Navigating Performance Bonds, Subcontractor Default, and CGL - - PowerPoint PPT Presentation

The audio portion of the conference may be accessed via the telephone or by using your computer's

• speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

Presenting a live 90-minute webinar with interactive Q&A

Navigating Performance Bonds, Subcontractor Default, and CGL Coverage for Defective Workmanship and Property Damage

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, DECEMBER 13, 2016

Michele Leo Hintson, Esq., Partner, Shumaker Loop & Kendrick, LLP, Tampa, Fla. Kirk D. Johnston, Partner, Smith Currie & Hancock, Atlanta Michael S. McNamara, Partner, Pillsbury Winthrop Shaw Pittman, Washington, D.C.

Tips for Optimal Quality

Sound Quality If you are listening via your computer speakers, please note that the quality

• f your sound will vary depending on the speed and quality of your internet

connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-871-8924 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

FOR LIVE EVENT ONLY

Continuing Education Credits

In order for us to process your continuing education credit, you must confirm your participation in this webinar by completing and submitting the Attendance Affirmation/Evaluation after the webinar. A link to the Attendance Affirmation/Evaluation will be in the thank you email that you will receive immediately following the program. For additional information about continuing education, call us at 1-800-926-7926

• ext. 35.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

Navigating Performance Bonds, Subcontractor Default, and CGL Coverage for Defective Workmanship and Property Damage

Presented by: Michele Leo Hintson Kirk D. Johnston Michael S. McNamara

Performance Bonds and CGL Coverage

Michele Leo Hintson Shumaker, Loop & Kendrick, LLP Mhintson@slk-law.com.com 813.227.2338

6

INTRODUCTION

• Background and Experience
• Goals for Today

7

THE TYPICAL CASE

• Surety issues performance and payment bond on a Project
• Certificate of Occupancy issued
• Notice of potential construction defect is sent to surety
• Surety determines through investigation that poor

workmanship attributable to the principal and its subcontractors

• Lawsuit is filed against Surety, principal and its Subcontractors
• Surety begins strategic plan regarding its avenues of recovery

8

THE SURETY BOND V. INSURANCE

What is “Bonded and Insured”

9

THE SURETY BOND V. INSURANCE

• The Underlying Agreement or Contract

― Insurance ― Business risk management tool ― Only a Two party contract ― The Carrier pays that loss which is covered under the Policy ― Surety Performance Bond ― At least a three party agreement (the “tripartite” relationship) ― Issued by the Surety on behalf of the Principal ― The Bond insures completion of the Project ― The construction contract is usually incorporated by reference

10

THE SURETY BOND V. INSURANCE

• The Security Provided by Each Instrument

― Insurance ― Protects the Insured against risk of accidents ― Performance Bond ― Protects the obligee against a default

• f the principal

11

THE SURETY BOND V. INSURANCE

• The “Money”

― Insurance ― premium paid is formulated to cover potential losses and the risk associated with such losses ― Performance Bond ― premium is paid to guarantee that the principal satisfies its obligations afforded under the Contract

12

THE SURETY BOND V. INSURANCE

• The Risk

― Insurance ― Losses are just “part of the business” ― Rates are adjusted to cover the forecast of loss ― Performance Bond ― Losses are not expected and bonds are issued only in theory to those whose risk of a default is low ― Sureties can seek recovery from the principal and indemnitors as a result of the loss (the “GAI”)

13

THE SURETY BOND V. INSURANCE

• Claims

― Insurance ― Claims must be covered by policy, and exclusions exist that preclude coverage ― Carrier does not expect payment by insured ― Performance Bond ― Contract and Bond form define coverage (completion) ― payment expected by principal

14

THE SURETY BOND V. INSURANCE

Florida Specific Issues  Bad Faith Claims  Attorneys’ Fees

15

THE SURETY BOND V. INSURANCE

• The “Duty to Defend”

― Unique to Insurance ― Implications for Surety if Principal Not Defended

• Elements

― Florida follows “Eight Corners Rule” ― If there is question of coverage, insurer must defend an entire suit ― Insured required to defense even if true facts later show no coverage ― All doubts as to coverage resolved in favor of insured

16

THE SURETY BOND V. INSURANCE

• The “Duty to Indemnify”

― Must determine when “property damage” “occurs” under the policy to “trigger coverage” ― Florida is in flux as to when coverage is triggered ― Manifestation Theory (when the damage first manifests itself) ― Injury in fact (when the property damage actually occurs)

17

THE SURETY BOND V. INSURANCE-THE SURETIES RIGHTS AS

AN ASSIGNEE AND SUBROGEE OF ITS PRINCIPAL

• When a surety sustains a loss, it stands in the shoes of its principal
• A surety may obtain standing to sue its principal’s CGL carrier either

as an “assignee” or “equitable subrogee”, or both ― Surety has been found to have claims as a first party claimant under policy

• Subrogation arises when a surety paid a judgment for the principal’s

wrongs or towards a settlement to resolve the claims of the principal

• Courts have held that if a principal has a right to a defense against

an obligee’s claim, the surety also by law benefits from such a defense

18

POTENTIAL AVENUES OF RECOVERY BY THE SURETY

AGAINST A CGL CARRIER

• Equitable Subrogation
• Assignment
• Contractual Indemnity
• Additional Insured Status

19

POTENTIAL AVENUES OF RECOVERY BY THE SURETY

AGAINST A CGL CARRIER

• Equitable Subrogation

― Little case law authority ― Western Word Ins. Co., Inc. v. Travelers

• Indem. Co., 358 So. 2d 602 (Fla. 1st DCA

1978) ― Difficult avenue for surety based upon lack of case law

20

POTENTIAL AVENUES OF RECOVERY BY THE SURETY

AGAINST A CGL CARRIER

• Contractual Indemnity

― Case law supports a surety recovery under this theory ― Indemnity Obligation commonly falls within the definition

• f “insured contract”

― Merrick Const. Co., Inc. v. Hartford Fire Ins. Co., 449 So.2d 85 (La. App. Ct. 1984) ― Spirco Environmental, Inc. v. American Int’l Spec. Lines Insur., 555 F .3d 637 (8th Cir. 2009)

21

POTENTIAL AVENUES OF RECOVERY BY THE SURETY

AGAINST A CGL CARRIER

• Assignment

― “Anti-Assignment” clause in CGL policies ― Basic tenant of Florida law that the policyholder may freely assign post-loss insurance claims, even with such a clause ― Lack of specificity of assignment ― Prior courts found that GAI assignments do not constitute an assignment of rights of the principal to sue its CGL carrier for insurance coverage (specifically as it relates to recovery

• f its attorneys’ fees)

22

POTENTIAL AVENUES OF RECOVERY BY THE SURETY

AGAINST A CGL CARRIER

• Additional Insured Status

― Surety generally will not be considered “additional insured” under principal’s policy ― If principal was required to be additional insured under subcontractor policy, may have avenue of recovery against subcontractor CGL policy

23

BEST PRACTICES AND POINTERS FOR SURETIES/PRINCIPALS UPON RECEIPT OF POTENTIAL CLAIM

• Perform coverage analysis early

― Use books and records rights to get all applicable policies and certificates of insurance ― Request information about subcontractors’ Insurance ― Put carrier on notice immediately

24

BEST PRACTICES AND POINTERS FOR SURETIES/PRINCIPALS UPON RECEIPT OF POTENTIAL CLAIM

• Conduct a Factual Investigation

― Is there still coverage under the Bond? ― Is there an occurrence? ― Is this limited to defective workmanship? ― Is there property damage? ― Are there ongoing operations at the site?

25

CGL Coverage for Defective Workmanship and Property Damage

Kirk D. Johnston Smith, Currie & Hancock LLP kdjohnston@smithcurrie.com 404.582.8052

26

Parts of the CGL Policy

• Declarations
• Insuring Agreement
• Exclusions
• Exceptions
• Definitions
• Endorsements

27

Declarations

28

Insuring Agreement

• Scope of Coverage

“We will pay those sums that the insured becomes obligated to pay as damages because of bodily injury or property damage to which this insurance applies…”

29

Insuring Agreement

• When is the policy “applicable”

“This insurance applies to … property damage only if the … property damage is caused by an occurrence …”

30

Occurrence

• Policy defines an occurrence as an “accident”
• No definition for accident
• Courts define accident as an “unexpected happening”

31

Faulty Workmanship

• Accidental?
• Two conflicting statements of absolute truth
• Trends in case law

32

State of the Union

• The “occurrence” debate has, for the most part, been

resolved. ― Most courts now recognize and apply the “subcontractor exception” to exclusion l and recognize its intended effect. ― More jurisdictions are applying j(5) and j(6) in a manner that gives effect to the “that particular part” language.

33

Is Faulty Workmanship an Occurrence, i.e., Accidental?

34

Alabama Arizona Arkansas California Colorado Florida Georgia Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming Connecticut Delaware Maryland New Jersey Rhode Island

No - Cases/Statute Unclear – Conflicting Cases/Statute Yes - Supreme Court or Statute Yes - Lower Court or Federal Court No - Supreme Court No - Lower Court or Federal Court

Hawaii Alaska

The Crux of the Debate

• A difference exists between a claim for:

The cost of repairing or removing defective work and The costs for repairing damage caused by the defective work

35

Property Damage

• Physical Property Damage

― Tangible ― Capable of seeing or touching

• Intangible Property Damage

― Loss of Use

36

What has to be Damaged?

• Insured’s Own Work vs Other Work vs Third-Party Property
• Traditional View: Damage must occur to third-party property
• Emerging Middle Ground …

― Defective work itself, even if physically damaged, is not “property damage” ― Damage to otherwise non-defective part of the project, i.e., “other work” can constitute “property damage” ― Damage to insured’s “own work” can constitute “property damage”

37

Jurisdictional Trends

38

• Ark. Code Ann. §23–79–155

A commercial general liability insurance policy offered for sale in this state shall contain a definition of “occurrence” that includes: (1) Accidents, including continuous or repeated exposure to substantially the same general harmful conditions; and (2) property damage or bodily injury resulting from faulty workmanship.

(Effective July 27, 2011)

Jurisdictional Trends

39

• S.C Code Ann. § 38–61–70

Commercial general liability insurance policies shall contain or be deemed to contain a definition of “occurrence” that includes: (1) an accident, including continuous or repeated exposure to substantially the same general harmful conditions; and (2) property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself.

(Effective May 17, 2011)

Business Risk Exclusions

40

• Real Property - Exclusion (j)(5)
• Performance of Work - Exclusion (j)(6)
• Your Work - Exclusion (l)

Real Property Exclusion j(5)

41

“That particular part of real property on which you or any contractor … working … on your behalf are performing operations, if the property damage arises out of those operations…”

• Excludes …

― Particular part of workmanship

• Only applicable to ongoing operations

― Temporal element

Real Property Exclusion j(6)

42

“That particular part of any property that must be restored, repaired or replaced because your work was incorrectly performed on it… Does not apply to property damage included in the products-completed operations hazard.”

• Products completed operations hazard

― Temporal element

Your Work Exclusion (l) (Two Critical Parts)

43

• Exclusion

“Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

• Exception

“This exclusion does not apply if the damaged work or the work

• ut of which the damage arises was performed on your behalf by

a subcontractor.”

Subcontractor Exception (History)

44

• Prior to 1976

― No coverage arising out of “your work” regardless if subcontractor involved

• 1976 – BFPD Endorsement

― Coverage arising out of “your work” performed by subcontractor

• 1986 – BFPD added for form policy
• 2006 – Endorsement to form policy

― Excluding coverage arising out of “your work” performed by subcontractor

Your Work Exclusion (l) (Two Critical Parts)

45

• Exclusion

“Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

• Exception

“This exclusion does not apply if the damaged work or the work

• ut of which the damage arises was performed on your behalf by

a subcontractor.”

Damage to Work Performed by Subcontractors (CG 22 94)

46

Damage to Work Performed by Subcontractors (CG 22 95)

47

Contractual Liability Coverage

• Coverage for indemnity obligation

Exclusion Exception to Exclusion

48

Contractual Liability

(CG 21 39)

• The definition of

an “insured contract” is modified by removing subparagraph f.

• No coverage for

indemnity

• bligation

49

• Immediately
• Conditions Precedent to Coverage

Notice Requirements

“You must see to it that we are notified as soon as practicable of an ‘occurrence’ or an

• ffense which may result in a claim.”

50

Subcontractor Default Insurance

Michael S. McNamara Pillsbury Winthrop Shaw Pittman michael.mcnamara@pillsburylaw.com 202.663.9386

51

Subcontractor Default Insurance

Subcontractor Default Insurance vs. Subcontractor Performance Bonds

• What is default insurance?
• A blanket policy that indemnifies the contractor (insured) from a loss

incurred as a result of default by an enrolled subcontractor or supplier on a project.

• It provides an alternative to subcontractors providing payment and

performance bonds to guarantee subcontract performance.

• Who sells default insurance?
• Zurich has been in the market the longest
• Arch and XL are now established as well

52

Subcontractor Default Insurance

• Performance bonds involve a three-party relationship
• Subcontractor negotiates surety line
• GC pays subcontractor for bonds and limits of coverage (typically

the subcontract amount)

• Defaulted subcontractor’s surety negotiates claim with GC
• Surety’s customer is defaulted subcontractor – not the GC
• In many states, GC must default terminate the subcontractor to

trigger coverage

• Even under AIA forms, scope of coverage varies from state to

state

53

Subcontractor Default Insurance

Subcontractor Default Insurance only involves a two-party relationship

• GC negotiates coverage with SDI carrier
• GC pays carrier directly for insurance
• Carrier indemnifies insured GC for covered Loss
• While default of performance under the subcontract dictates

coverage, subcontractor is not a party to the insurance transaction

• Payment 30 days from adequate proof of loss
• Coverage applies through statutory periods
• Retro premiums

54

Subcontractor Default Insurance

Subcontractor Default Insurance vs. Surety Bond -- Pros

• The insured contractor has greater control
• Controls subcontractor qualification
• Controls subcontractor selection
• Controls which jobs are covered
• Enhanced protection
• Coverage for certain Soft Costs (“Indirect Costs” subject to limit)
• Coverage extends to statute of repose

55

Subcontractor Default Insurance

Subcontractor Default Insurance vs. Surety Bond -- Pros

• Profit Potential
• The dual premium structure (a fixed rate plus a variable rate)

rewards successful management

• Good risk management and loss control can result in a return of

variable premium.

• Bond premiums cannot be recaptured.
• With strong subcontractor pre-qualification and adequate

volume, can become self-funding

56

Subcontractor Default Insurance

Subcontractor Default Insurance vs. Surety Bond -- Cons

• Contractor will incur additional overhead costs
• Qualification and risk management
• Billing and reporting
• Deductible and co-payment obligations apply where subcontractor

defaults

• Subcontractor pre-qualification program (but should be done in

any case.)

57

Subcontractor Default Insurance

Insured Contractor Responsibilities

• The insured contractor must qualify all subcontractors covered by the

policy

• The insured contractor is responsible for managing the risk covered by

the policy

• Subcontractor default insurance is best suited to use on negotiated

projects where selection of subcontractors is based on qualification rather than the low responsive bid

• The contractor has a responsibility to report subcontractor enrollment

to the broker/carrier

• The contractor must cooperate with the carrier’s Risk Engineers

58

Subcontractor Default Insurance

Other tips for those considering buying subcontractor default insurance for the first time

• Careful subcontractor pre-qualification is critical; do not use SDI as a

vehicle to cover subs who cannot obtain traditional bonds (and thus are a significant default risk)

• SDI offers the ability to accumulate retro premiums over time in

excess of the cost of the program if sufficient subcontractor volume is run through the program

• SDI allows for a quicker recovery in the event of a default BUT
• Care must be taken to timely identify and declare a material

“default” as defined by the Policy

59

Subcontractor Default Insurance

Other tips for those considering buying subcontractor default insurance for the first time

• Carefully document damages flowing directly from the default – set

up separate cost codes

• SDI insurers require very detailed documentation to justify the

reimbursement of costs incurred – but it is typically documentation that is available – detail and patience

60

Subcontractor Default Insurance

Other tips for those considering buying subcontractor default insurance for the first time

• An SDI policy is a reimbursement policy – costs must be expended and

proven before reimbursed

• promises to pay or contingent costs will create problems and may

go unreimbursed

• be mindful of how costs are bucketed for purposes of

reimbursement – direct costs typically subject to overall policy limit

• Indirect costs are sub-limited
• Protect SDI insurer’s subrogation rights – monies recovered by SDI

insurer replenish policy limits

61

Subcontractor Default Insurance

Case study

• Interplay between SDI and CGL coverage for business risk exclusions:
• Pavarini Constr. Co. (SE), Inc. v. ACE Am. Ins. Co., 161 F

. Supp. 3d 1227 (S.D. Fla. 2015)

62

Thank You

Questions?

Presented by: Michele Leo Hintson Kirk D. Johnston Michael S. McNamara

63