In For a Penny, Out For a Pound, Due to an Exclusion Mishap
Welcome to all who have boarded our “A” Train series of articles intended to guide the perplexed owner or general contractor on measures to take (or to refrain from taking) to limit exposure from workplace accidents. Today’s discussion examines choices made by subcontractors or vendors in selecting commercial general liability insurance coverage that can unexpectedly harm the owner/general contractor, let alone, the subcontractor. Thus, it is not the contractual arrangements in place with the subcontractor/vendor that are deficient or inadequately worded but the insurance policy itself.
The narrow issue arises in instances where—often for cost containment purposes—the subcontractor/vendor ventures out and chooses to secure a lower insurance premium by accepting a rider or endorsement generally known as “Employee Exclusion” in its policy.
For the purposes of this article, we’ll refer to subcontractors’ employees, but similar endorsements may be in place for independent contractors’ employees and others (sometimes known as “Payroll Exclusions”). There are a number of endorsements that could be added to subcontractors’ policies – and even to general contractors’ policies – that can dramatically impact the opportunities for coverage under both subcontractors’ and general contractors’ policies and thus substantially and dramatically impact on the availability of coverage. In this article, we’ll speak about the “Employee Exclusion,” but we underscore the importance of reviewing policies because other, similar coverage-limiting endorsements may be found in your policy or those of your subcontractors.
This Employee Exclusion endorsement may substantially decrease insurance costs but may serve to bar coverage in the event the construction site accident stems from the performance of work by the subcontractor’s employees. This decision has unwanted repercussions for the owner/general contractor and the subcontractor, who pays the price when the entity that would ordinarily owe indemnification (the subcontractor/vendor) has a carrier that disclaims coverage, leaving the owner/general contractor more exposed than a 1970’s “streaker” at the Academy Awards program. An example follows.
What are the facts?
Jaime (Che) Gonzalez works for Red Star Enterprises (the Subcontractor and Named Insured) as a Union Laborer engaged in construction activities. Jaime had been working on the construction site since 7:00 am that day but had bent down to retrieve his COVID-19 N-95 mask before going to take a lunch break off-site. While doing so, his hard hat fell off. The next instant, he was clobbered by falling rubble or debris—honest, you can’t make this up! Jaime allegedly sustained severe injuries at this construction site, owned and operated by Good Hearts, a not-for-profit agency in Brooklyn (the Owner). Jaime was examined at the scene by first responders and removed by ambulance to a hospital for further treatment. Three and a half months later, a lawsuit was filed on Jaime’s behalf by a well-known local attorney against the property owner, Good Hearts, and the general contractor, GenCon.
Good Hearts and GenCon sought defense and indemnity from Red Star, but unfortunately the Red Star policy contained an Employee Exclusion. While it covered executive supervision, shoring, excavation, foundation, concrete superstructure and debris removal, it specifically excluded claims arising out of injuries to employees of the named insured, including claims for contribution, indemnity and sharing made by others. The policy/disclaimer letter specifies:
“This insurance does not apply to any obligation of any insured to indemnify or contribute with another because of damage arising out of the bodily injury” for injury to any employee of the named insured, or anyone acting on its behalf.
. . . .
"This exclusion applies to all claims by any person or organization for damages because of such bodily injury, including damages for care and loss of services.”
Those policies may also amend the definition of “insured contract” to remove indemnity agreements from the definition. When that occurs, the “insured contract” exception to the contractual liability exclusion does not restore coverage for those claims.
Because the claim arises from Gonzalez, an employee of Red Star, while performing construction work at the premises, there is no coverage for Red Star for any claims by Gonzalez, and no coverage for any claims for contribution or indemnity by Good Hands and GenCon against Red Star. So, Good Hearts and GenCon have no avenue for contribution or indemnity from the responsible party and Red Star has no coverage for those claims either. Potential risk transfer opportunities are lost.
Is this permissible?
Now, as you may have already noticed, this insurance policy afforded to Red Star does not cover much. In fact, in all practicality, it only covers non-employees injured at the premises as a result of the insured’s work. Coverage would be applicable to, for example, employees of other contractors and/or building inspectors at the premises injured by the subcontractor’s negligence. It is due to these narrow instances where coverage would apply that this exclusion has been permitted. Since, despite this wide exclusion, the policy would provide coverage for some acts, the exclusion has been determined to be valid under prevailing case law. See, for example, Lend Lease (US) Const LMB Inc. v. Zurich Am. Ins. Co., 28 N.Y. 3d 675 (2017); North River Ins. Co. v. United National Ins. Co., 81 N.Y.2d 812, 595 N.Y.S.2d 377 (1993).
Other, similar exclusions might provide even greater coverage restrictions.
What are the benefits of proper coverage?
There are numerous benefits to having your contractor/sub-contractor maintain an insurance policy that affords proper coverage and does not include an employee exclusion. First and foremost, it affords you peace of mind and establishes an effective risk transfer opportunity. Anything that happens on site as a result of your contractor/sub-contractor’s work can be promptly tendered to the appropriate party and your defense and indemnification should be picked up by their insurance carrier without complaint. Additionally, your insurance policy will not be made the primary policy affording coverage. As such, the possibility of a premium increase is reduced. Finally, in the event your policy does not afford coverage, for whatever reason, there is further insulation of your assets by your contractor’s/sub-contractor’s insurance policy.
Is there a simple solution to this unwanted surprise?
Yes. Each owner or general contractor should have a procedure in place to review the insurance policies of its various subcontractors and vendors to make sure that the Payroll Exclusion rider has NOT been elected. However, there are likely costs associated with any such inquiry and demand for coverage, as it is reasonably foreseeable that the subcontractor/vendor will not choose to absorb the additional overhead (premium cost), thus passing on its costs to you in the form of a higher contract price. It is difficult to estimate, without further facts and information, the actual additional annual premium costs attributable to this enhanced coverage as the premiums in policies vary so greatly based on the size of the insured, the scope of work to be insured, the size of the job, the number of a subcontractor’s laborers, etc.
What each owner/contractor must determine in advance of commencing a project is whether ignoring this potential problem is worth it. Is the risk of being unable to benefit from risk transfer opportunity worth the elevated project costs? This is, of course, an individual business decision and will depend on your risk tolerance.
Our advice? Think ahead! Don’t wait to do this calculation until you receive the disclaimer letter and begin to incur out-of-pocket costs until your self-insured retention is satisfied and/or exceed your primary insurance policy limits and eat into your excess, or worse!!