were left on the first floor.(6)Pursuant to its insurance policy, XL reimbursed Chowaiki and subsequently sued Christie’s in October 2013 seeking $704,000 in damages. XL sought damages for negligence, gross negligence, breach of bailment, breach of contract, negligent misrepresentation and fraudulent misrepresentation, stemming from Christie’s handling of the artwork and assurances that it would be moved to a higher floor. The trial judge dismissed XL’s lawsuit based on the waiver of subrogation provision.

On appeal in the First Department, the three judge panel held that the waiver of subrogation was unenforceable. Key to the ruling was the trial judge’s (correct) holding that, based on the terms of the storage agreement, the relationship between Chowaiki and Christie’s was that of a bailor/bailee (or warehouseman) under the Uniform Commercial Code.(7) This classification imposed specific statutory standards and responsibilities on the parties. Specifically, Section 7–204(a) of the code provides that a “warehouse is liable for damages for loss of or injury to the goods caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances”.(8) Section 204(b) allows a warehouseman to limit damages by terms in the storage agreement, but Section 7-202(c) states that such terms must not “impair its … duty of care under Section 7–204”.(9)

The First Department pointed to a Fourth Department case, Kimberly-Clark Corp v Lake Erie Warehouse, Div of Lake Erie Rolling Mill,(10) for the proposition that while a warehouseman can limit its amount of liability, it “cannot completely exempt itself from liability as imposed by UCC Article 7”. In Kimberly-Clark, the court found a similar clause to be invalid and held that a warehouseman “may not contract away or lessen his responsibility except in such manner as the statute provides”.(11) Ultimately, the panel in XL held that:

Provisions purporting to exempt the bailee from liability for damage to stored goods from perils against which the bailor had secured insurance, even when caused by the bailee’s negligence have been held to run afoul of the statutory scheme of UCC Article 7.“(12)

The court noted that “there is a question of fact concerning whether defendant, in failing to move Chowaiki’s goods to either another floor, or to a location above ground level on the floor they were on, was reasonable under the circumstances”.(13) Therefore, the immediate result of the First Department’s holding is that XL’s claim for subrogation against Christie’s now goes forward in New York Supreme Court, turning on whether Christie’s actions during Superstorm Sandy were reasonable.

However, two other insurers – StarNet Insurance Co and AXA Art Insurance Corp – also sued Christie’s in 2013 as subrogees to other parties whose art was damaged in the same warehouse during the storm. Sarpulla dismissed both claims in January 2016, citing their respective waiver of subrogation provisions.(14) In light of the First Department’s ruling in XL, both StarNet and AXA filed motions to have their cases reheard.

Waivers of claims for gross negligence

In many subrogation actions, the subrogee insurer alleges multiple theories of liability, including gross negligence. While freedom of contract principles generally allow the principal parties to enter into agreements containing exculpatory clauses to absolve them from ordinary negligence, many jurisdictions do not allow parties to limit their liability for gross negligence or wilful or wanton acts out of public policy concerns. However, as the New York Court of Appeals described, waivers of subrogation, which involve a third-party insurer, differ from mere exculpatory clauses: “A distinction must be drawn between contractual provisions which seek to exempt a party from liability … and contractual provisions … which in effect simply require one of the parties to the contract to provide insurance for all of the parties.”(15) Using this line of reasoning, New York courts have held that parties can, through waivers of subrogation (and the necessity to maintain insurance), absolve themselves of grossly negligent conduct. Indeed, buried in Scarpulla’s opinion dismissing the claims of StarNet and AXA (which alleged gross negligence against Christie’s) is a citation to Footlocker, Inc v KK&J, LLC, a New York Appellate Division, First Department case which specifically held that a “waiver of subrogation may bar a claim for gross negligence”.(16)

However, the approach to this issue is by no means uniform across the country. A recent ruling of the Michigan Court of Appeals highlights the approach taken in other jurisdictions. In Lexington Insurance Company v Alan Group,(17) an insured’s property was damaged when a defectively installed sprinkler system ruptured. Its insurer, Lexington, filed a subrogation lawsuit against the general contractor and subcontractor responsible for the system’s installation. Lexington’s lawsuit asserted claims for negligence, gross negligence, breach of warranty and breach of contract. The trial court held that the waiver of subrogation clause barred Lexington’s claim for gross negligence. On appeal, however, the Michigan Court of Appeals held that while a party may contract against liability for ordinary negligence, “a party may not, by contract, protect itself from liability for gross negligence or willful and wanton misconduct”.(18) Other states that, like Michigan, explicitly do not allow waivers of subrogation to be enforced against claims of gross negligence include Georgia(19) and Kansas.(20) Indiana, for its part, appears to have reached a similar conclusion despite only discussing the issue in a footnote(21) and in dicta;(22) and Massachusetts chose to not address the issue directly.(23) Of course, even if gross negligence claims are not barred by the waiver, the underlying claim still needs to allege facts that are consistent with gross negligence, tasking the courts with parsing through the facts of each case to determine whether that particular claim can go forward. The court in Lexington examined the underlying facts and determined that because Lexington failed to assert more than ordinary negligence, its gross negligence claim was barred.(24)

These holdings barring gross negligence claims despite waivers of subrogation essentially treat exculpatory clauses and waivers of subrogation identically. The better-reasoned decisions, such as that of the New York Court of Appeals, focus on the important differences between the two. For example, in Reliance National Indemnity v Knowles Industrial Services(25) the Supreme Judicial Court of Maine reasoned that:

The rule [that claims of gross negligence render exculpatory clauses void] exists…to ensure that a party injured by another’s gross negligence will be able to recover its losses. In cases involving waivers of subrogation, however, there is no risk that an injured party will be left uncompensated, and it is irrelevant to the injured party whether it is compensated by the grossly negligent party or an insurer.“(26)

The Reliance court further noted the important social goals furthered by waivers of subrogation, including anticipating risk, avoiding litigation and sustaining economic relations between the parties.(27)Other courts have noted the usefulness of waivers of subrogation specifically in the context of construction contracts by avoiding disruption of the work.(28) Apart from New York and Maine, jurisdictions which have adopted this approach include Vermont(29) and Nebraska.(30) Ultimately, the Michigan Court of Appeals’ decision in Lexington is a reminder that insurers may have an avenue in certain jurisdictions to bring their subrogation claims for gross negligence (where applicable) despite signing a waiver indicating otherwise.

Comment

Waivers are part of an insurer’s bargaining power with an insured. Usually, a waiver of subrogation is accompanied by an increase in premiums, for example. However, as is clear, even where an insurer purportedly waives its rights to bring a subrogation claim, many factors determine whether such a claim is nonetheless viable. As XL indicates, existing statutory law such as the Uniform Commercial Code may override the waiver and permit claims to be brought. In the majority of states – meaning those that have not adopted Section 7 of the code – limitations of liability may exonerate negligent defendants, even when the facts indicate a bailor/bailee relationship exists.(31) Additionally, the ability of an insurer to bring a gross negligence claim in the face of a waiver of subrogation is highly variable from state to state, and many states have not yet directly addressed the issue. Therefore, insurers, insureds and third parties which require waivers of subrogation would be doing themselves a disservice by not fully understanding the applicable statutory and case law in regards to potential claims for subrogation in this context.

Endnotes

(1) New York is one of just 15 states to have adopted Article 7 of the Uniform Commercial Code – the others being Arizona, Arkansas, California, Georgia, Kansas, Kentucky, Louisiana, Missouri, Nebraska, Nevada, New Hampshire, New Jersey, North Dakota and Oklahoma.

(2) XL Specialty Insurance Co v Christie’s Fine Art Storage Services, 137 AD 3d 563 (NY App Div 2016).

(3) Id at 564.

(4) See, for example, Argonaut Great Cent Ins Co v Ditocco Konstruction, Inc, 2007 US Dist LEXIS 93846, at *14 (DNJ Dec 20 2007).

(5) See, for example, Tate v Trialco Scrap, Inc, 745 F Supp 458 (MD Tenn 1989), aff’d, 908 F 2d 974 (6th Cir 1990).

(6) XL, 137 AD 3d at 564-65.

(7) “‘Bailee’ means a person that by a warehouse receipt, bill of lading, or other document of title acknowledges possession of goods and contracts to deliver them.” Uniform Commercial Code § 7-102 (2003).

(8) Uniform Commercial Code § 7-204(a) (2003).

(9) Uniform Commercial Code § 7-202(c) (2003).

(10) Kimberly-Clark Corp v Lake Erie Warehouse, Div.of Lake Erie Rolling Mill, 49 AD 2d 492 (NY App Div 1975).

(11) Id at 495.

(12) XL, 137 A D 3d at 566.

(13) Id at 565.

(14) See Starnet Ins Co v Christie’s Fine Art Stor Servs, Inc, 2016 NY Slip Op 30147(U) (Sup Ct NY Cty 2016); AXA Art Ins Corp v Christie’s Fine Art Stor Servs, Inc, 2016 NY Slip Op 30148(U) (Sup Ct NY Cty 2016).

(15) Board of Educ v Valden Assoc, 46 NY 2d 653, 657 (1979).

(16) Footlocker, Inc v KK&J, LLC, 69 AD 3d 481, 482 (NY App Div 2010).

(17) Lexington Ins Co v Alan Group, 2016 WL 4203610 (Mich Ct App 2016).

(18) Id at *3 (citations omitted).

(19) Colonial Props Realty Ltd P’ship v Lowder Constr Co, 567 SE 2d 389, 394 (Ga 2002) (holding that waivers of subrogation “do not relieve a party from liability for acts of gross negligence or wilful or wanton conduct”) (citations omitted).

(20) Butler Mfg Co, Inc v Americold Corp, 841 F Supp 1107, 1111 (D Kan 1993) (citing the court’s previous order which held that “any attempt by a party to limit its damages for gross negligence or willful or wanton conduct would be void as against public policy”).

(21) Bd of Comm’rs v Teton Corp, 3 NE 3d 556, 571 n 10 (Ind Ct App 2014).

(22) SC Nestel, Inc v Future Const, Inc, 836 NE 2d 445, 451 (Ind Ct App 2005).

(23) Lumbermens Mut Cas Co v Grinnell Corp, 477 F Supp 2d 327, 334 (“Legal support exists in various jurisdictions on both sides of that argument but the Court need not resolve the debate because the plaintiff’s claims are not barred by the waivers of subrogation”).

(24) Lexington, 2016 WL 4203610 at *3-4. See also Travelers Ind Co v Losco Group, Inc, 204 F Supp 2d 639 (SDNY 2002) declined to follow by St Paul Fire Ins v Univ Builders Supply, 409 F 3d 73 (2d Cir 2005) (examining whether there is a genuine issue of material fact of the gross negligence claim after determining that claims for gross negligence are not precluded by waivers of subrogation).

(25) Reliance Nat Indem v Knowles Ind Ser, 868 A 2d 220 (Me 2005).

(26) Reliance Nat Indem, 868 A 2d 220, 226 (internal citations and quotations omitted). See also St Paul Fire and Marine v. Universal Builders, 409 F 3d 73, 86 (2d Cir 2005) (“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 latter agreements are not contrary to public policy unless they purport to indemnify a party for damages flowing from an injury that was intentional”) (internal quotations omitted).

(27) Reliance, 868 A 2d at 225-26.

(28) See Haemonetics Corp v Brophy & Phillips Co, 23 Mass App Ct 254, 258 (App Ct 1986) (holding that waivers of subrogation in the construction context “avoid[] disruption and disputes among the parties to the project…[and] eliminates the need for lawsuits, and yet protects the contracting parties from loss by bringing all property damage under the all risks builder’s property insurance'”), quoting Tokio Marine & Fire v Employers Ins of Wausau, 786 F 2d 101, 104 (2d Cir 986). See also Lexington Ins Co v Entrex Commc’n Servs, 749 N W 2d 124, 134-135 (Neb 2008).

(29) Behr v Hook, 787 A 2d 499, 504-505 (Vt 2001).

(30) Lexington Ins Co v Entrex Communication Services, Inc, 749 N W 2d 124, 129-131 (Neb 2008).

(31) Although the case did not involve an insurer’s waiver of subrogation, Leprino Foods Co v Gress Poultry, Inc 379 F Supp 2d 659 (MD Pa 2005) held that in Pennsylvania, which has not adopted Section 7 of the Uniform Commercial Code, the defendant’s limitation of liability provision precluded summary judgment in favour of the bailiee-plaintiff because genuine issues of material fact existed as to whether the bailor’s cheese was spoiled as the result of the bailee’s negligence or gross negligence. Had the case been in a jurisdiction which had adopted the code, the outcome would have been different.

News for Contractors and Construction Lenders in Arizona and Nevada – The Contractors’ Lien May Trump the Bank’s

Roy Bash, G. Edgar James and Scott C. Ryan – Polsinelli – July 10, 2014

In addition to an arid climate and plenty of sunshine, Arizona and Nevada have something more to offer contractors: a potentially advantageous position over lenders when a project goes bad.

When a project derails and everyone involved is looking to be made whole, banks typically have protected their first-place position even if the contractor commenced with construction prior to the bank making its loan. The bank achieves this by requiring the contractor to have executed a subordination agreement or by claiming its first-place position via the theory of equitable subrogation. Subordination agreements are typically enforceable, and equitable subrogation is the rule of law in much of the country. However in two separate rulings in Arizona (view here and here), the courts held that mechanic’s liens have priority of all other claims attaching after the commencement of construction. In Nevada, state law prohibits a bank’s jumping to the front of the line, going so far as to state that even if such an agreement to subordinate is made, it is “contrary to public policy and is void and unenforceable.”

Determining the order of repayment is an important consideration when entering into any construction deal. After a project derails this issue is complex, and typically involves a significant number of parties with none wanting to concede their position. Furthermore, as demonstrated above, some parts of the country operate under state laws that are counter to what is considered standard business practice elsewhere.

via Polsinelli.

Waiver of Subrogation – Two Reminders

Stanley A. Martin – February 5, 2014

Diesel fuel is spilled during renovation of a library, damaging both the work in progress and the surrounding building or land.  Damages may exceed $500,000, but the owner’s pollution coverage is apparently limited to $5,000.  Is the owner barred from pursuing the contractor and others based on the waiver of subrogation language in the contract?  The Indiana Court of Appeals focused on one issue in its analysis:[1] that the waiver of subrogation applies only to claims paid relative to the “Work”, and not to other surrounding elements that were damaged.  A second issue seems to an outsider to be equally if not more important: the waiver does not apply if the insurance policy has not covered the damage. 

The focus of the recent decision is whether the contractor had preserved in prior filings its position that the damage was limited to the “Work” and thus within the waiver of subrogation.  The Indiana court followed what it characterizes as the majority position, that AIA A201 § 11.3.7 does not bar claims against the contractor for damage to “non-Work” areas.  Thus, any damage to “non-Work” areas would be outside the waiver of subrogation, and not barred by that waiver, in any event.  That is the first reminder – to be mindful of the scope of the waiver. 

The Indiana court discusses the second point only when it cites a New York appellate decision[2] supporting its position.  In the NY case, the court held that the owner had not waived claims against the contractor if such claims were not covered by the owner’s property insurance.  That would appear to be the more important factor here.  If the owner’s insurance covers only a small portion of the damage, then a waiver that applies only “to the extent covered by property insurance” (per A201 § 11.3.7) would not extend beyond what has been covered; subrogation has been waived by the library only as to the $5,000 in damages covered by insurance.  The second reminder is that the waiver of subrogation does not come into play if the damage is not covered by insurance, when following the standard AIA waiver language.



[1]  Allen County Public Library v. Shambaugh & Son, L.P., et al., No. 02A04-1302-PL-78 (Jan. 28, 2014), available here.   

[2]  Mu Chapter of Sigma Pi Fraternity v. Northeast Construction Services, 273 A.D.2d 579, 582 n.2 (N.Y. A.D. 2000). 

via Waiver of subrogation – two reminders – Lexology.