Risk management and allocation are critical issues to any construction executive. Insurance policies, and the related contract language, are important tools used in risk management and allocation in construction contracts.

For this reason, it is important to clearly understand the impact of contract language to which a party is agreeing. One clause that is present in most contracts, the waiver of subrogation clause, has meaning far beyond what a construction executive might ordinarily anticipate. The language of such a waiver is generally as follows:

“The Owner and Contractor waive all right against (1) each other and any of their subcontractors, sub-subcontractors, agents and employees, each of the other…for damages cause by fire or other causes of loss to the extent covered by [Builder’s Risk Insurance] … or other property insurance applicable to the Work, …”

This standard waiver of subrogation clause, coupled with builder’s risk insurance and other typical insurance policy language and coverage, potentially provides a construction company very broad defenses to claims against it by an owner. The cornerstone to these defenses is the argument that the “waiver” contained in a waiver of subrogation clause constitutes a complete waiver of many, if not all, claims by an owner against the contractor. To reach this result, courts focus on the fact that a written and executed construction contract means the parties negotiated an agreement, before construction started, which included how they wanted to allocate risk. If evidence exists in the form of a clearly written contract, courts do not believe it is their role to rewrite that agreement.

If a pre-construction risk allocation agreement is present in Texas, for example, Texas courts reach far beyond an interpretation that such clauses are effective only to the extent that the loss is covered by builder’s risk insurance or “other insurance applicable to the work.” They may determine that liability for any damage caused by an identified party is waived.

For example, one court said “a review of the contract and the case law interpreting similar AIA contract provisions reveals the parties agreed that the owner’s property coverage would protect all the parties from property loss,” noting that “the parties agreed in advance to avoid disruption and disputes by agreeing that all contracting parties are protected from property loss under the owner’s property insurance.” So, if damages suffered by an owner are covered by insurance that is applicable to the project work, a waiver of subrogation clause can be effective to release the party in error from liability.

Some courts have gone so far as to determine by defining the “applicable to the work” portion of the waiver clause as referring to insurance applicable to the location of the work or the building containing the work. Most courts only look to the applicable insurance coverage itself, and decide whether it references the location of the work or the building containing the work. If it does, then the waiver of subrogation limits an owner or its insurance carrier’s potential recovery against a contractor and the pre-construction risk allocation will remain intact. Courts do this by looking at the insurance policy itself for reference to the location of the work or the building containing the work. If the location of the damages suffered is covered in the policy, then the policy constitutes “other property insurance applicable to the work” and a party may be absolved of all potential liability, even for damages it caused.

Case law interpreting waivers of subrogation also identifies a very interesting result concerning this waiver and builder’s risk insurance. In the event a party to a contract agrees to purchase builder’s risk in a certain amount, or to cover certain specific costs resulting from a loss, and does not actually purchase coverage in strict compliance with that agreement, that party may well become a “de-facto” insurer of the project. As a result, a contractor on a project that experiences a loss as a result of its own negligence during construction could find itself released from the owner’s claims against it, because the owner did not honor the pre-construction risk allocation agreement between the parties found in the written contract.

In summary, construction executives need to understand the potential impact of decisions they make with regard to insurance coverage. If the executive is in the position of being required to purchase builder’s risk insurance coverage as a result of its contract, it is essential that the exact coverage called for be purchased. An executive in that position also may want to consider modifying the release language found in the waiver of subrogation clause. On the other hand, an executive whose company may have caused a loss during construction that has resulted in a claim against it should carefully consider the arguments above, because the result may be a complete waiver of liability from that claim. In the event of a loss, consultation with qualified counsel is important, as any issue regarding the scope of any potential release will be driven by the facts of the particular event.