Properly structured contractual risk transfer places the financial responsibility for an accident or injury to a third party on the person or entity closest to and best able to control the activity and, presumably, its outcome. Upper tier contractors also use contractual risk transfer to financially protect themselves from the vicarious liability exposure created by the mere presence and actions of the lower tier contractors. This is really two sides of the same coin, provided the upper tier contractor is not trying to contractually transfer liability for their own or other's injurious actions to the lower tier contractor.

As was detailed in the prior post, the unendorsed commercial general liability (CGL) policy extends very broad protection to contractually created indemnitees, provided specific conditions are met. But there are several reasons that upper tier contractors are usually not satisfied with the breadth of coverage provided by the CGL:

  1. The definition of "insured contract" in the CGL could be endorsed to remove the breadth of coverage extended to indemnitees;
  2. A particular claim or suit may fail to meet all the conditions required for coverage to apply; or
  3. The contract's indemnity wording may not hold up in court and be unenforceable, leaving the upper tier contractor without effective transfer and, thus, financially responsible.

Because the loss of contractual protection is possible, upper tier contractors generally include specific insurance requirements in addition to the indemnity wording in construction agreements stipulating the type and limits of coverage the lower tier contractor must purchase, maintain and show proof of before beginning work (or getting paid). The extension of additional insured status to the upper tier contractor and a waiver of subrogation endorsement in favor of the upper tier contractor are the two most common insurance requirements placed on lower tier contractors. The waiver of subrogation requirement is only mentioned in regard to additional insured status as this requirement should be contractually handled rather than dealt with in the policy.

(Contractual Risk Transfer Rant: Contractual provisions within construction contracts often are violated by the upper tier contractor and then unconscionably held over the lower tier contractor. As stated above, lower tier contractors are generally required to carry certain prescribed insurance coverages; the contract goes on to state that the lower tier contractor MUST show acceptable proof of such coverage BEFORE beginning work. For expediency this requirement is often waived by the general contractor to allow the subcontractor to start work without delay. But when the subcontractor requests payment, the aforementioned contractual requirements are held over his head, and used to hold up payment.

By allowing the subcontractor on the jobsite prior to the receipt of proof of acceptable coverage, in direct violation of the contract, the general contractor, by rule of estoppel, effectively waives his right to enforce that part of the contract. But no subcontractor has the time or money to take this court to put an end to this violation. However, the argument is moot if the contract states that the lower tier contractor "attests" or" warrants" that such coverage exists, the lack of specified coverage then is a breach of contract.)

Additional Insured Status

Upper tier contractors commonly request lower tier contractors attach two additional insured (AI) endorsements to the policy: 1) the CG 20 10 to extend AI status for ongoing operations; and 2) the CG 20 37, required to extend protection to the AI for injury or damage caused after the operations are complete. Both forms were updated in 2004 and this article is based on that edition. (For a comparison of the current and prior AI forms, see the four-part series on additional insured endorsements.)

Unlike the unendorsed CGL and its dependence on the definition of "insured contract," these two endorsements extend protection by changing the definition of "insured" to include the upper tier contractor within Section II - Who Is An Insured. Because the definition of insured is redefined, the presence, absence or enforceability of an indemnity agreement is of little consequence. The AI is protected to the extent the endorsement(s) allows; unless the construction contract's indemnity agreement is broader. If the indemnity agreement is broader than the AI endorsement, and is enforceable, the broader coverage will be granted to the indemnitee/additional insured.

Advantages of Additional Insured Status

Any advantage of additional insured status applies only to the upper tier contractor. There is little advantage created for the named insured by extending additional insured status to another party, other than the satisfaction of a contractual requirement and the treatment of defense costs.

Additional Insured vs. Indemnitee: The obvious advantage for the upper tier contractor is moving from a contractually created indemnitee to a defined insured. An "indemnitee" is not a direct party to the insurance contract and derives only those benefits enumerated by and created in the construction contract, subject to the limitations of the CGL and the definition of "insured contract." Additional insureds are a party to the insurance contract and are granted the protection provided by the CGL regardless of any external document. But although a party to the contract, additional insureds are granted the least amount of coverage and have very few "rights" under the insurance policy. All other advantages flow from this one.

Defense: The cost to defend additional insureds is in addition to the limit of coverage even if the named insured is not named in the suit, which is the requirement under the supplementary payments sections when the upper tier is but an indemnitee. Also, defense is provided to additional insureds regardless of contractual language whereas indemnitees are granted defense only if it is required in the indemnity wording of the contract.

Level of Transfer: Most states statutorily control the level of risk transfer allowed in an indemnity agreement (limited, intermediate, broad). Some states permit only limited transfer, meaning that the upper tier contractor can contractually transfer only its vicarious liability for the actions of the lower tier contractor. However, the only apparent limitation in the 07 04 edition of these two AI endorsements is that the upper tier contractor cannot transfer its sole negligence to the lower tier contractor. Many states permitting only limited transfer by indemnity agreements in the contract do not place such limitation on insurance wording, so if the insurance contract allows for intermediate transfer, the AI is granted coverage for injury caused jointly by the lower tier contractor and other contractors; or even caused jointly by the lower tier and upper tier. The current version (07 04) of the CG 20 10 and 20 37 seem to allow for intermediate transfer.

Waiver of Subrogation: Being named as an additional insured removes the need for an endorsed waiver of subrogation to the extent of coverage; unless the transferor is trying or allowed to transfer broader exposures than those contemplated by insurance. There are three parties to a liability loss: 1) the insured; 2) the insurer; and 3) the injured person or entity. As a defined insured, the AI is protected by the policy without fear of subrogation, just like all other insureds (named, automatic and additional).

Upper tier contractors might try to use the CG 24 04 endorsement to waive subrogation for their sole negligence, but likely without success. The endorsement states that the injury or damage must arise out of the named insured's ongoing operations or completed work, meaning that the insured must at least be partially culpable in the incident leading to injury or damage. The AI endorsements will protect the upper tier contract if the lower tier contractor is at all responsible for the incident. (The meaning of the term "arising out of…" has been subject to some court tests.)

Requirements of Coverage as an Additional Insured

Reviews of both the CG 20 10 07 04 and 20 37 07 04 reveal an important fact about the protection extended to the additional insured: the named insured must in some way be negligent in causing the injury or damage for the additional insured to be protected by the policy. Both endorsements employ the phrase "caused, in whole or in part, by…." "Caused" connotes the named insured's (the "you's") direct or indirect involvement and the phrase, "in whole or in part," solidifies the idea that the named insured must be involved.

Upper tier contractors are also protected in the CG 20 10 when the lower tier named insured is directly liable or can be held vicariously liable for the actions of a sub-subcontractor. The endorsement states that the additional insured is also protected if the injury or damage is caused by another party acting on the named insured's ("your") behalf. The idea of "acting on your behalf" (as written in the endorsement), in the apparently intended interpretation, seems to mean "at the direction of the named insured."

The CG 20 37 does not contain the "acting on your behalf" wording. Completed work apparently becomes the sole responsibility of the party charged with delivering the final product just like the general contractor becomes statutorily responsible for the entire structure in many states.

Combining the CG 20 10 and 20 37 extends protection to the additional insured for ongoing and completed operations. Both endorsements apply only to the entity and location listed in the endorsement. However, the CG 20 33 can be used as a blanket version of the CG 20 10; but be warned, there is no blanket version of the CG 20 37, so any AI's requiring completed operations must be added individually (unless the underwriter is willing to issue the 20 37 on a blanket basis, but the availability varies by carrier and region).

Agents should be given the opportunity to review every construction contract to assure that all locations and additional insureds are covered to avoid a breach of contract. In fact, agents probably should undertake to send a letter to their construction clients at renewal every year warning that if they, the agent, are unable to review contracts prior to the insured signing it, the agent and agency cannot be held liable if the insurance provisions are not or cannot be met once the contract is signed.

Finishing Up

These three articles have attempted to give a brief overview of contractual risk transfer, the contractual protection provided by the CGL and how the additional insured endorsements work. This is by no means fully detailed to handle every case in every jurisdiction, but the general principles can be applied to nearly every construction contract.