Robert M Flannery Douglas Giombarrese October 25 2016 Waivers of subrogation: when a waiver is not a waiver Mendes & Mount LLP | Insurance - USA Robert M Flannery, Douglas Giombarrese Insurance IntroductionStatutory bars to enforcementWaivers of claims for gross negligenceCommentIntroductionSubrogation – 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; anda 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 enforcementIn 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 negligenceIn 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.CommentWaivers 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.For further information on this topic please contact Robert M Flannery or Douglas Giombarrese at Mendes & Mount LLP by telephone (+1 212 261 8000) or email ([email protected] or [email protected]). The Mendes & Mount website can be accessed at www.mendes.com.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.