INSURANCE COVERAGE FOR CONTRACTUAL LOSS
SHIFTING OBLIGATIONS

Secura Claims Seminar
September 11, 12, and 13, 2006
Fox Hills Resort, Mishicot, Wisconsin

INDEMNITY OBLIGATIONS IN LITIGATION

The problem presented for this seminar offers interesting issues as to the defense and indemnity obligations presented. The contracts and insurance provisions cast some light on those issues, and the problem itself offers some things to watch for in similar cases.

In the problem presented, the property owner was Heritage Management. Heritage Management arranged with your insured, La Rosa Landscaping, to provide snow plowing services. A certificate of insurance was issued naming Heritage Management as an additional insured under the La Rosa Landscaping policy.

Initially, it appears relatively clear that Secura is obligated to defend and indemnify its insured, La Rosa, for this loss. However, before making that determination, a quick review of both the policy of insurance and the plaintiff's complaint are required. The La Rosa policy would be required chiefly to make sure that the date of loss was during the policy term.

A review of the Complaint also would be required. First, given the fact that this is a personal injury action, we can assume that the Complaint alleges negligence. However, in some cases the Complaint may allege either a breach of contract or intentional conduct. In those circumstances, coverage may potentially be denied. Instance such as those are rare but nonetheless do arise and as such a review of the Complaint is necessary.

I. Coverage for Heritage Under the La Rosa Policy

Although coverage for La Rosa appears relatively free from doubt, coverage for Heritage would appear to be more problematic. The initial Claim Scenario mentioned a "contract" only and did not specify whether there was a written contract that would require the named insured to add the purported additional insured to the policy.

That fact pattern alone might not necessitate coverage under the La Rosa policy. As discussed below, the Secura T-Series wrap requires a written contract. Second, in most states the Certificate of Insurance alone will not grant coverage. That Certificate is for information only and where the Certificate is in conflict with the policy, the policy will control.

If it can be established that Heritage would qualify as an additional insured, then the question would be raised as to whether the Secura policy would be primary and non-contributory.

Finally, we would also then be left with issues as to whether the indemnity provision in the Heritage/La Rosa contract would be enforceable.

To determine whether a policy of insurance provides coverage, it is necessary to compare the allegations of the Complaint to the terms of the policy of insurance. State Farm v. Acuity, 280 Wisc. 2nd 624, 695 N.W.2d 883 (Wisc. App. 2005). In Illinois, the basic rules for determining whether there is a duty to defend were set forth by the Illinois Supreme Court in United States Fidelity & Guaranty Co. v. Wilkin Insulation Co., 144 Ill.2d 64, 73-84, 161 Ill.Dec. 280, 284, 578 N.E.2d 926, 930 (IL 1991):

To determine an insurer's duty to defend its insured, the court must look to the allegations of the underlying complaints. If the underlying complaints allege facts within or potentially within policy coverage, the insurer is obliged to defend its insured even if the allegations are groundless, false, or fraudulent. An insurer may not justifiably refuse to defend an action against its insured unless it is clear from the face of the underlying complaints that the allegations fail to state facts which bring the case within, or potentially within, the policy's coverage. Moreover, if the underlying complaints allege several theories of recovery against the insured, the duty to defend arises even if only one such theory is within the potential coverage of the policy.

In order to evaluate coverage, the first matter to be determined is whether the purported additional insured was ever added to the Secura policy under a CG 2010 endorsement. That form is a "scheduled" additional insured endorsement which specifically lists certain organizations as additional insureds under the policy.

As a practical matter that is not often done. Instead, additional insureds usually qualify under a "blanket" endorsement. As a result, in most cases the question will be whether the purported additional insured will qualify under a "blanket" endorsement such as the endorsement found in the Secura T-Series Wrap.

That endorsement expands coverage to additional insureds as follows:

G. ADDITIONAL INSURED BY CONTRACT

1. With respect to SECTION I - COVERAGE A. BODILY INJURY AND PROPERTY DAMAGE LIABILITY, Section II - Who Is An Insured is amended to include as an insured any person for whom you are performing operations when you and such person or organization have agreed in writing in a contract or agreement that such person or organization be added as an additional insured on your policy. Such person or organization is an additional insured only with respect to liability arising out of your ongoing operations performed for that insured. A person's or organization's status as an insured under this endorsement ends when your operations for that insured are completed.

That endorsement has two major requirements:

1. There must be a written contract requiring additional insured status; and

2. The coverage must arise out of the named insured's ongoing operations for the additional insured.

In this case, the language of the contract between Heritage and La Rosa clearly requires that La Rosa be added as an additional insured and as such the first requirement has been met. That leaves the question of "arising out of."

In interpreting the "arising out of" language, courts will impose a "but for" test, i.e. there is coverage where there would not have been an injury but for the involvement of the named insured. The phrase has been interpreted to be both broad and vague and must be liberally construed in favor of the insured. Maryland Cas. v. Chicago and Northwestern, 126 Ill.App.3d 150, 466 N.E.2d 1091, 81 Ill.Dec. 289 (1984). "But for" is required, while "proximate cause" is not. Id. Coverage is not limited to situations where the named insured was negligent. J.A. Jones Construction v. Hartford, 269 Ill.App.3d 148, 645 N.E.2d 180, 206 Ill.Dec. 728 (1st Dist. 1995).

Illinois courts interpret the "arising out of "language to mean "originating from," "having its origin in," "growing out of," and "flowing from." Shell Oil Company v. AC&S, Inc., 271 Ill.App.3d 898, 906, 649 N.E.2d 946, 952, 208 Ill.Dec. 586, 592 (5th Dist. 1995). Shell involved a pipe insulator who slipped and fell at the defendant's premises while employed by AC&S. The Court found since the plaintiff was there due to his employment, the "but for test" was satisfied and the injury arose from the work of AC&S (See Also Liberty Mutual v. Westfield Ins., 301 Ill.App.3d 49, 703 N.E.2d 439, 234 Ill.Dec. 548 (1st Dist. 1998), American States v. Liberty Mutual, 291 Ill.App.3d 336, 683 N.E.2d 510 (1st Dist. 1997) (But See Cincinnati Insurance v. Dawes Rigging, 321 F.Supp.2d 975 (C.D. IL 2004) (employment alone not sufficient).

Where insurers have limited the scope of the additional insured endorsement, Illinois courts have upheld the limitation. In American Country v. McHugh, 344 Ill.App.3d 960, 801 N.E.2d 1031, 280 Ill.Dec. 86 (1st Dist. 2003), the additional insured endorsement contained the following exclusion:

(2) Additional exclusions. "This insurance does not apply to: * * * (c) 'Bodily Injury' or 'property damage' arising out of any act or omission of the additional insured(s) or any of their employees."

The Court found that exclusion to be non-illusory, despite the fact that it limited the scope of the additional insured endorsement to cases of vicarious liability. As a result, if Secura was to dramatically limit the scope of its endorsement, it is likely that the Illinois Department of Insurance would accept that modification and that Illinois courts would enforce it.

II. Determining Which Policy Will Be Primary

A. Non-Illinois Rules

Upon determining that the Secura policy might provide coverage to Heritage, the next step would be to determine whether that loss can be shared with another insurer. Doing so requires the comparison of the "other insurance" provisions in the respective policies. Hansen v. Degnitz, 283 Wis. 2d. 455, 701 N.W.2d 77 (Wis. 2005). Typically, each policy provides that it is primary in most cases. In such a scenario, the policies are considered mutually repugnant and each insurer is to share the loss. However, in other circumstances a comparison may reveal language clearly making one policy primary and the other excess. As a result, it is good practice to attempt to obtain copies of any other insurance policies potentially providing coverage for the loss.

B. Illinois and "Targeted Tenders"

Illinois has unusual rules for deciding between primary and excess. The key construction litigation issue facing insurers doing business in Illinois concerns what has become known as the "targeted tender." Typically, a general contractor on a construction project will be covered under its own Commercial General Liability policy. In addition, the general contractor will be named as an additional insured under the CGL policies of each sub-contractor. In such a situation, the insured, along with the insured's own CGL carrier, will attempt to shift the loss to the CGL policy of the sub-contractor. Under certain circumstances, Illinois now allows the contractor to do so by means of the targeted tender.

In allowing the insured to target a tender to one insurer instead of another, Illinois courts have relied upon "strong public policy." Those cases allowing the targeted tender have almost always involved primary policies covering construction operations. Interestingly, Illinois courts, in a second string of cases, have found that "strong public policy" bars an insured from choosing among potential excess insurers.

Under Illinois law, the discussion of which policies can cover to a loss hinges on whether the policies have been "triggered" or "activated." As a result, in analyzing the potential for loss shifting the first question to be addressed is whether the policies have been triggered at all. The next question to be addressed will be whether the policy of insurance, once activated, can be "de-activated." Finally, a third scenario has now emerged in which an insured who, through means of the targeted tender de-activated a policy, will seek to re-activate the policy once it appears that the loss will exceed the policy limits of the targeted insurance policy.

Where an insured is covered by multiple policies, Illinois law allows the insured to tender the claim to one insurer, and to advise the other insurer not to participate in the defense. John Burns v. Construction Co. v. Indiana Insurance Co., 189 Ill.2d 570, 727 N.E.2d 211, 244 Ill.Dec. 912 (2000). Illinois Courts have analyzed the procedure in terms of "tender" or "trigger," finding that by advising the insurer not to participate, the insured has "de-activated" any tender.

The Illinois Supreme Court found that the contractor had a right to choose which insurer would be required to defend and indemnify it. John Burns. at Ill.2d 574, N.E.2d 215, Ill.Dec. 916. An insured has a right to "knowingly forgo the insurer's assistance by instructing the insurer not to involve itself in the litigation." Id at Ill.2d 575, N.E.2d 215, Ill.Dec. 916, quoting from Cincinnati Companies v. West American, 183 Ill.2d 317, 233 Ill.Dec. 649, 701 N.E.2d 499 (1998). The Court further ruled that the chosen insurer could not seek equitable contribution from other carriers. Burns at Id. In so ruling, the Court found that the insured's own policy was not "available" under the terms of the policy. Id. Since the coverage was not "available", the other insurer could not invoke the "other insurance" clause to seek equitable contribution.

Given the approval of the Illinois Supreme Court of the "targeted tender" strategy, the next issue will become whether the actions of the insured actually constitute a "targeted tender." Unfortunately, to date, Illinois courts have provided little guidance on that issue. In the few decisions on point, the courts have looked for notification to an insurer that the insured would look solely to one insurer for defense. Dearborn at Ill.App.3d 374, N.E.2d 1097, Ill.Dec. 694. The insured must express the desire that one insurer provide the exclusive defense and coverage. Id. Where an insured advised the insurer that it did not "need to take an active role unless, of course, your claims people disagree" the Illinois Appellate Court ruled that there had been no Burns tender. Id. The Court found that the insured did not provide a clear direction not to defend. Id.

In ruling on John Burns issues, courts have looked to two Illinois Appellate decisions that pre-date the John Burns decision. In Institute of London Underwriters v. Hartford, 234 Ill.App.3d 70, 599 N.E.2d 1311, 175 Ill.Dec. 297 (1st Dist. 1992), the insured notified Hartford of the claim, but "unequivocally stated that Hartford should not respond to the loss." Institute at Ill.App.3d 74, N.E.2d 1313, Ill.Dec. 299. The Court went on to find that where coverage has not been triggered, the "other insurance clause" of the respective policies do not come into play. Id. at Ill.App.3d 77, N.E.2d 1315, Ill.Dec. 301. As such, where coverage has not been triggered, it is not applicable to the loss and in such situation, a co-insurer cannot seek equitable contribution. Id. at Ill.App.3d 78, N.E.2d 1316, Ill.Dec. 302.

A second case that foreshadowed John Burns is Bituminous Casualty Corp. v. Royal Insurance Group, 301 Ill.App.3d 720, 722, 704 N.E.2d 74, 76, 234 Ill.Dec. 916, 918 (3rd Dist. 1998). In that case, the [additional] insured sought coverage from Bituminous only, and advised Royal Insurance that it was to remain on notice as an excess carrier only. The Court ruled that in such a situation, Royal was "effectively relieved of its obligation with regard to the lawsuit." Bituminous at Ill.App.3d 724, N.E.2d 78, Ill.Dec. 920.

Once an insurer is chosen, the insured has the right to deactivate that tender. Alcan United v. West Bend Mutual, 303 Ill.App.3d 72, 83, 707 N.E.2d 687, 694, 236 Ill.Dec. 560, 567 (1st Dist. 1999), Richard Marker at Ill.App.3d 1143, N.E.2d 1082, Ill.Dec. 926. That deactivation can take place even after a settlement is reached by another insurer. Richard Marker at Ill.App.3d 1143, N.E.2d 1082-1083, Ill.Dec. 926-927. In Richard Marker, Marker initially tendered the defense to Pekin Insurance, which refused the tender. Id. at Ill.App.3d 1139, N.E.2d 923, Ill.Dec. 1079. Marker later tendered the defense to Statewide Insurance. Id. Subsequently, after the underlying case had been settled, Marker withdrew the tender to Statewide, and pursued Pekin only. Id. The Court found that Marker was able to withdraw the tender to Statewide even after the settlement of the underlying case.

Similarly, in Alcan United v. West Bend Mutual, at Ill.App.3d 76, N.E.2d 690, Ill.Dec. 563, West Bend argued that, since Alcan initially tendered its defense to both West Bend and Reliance, both policies were triggered and both would provide coverage. That Court found the insured's right to choose to be a "paramount right." Id. at Ill.App.3d 80, N.E.2d 693, Ill.Dec. 566. The Court ruled that an insured should be able to deactivate coverage previously selected for purposes of invoking exclusive coverage with another carrier. Id. at Ill.App.3d 83, N.E.2d 695, Ill.Dec. 568.

The Richard Marker and Alcan United decisions would appear to give an insured wide ranging authority with regard to tender. An insured can hypothetically use his insurers like a basketball coach uses his bench. The insured can anoint one insurer as the "starter." If the insured then wants a different defense, the insured can go to his bench and appoint another insurer half way through the litigation. After the result is achieved, the insured can deactivate the second insurer and point to the first insurer for indemnity. We note that if a court seeks to limit this authority by the insured, the court may limit Richard Marker to situations where the initial chosen insurer declines coverage.

In the above-cited cases, the insurers were pursuing coverage from other insurers under a theory of "equitable contribution." Under that theory, an insurer can pursue other insurers for contribution for amounts paid to defend and indemnify a mutual insured. See Cincinnati v. West American at Ill.2d 323, N.E.2d 502, Ill.Dec. 652. Before an insurer can look to the "other insurance" clause and obtain equitable contribution, multiple policies must be triggered by the insured. Richard Marker at Ill.App.3d 1141, N.E.2d 1081, Ill.Dec. 925 (2nd Dist. 2001).

The holding of John Burns was significant mainly because it prevented one insurer, who had paid a claim, from invoking its policy's "other insurance clause" in order to obtain contribution from another insurer. According to Chicago Hospital Risk Pooling Program v. Illinois State Medical Inter-Insurance Exchange, 325 Ill.App.3d 970, 976, 758 N.E.2d 353, 357, 259 Ill.Dec. 230, 234 (1st Dist. 2001), "other insurance" clauses only affect insurers rights among each other. The clauses do not affect the insured's right to recover under concurrent policies. As the cases note, where the policy, through a John Burns tender, has not been activated, or triggered, it is not "available" under the other insurance clause.

The concept of the targeted tender becomes more complicated when it is applied in the context of a loss that goes beyond the policy limits of a single primary policy. Illinois courts have yet to decide whether, in such circumstances, the insured can target an excess policy issued to another contractor, or must first exhaust its own CGL policy. It is in this discussion that the public policy basis for these decisions become apparent, and also becomes clearly contradictory.

The common understanding of Illinois law is that it requires "horizontal exhaustion" of policies. That term refers to the rule that an insured first must exhaust its primary policies before seeking indemnification from its excess policies. That requirement was explained in the U.S. Gypsum case and the case of Maremount Corporation v. Continental Casualty Co., 326 Ill.App.3d 272, 760 N.E.2d 550, 260 Ill.Dec. 133 (1st Dist. 2001), discussed below. It is our opinion that the John Burns decision has cast some doubt on the horizontal exhaustion rule in Illinois law. We believe that Illinois law may now allow an insured to first seek defense and indemnification from certain chosen primary insurers, while ignoring other policies, and then to seek indemnification from certain excess policies, while ignoring other primary and excess insurers. We must point out that this is our reading of the logical direction of Illinois law following the John Burns decision, and that no Illinois court has yet accepted or rejected the argument in this context.

Due to the nature of the claims presented, issues over the priority of excess policies have usually been litigated in environmental or toxic tort cases. In Illinois, a leading case concerning the priority of primary, as opposed to excess policies, is the U.S. Gypsum decision. That decision pre-dated both Cincinnati v. West American and John Burns. The case involved property damage due to exposure to asbestos. The policies where issued between the 1930s and 1984. U.S. Gypsum at Ill.App.3d 602, N.E.2d 1229, Ill.Dec. 622. During some of the years at issue, U.S. Gypsum was covered by "fronting" primary insurance in which U.S. Gypsum effectively made U.S. Gypsum self-insured on a primary level. Id. at Ill.App.3d 652, N.E.2d 1260, Ill.Dec. 653. U.S. Gypsum sought to be allowed to reach the excess policies after exhausting only one of its primary policies. Id. at Ill.App.3d 653, N.E.2d 1261, Ill.Dec. 654. In essence, U.S. Gypsum made a "targeted tender" and surprisingly decided against triggering what in effect is "self-insurance." As the Court pointed out, U.S. Gypsum was attempting to avoid the cost resulting from its position as a self-insurer. Id.

As in the John Burns decision, the U.S. Gypsum court examined the "other insurance" clauses in the policies, which required exhaustion of other insurance that is "available," but reached the opposite conclusion from the John Burns decision. The U.S. Gypsum Court noted with approval certain cases finding:

[A]ll [emphasis in original] primary policies must be exhausted before liability attached under a [emphasis added] secondary policy. Further, `liability under an excess policy will not attach until all [emphasis in original] primary insurance is exhausted, even if the total amount of primary insurance exceeds the amount contemplated in the secondary policy. Id. at Ill.App.3d 654, N.E.2d 1262, Ill.Dec. 655.

The U.S. Gypsum court's reasoning was directly contrary to the reasoning of the John Burns line of cases. While John Burns found that the insured has a "paramount right" to choose coverage, the U.S. Gypsum court found that the insured should have no such right. Instead, the court concluded:

Adopting Gypsum's position permitting `vertical exhaustion' would allow Gypsum to effectively manipulate the source of its recovery [emphasis added], avoiding difficulties encountered as the result of its purchase of fronting insurance and the liquidation of some of its insurers. This would permit Gypsum to pursue coverage from certain excess insurers at the expense of others. Such a practice would blur the distinction between primary and excess insurance [citation omitted] and would allow certain primary insurers to escape unscathed when they would otherwise bear the initial burden of providing indemnification. Id.

This reasoning by the U.S. Gypsum court is directly contrary to the John Burns reasoning. Of course, U.S. Gypsum is an Appellate Court decision which pre-dates the Illinois Supreme Court's decision in John Burns. However, in cases subsequent to John Burns, the Illinois Appellate Court has clung to the reasoning of the U.S. Gypsum decision. Most recently, the case was followed in Maremont. Similar to U.S. Gypsum, that case involved costs incurred over a forty year period to clean up a toxic chemical. Maremont at Ill.App.3d 273, N.E.2d 551, Ill.Dec. 134. The Maremont court adopted the reasoning of the U.S. Gypsum case, agreeing that an insured should not be allowed to manipulate the source of its recovery. Id. at Ill.App.3d 280, N.E.2d 556, Ill.Dec. 139. The court further pointed out that no Illinois court has spoken in favor of vertical exhaustion. Id.

We are left with a clear conflict in Illinois law, and importantly, a clear conflict over public policy. It is our opinion that perceived public policy is the driving force behind both lines of cases. In John Burns, that public policy gave the insured the right to manipulate coverage. In U.S. Gypsum and Maremont, public policy provided no such right. Simply put, the cases appear irreconcilable. Further complicating the matter is that the Illinois Supreme Court has had five new justices chosen in the past two years. The Court has not provided any guidance as to how it might rule, and has specifically declined to hear appeals on both the Richard Marker and the Maremont decisions.

Given the lack of guidance by the Illinois courts, both the insured and insurer must tread in dangerous waters. Where the case appears to be within the policy limits of a single policy of insurance, the answers seem clear. Strategically, the ideal way for both insurer and insured to approach these issues would be to have the insured, and counsel appointed to represent the insured, obtain all construction contracts. After identifying any sub-contractors that may potentially have played some role in the underlying accident, counsel must obtain all insurance policies and certificates issued to those sub-contractors. The insured, by its own officer or by counsel, must then tender the defense of the general contractor to each insurer named. That tender must specify that the insured intends to look solely to that insurer for defense and indemnity, and should state that the general contractor's own insurer has been put on notice only, but has been advised not to defend or indemnify the general contractor.

III. Impact of Accepting Defense Tender on Claim for Contribution

The acceptance of that tender may have additional consequence. In Illinois, where a party is contractually obligated to provide insurance to another party and does so, then the party to whom such coverage is provided cannot turn around and seek contribution from the first party. In our scenario, if Secura accepts the defense of Heritage under the La Rosa policy, Heritage then would be barred from seeking contribution from La Rosa. See Briseno v. Chicago Union Station Company, 197 Ill. App.3d 902, 557 N.E.2d 196 (1st Dist. 1990).

The reasoning behind this rule is based on the fact that an insurer cannot subrogate against itself. The facts of Briseno follow a common construction industry practice. In that case, the plaintiff’s decedent, Briseno, was employed by NWC. That company was a subcontractor to Chicago Union. As part of that subcontract, NWC paid for an insurance policy (provided by Bituminous Casualty Company) naming NWC as insured, and providing coverage to Chicago Union as an additional insured. After suit was filed, Bituminous accepted a tender of defense from Chicago Union. Attorneys for Chicago Union then filed a Third Party Complaint against NWC.

After Briseno and Chicago Union settled their lawsuit within the policy limit, NWC sought to dismiss the third party complaint. The Illinois Appellate Court ruled that where the liability of the parties has been determined and satisfied from the proceeds of any insurance policy provided by the parties pursuant to a contractual agreement, the third party claim should properly be dismissed. The parties are deemed to have agreed to look solely to the insurance in the event of loss and not impose liability on the part of the other party. Briseno at Ill.App.3d 905, N.E.2d 198.

The mere fact that some insurance has been provided will not relieve a party from liability in contribution. Where the insurance proceeds are inadequate to cover the loss, a party may seek contribution to the extent that the loss exceeds the insurance coverage. Kirincich v. Jimi Construction Co., 267 Ill.App.3d 51, 53-54, 640 N.E.2d 958, 960-961 (2nd Dist.. 1994).

IV. Coverage Issues Involving CGL and Employer's Liability Policies

Although the problem presented for the seminar does not touch on any issues involving Employer's Liability policies, a typical construction liability claim will involve those issues.

The issues all revolve around the exclusion in the CGL policy for injuries to the insured's own employees. In most states, the state's Workers' Compensation Act will bar a direct action by the plaintiff against his employer. For instance, the Illinois Workers’ Compensation Act, 820 ILCS 305/5 provides statutory immunity to employers from most direct tort actions by employees. As a result, most actions against employers are Third Party Contribution actions.

In Illinois, such contribution actions have caused an ongoing debate over whether a CGL insurer may be called upon to defend an employer sued for contribution. As a general rule, the employer's liability in contribution is limited to the amount of the worker's compensation payments. Kotecki v. Cyclops Welding Corp., 146 Ill.2d 155, 585 N.E.2d 1023, 166 Ill.Dec. 1 (1991). However, in Braye v. Archer-Daniels-Midland Co. 175 Ill.2d 201, 676 N.E.2d 1295 (1997) and Liccardi v. Stolt Terminals, Inc., 178 Ill.2d 540, 687 N.E.2d 968 (1997), the Illinois Supreme Court found that the Kotecki limitations could be waived by contract.

The issue then arises as to whether the CGL insurer may be obligated to provide a defense to the employer in that scenario. In Christy-Foltz v. Safety Mut. Cas. Corp., 309 Ill.App3d 686, 722 N.E.2d 1206 (4th Dist., Ill. 2000), the Fourth District ruled that an employers voluntary assumption of liability (the waiver) constituted a voluntary assumed liability, and as such was excluded under an Employer’s Liability policy. The issue then becomes whether the CGL insurer is obligated to provide coverage or whether the insured is left with an uninsured loss. To date, Illinois courts have not decided that issue although the matter is currently pending before the Illinois Supreme Court.

In Michael Nicholas, Inc. v Royal Insurance Co., 321 Ill.App.3d 909, 748 N.E.2d 786 (2nd Dist. Ill., 2001), a construction case, the Illinois Appellate Court was faced with an insurer’s denial of coverage under a CGL policy. That policy contained the following exclusions for "An employee of the insured arising out and in the course of employment by the insured" and "Bodily injury or property damage for which the insured is obligated to pay damages by reason of assumption of liability in a contract or agreement." Michael Nicholas at Ill.App.3d 911-912.

Further, the policy contained an exception to those inclusions, which provided coverage where liability was assumed under and “insured contract.”

The Second District Court held that the contract at issue was an “insured contract.” As such, the Second District held that the exclusions were defeated and the CGL policy provided coverage.

Outside the construction context a different result was reached. In Hankins v. Pekin Insurance Co., 305 Ill.App3d 1088 (5th Dist. Ill., 1999), the Fifth District held that the contract between a trucking terminal owner and a cartage operator was a contribution agreement and not a true indemnity agreement. The contract term did not explicitly say that the intent was to indemnify against the employer’s own negligence. As such, the insured contract exception did not apply. As a result, the exclusion for coverage assumed by contract applied, and the Court found that the CGL policy did not provide coverage.

We expect that this matter will be decided when the Illinois Supreme Court rules on Virginia Surety v. Northern. In that case, the general contractor on a construction project hired De Graf to work as a subcontractor. Virginia Surety Co. v. Northern Ins. Co. of New York, 362 Ill. App. 3d 571, 571, 840 N.E.2d 1271, 1272 (3rd Dist. 2005). The contract between them contained provided that DeGraf would indemnify and hold Capital harmless for any claims, damages, losses and expenses arising out of or resulting from performance of De Graf’s work. Id. at 571, 840 N.E.2d at 1273. The contract also required De Graf to obtain a commercial general liability policy (“CGL”), which it did from Northern. Id.

The CGL policy contained an employer’s liability exclusion providing that there was no coverage for an employee’s bodily injury occurring in the course of DeGraf’s employment or while performing duties related to the conduct of the subcontractor’s business. Id. at 573, 840 N.E.2d at 1273. The CGL policy further stated that the employer’s liability exclusion did not apply to liability assumed by the insured pursuant to an “insured contract.” Id. “Insured contract” was defined as:

That part of any other contract pertaining to your business * * * under which you assume the tort liability of another party to pay for ‘bodily injury’ . . . . to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement. Id.

In addition, De Graf purchased a worker’s compensation and employer’s liability policy from Virginia Surety. Id. Smith, De Graf’s employee, sued the general contractor to recover for injuries he sustained at the job site. Id. Capital filed a third-party complaint against De Graf. Id. In that Complaint, Capital alleged that De Graf had committed ten negligent acts that caused Smith’s injuries, and specifically referenced the Illinois Contribution Among Joint Tortfeasors Act. Id.

De Graf tendered the defense of the contribution action to Northern and Virginia Surety. Id. at 573, 840 N.E.2d at 1274. Virginia Surety accepted the tender, but Northern rejected, based on the employer’s liability exclusion. Id. Accordingly, Virginia Surety filed a declaratory judgment action. Id. In that action, Virginia Surety and Northern filed cross-motions for summary judgment as to whether Northern was required to defend DeGraf in the contribution action. Id. The trial court granted Northern’s motion, finding that the CGL insurer was not obligated to provide a defense. Id.

On appeal, Virginia Surety argued that Northern had a duty to defend DeGraf based on the Second District’s decisions of Michael Nicholas, Inc. v. Royal Insurance Co., 321 Ill. App. 3d 909, 748 N.E.2d 786 (2nd Dist. 2003) and Mulligan Masonry Company, Inc., 337 Ill. App. 3d 698, 786 N.E.2d 1078 (2nd Dist. 2003). Id. at 574, 840 N.E.2d at 1274. In those cases, the court held that the definition of “insured contract” was ambiguous and had to be construed in favor of coverage. Id. In response, Northern argued that the indemnity provision at issue was not an “insured contract” based on the Fourth District’s decision in Hankins v. Pekin Insurance Co, 305 Ill. App. 3d 1088, 713 N.E.2d 1244 (4th Dist. 1999). Id.

The appellate court affirmed the trial court, stating that it found the decisions cited by both parties instructive, but not controlling. Id. The court ostensibly based its holding on a procedural distinction. Specifically, in Hankins, Mulligan, and Michael Nicholas, the third-party plaintiffs sought indemnification. Id. In Virginia Surety, however, Capital filed a contribution action. Id.

The court explained that an “insured contract” exception to an employer’s liability exclusion only applied where one party to the contract agreed to assume liability for someone else’s tort negligence. Id. at 574, 840 N.E.2d at 1275. Thus, according to the court, that exception would only apply where a party sought indemnification. Id. In Virginia Surety, however, Capital did not request indemnification from DeGraf for Capital’s negligence. Id. Rather, the complaint alleged that DeGraf should pay for its own negligence. Id. Because the complaint did not trigger the “insured contract” exception in the CGL policy, the court concluded that Northern had no duty to defend DeGraf. Id.

The Illinois Supreme Court may go either way on this matter. Given the fact that the Illinois Supreme Court remains generally unfriendly to insurers, we have a hard time believing that the Court will find a whole class of cases to be uninsured, despite the clear merits of that position.

V. The Applicability of the Indemnity Provision

Besides the potential for coverage under the Secura policy, there is also a potential that the insured may be found liable under the indemnity provision of the contract. When presented with a claim for indemnity (or when attempting to present such a claim to shift loss) the first thing to determine is whether an indemnity agreement actually exists between the relevant parties. For instance, in a case based on an alleged written agreement, the defendant may be able to show that an indemnity agreement or provision was never finalized or reduced to writing. Karsner v. Lechters Illinois, Inc., 771 N.E.2d 606 (2002) (there can be no presumption that an indemnitor intends to assume the responsibility to indemnify unless the contract by express stipulation provides for such beyond a doubt.) See also, Cincinnati Ins. Co. v. Konicek, 503 N.W.2d 420 (Iowa 1993)(general law of indemnity under contract is that no action for indemnity may be maintained until all valid conditions precedent have been met.)

Where an agreement between the parties was reduced to writing, the details of the contract will have to be reviewed in order to determine whether it is actually an indemnity agreement. Zantop International Airlines Inc v Eastern Airlines, 200 Mich App 344, 503 NW2d 915 (1993) [although sales agreement required buyer to purchase insurance to benefit seller, this requirement did not establish buyer's obligation to indemnify seller against loss].

Occasionally, a party will attempt to prove an indemnity agreement through "course of dealings." If a claim for indemnity is based on the parties' prior course of dealings, the defendant may be able to show that the defendant did not agree to the indemnify the plaintiff respecting the particular transaction at issue. This may arise where there is a blanket indemnity agreement requiring a purchase order referencing the blanket agreement, and the actual purchase order makes no such reference. That situation is not unusual, due to casual dealings between parties. Such a defense may be accomplished by evidence that the transaction differed from previous dealings, for example, by failure to execute customary forms or documents relating to indemnity. See, e.g., Maxon Corp v Tyler Pipe Industries Inc, 497 NE2d 570 (Ind App 1986) [defendant buyer did not accept conditions imposed by plaintiff in its shipment invoice where purchase order made conditions imposed by seller invalid and those conditions were not accepted in writing by buyer].

You should also explore general contract provisions in determining the validity of the indemnity agreement, including whether it was properly executed. An indemnity agreement, like any other contract, must be properly executed in order to be enforceable. A defending party may prevail on the basis of an invalid and unenforceable contract if it proves failure to comply with the general requirements for formation or enforcement of a contract. See, e.g., Burcham v Procter & Gamble Manufacturing Co, 812 FSupp 947 (ED Mo 1993) [Under Missouri law, the indemnity agreement was not sufficiently conspicuous on contract form to warrant its enforcement; provision was in small print on back of standard purchase form and surrounded by unrelated provisions].

An indemnity agreement may also be invalid as a matter of public policy. The statutes from particular states are discussed below. Generally, an agreement seeking to indemnify a party for the consequences of its own negligence raises special public policy considerations. See, e.g., Moore Heating & Plumbing Inc v Huber, Hunt & Nichols, 583 NE2d 142 (Ind App 1991); Herter v Ringland-Johnson-Crowley Co, 492 NW2d 672 (Iowa 1992). Even where there is no statute barring such indemnity agreements, they may still be found to be void as against public policy. Such agreements may be strictly construed against indemnity for a negligent party due to these public policy considerations. E.g., Frederickson v Alton M Johnson Co, 402 NW2d 794 (Minn 1987). A defendant may be able to foil an attempt at enforcement of an indemnity agreement if it can prove that the agreement does not clearly contain the intent to indemnify a party against its own negligence. Moreover, a party may submit extrinsic evidence that the defendant did not willingly and knowingly entered into an indemnity agreement relieving the plaintiff of its negligence. See, e.g., Burcham v Procter & Gamble Manufacturing Co, 812 FSupp 947 (ED Mo 1993) [Under Missouri law; an indemnitor must have fair notice of existence of agreement indemnifying indemnitee against its own negligence]; Maxon Corp v Tyler Pipe Industries Inc, 497 NE2d 570 (Ind App 1986) [imposition of broad indemnity requirement without knowledge and express assent of indemnitor may be unconscionable].

For a claimant to enforce a right to indemnity, the claimant will need to establish that the particular injury falls within the scope of the indemnity agreement. Indemnity agreements typically identify those persons whose injuries are to be covered by the indemnity obligation, often referring to any and all persons. Howe v Lever Brothers Co, 851 SW2d 769 (Mo App 1993) [all persons]. However, where the indemnity agreement specifies particular persons as those whose injuries are covered by indemnification provisions, the defendant in an action to enforce a contractual right of indemnity may prevail by showing that the injured person was not among those for whose injuries indemnity was to be paid. Such a claim may lie outside the scope of the indemnity agreement in a number of ways, including:

(A) The plaintiff was not a person entitled to indemnity under the agreement;

(B) The plaintiff was not responsible for damages on the underlying claim;

(C) The person whose injury provides the basis for the indemnity claim was not among those persons to whom the indemnity agreement applied;

(D) The underlying personal injury claim did not bear the required relationship to the subject of the parties' contract;

(E) The cause of the injury was not one of those specified by the agreement as subject to indemnity.

The determination whether a particular situation falls within the scope of an indemnity agreement depends, in large part, on the construction of the indemnity agreement. An indemnity agreement typically includes among its terms a description of those persons who may be indemnified in the event a covered person suffers injury or loss. Howe v Lever Brothers Co, 851 SW2d 769 (Mo App 1993) [second tier subcontractor agreed to indemnify and hold harmless first tier subcontractor and property owner]. Thus, the defendant in an action to enforce a contractual right to indemnity may prevail where the plaintiff is not among those persons intended to be indemnified under the parties' agreement. Frederickson v Alton M Johnson Co, 402 NW2d 794 (Minn 1987) [subcontractor's agreement to indemnify general contractor did not amount to agreement to indemnify project engineers where engineers were not mentioned and terms of general contract protecting engineers were not incorporated into subcontract].

Similarly, the plaintiff's claim that it is entitled to indemnity as a third party beneficiary of the contract may be overcome by evidence that the plaintiff does not hold that status. Paul v Bogle, 193 Mich App 479, 484 NW2d 728 (1992) [driver's claim that he was third-party beneficiary of indemnity agreement in lease since he drove tractor on behalf of both parties was rejected since driver was not mentioned in contract which dealt with allocation of liability between parties to lease]. In attempting to establish that the plaintiff is not among those entitled to indemnity under the parties' agreement, the defendant may benefit from a rule that indemnitee status under an indemnity agreement is to be narrowly construed.

Since the plaintiff in an action to enforce a contractual right to indemnity must establish both the plaintiff's responsibility on the underlying personal injury claim and that the injury was covered by the indemnity agreement, the defendant may defeat an indemnity claim by evidence that the plaintiff was not responsible on the underlying claim. The nature of the requisite responsibility of the plaintiff on the underlying claim depends on the terms of the indemnity agreement. Where the language of the agreement requires actual rather than merely potential liability on the part of the plaintiff, the defendant may be able to avoid liability by showing that actual liability on the underlying claim has not attached or been determined.

Another avenue to attack an indemnity arises when the claim is brought after the settlement of an underlying claim. Since settlements often provide the basis for the plaintiff's claim for indemnity, the defendant may attack the validity of the settlement as a means of showing lack of the requisite responsibility on the underlying claim. Evidence that the plaintiff's settlement of the underlying claim was not reasonable may provide a basis for such a showing.

Indemnity agreements frequently limit indemnity coverage to injuries having a specified relationship to the subject matter of the larger contract between the parties. Burlington Northern Railroad Co v Chicago & Northwestern Transportation Co, 851 SW2d 28 (Mo App 1993) [agreement called for indemnity for injury or loss arising out of, resulting from, or connected with defendant's use of leased property]. In such a case, the defendant's showing that the injury on which the plaintiff's indemnity claim is based was not related to the performance of the contract will avoid liability in an action to enforce a contractual right of indemnity.

Where the indemnity agreement broadly refers to indemnity for injury or loss arising out of, resulting from, or connected to the performance of the parties' contract, the defendant may be able to establish the absence of the requisite relationship between the injury and the subject matter of the contract by evidence of a number of factors, including:

(A) The occurrence of the injury when the injured person was on break or off the job. Fossum v Kraus-Anderson Construction Co, 372 NW2d 415 (Minn App 1985) [offsite and after-hours injury sustained by foreman of construction site did not arise out of or result from performance of contract even though foreman was on way home from work at time of injury]; or

(B) The occurrence of the injury when the injured person was performing work other than that specified by the contract.

In certain agreements, the obligation to indemnify may be limited to injury related to the conduct required of the indemnitor and may not include an injury involving conduct of the indemnitee which does not relate to the performance contracted for by the indemnitor. The prerequisite that the act or omission be related to the subject matter of the contract related to the conduct of the indemnitor required under the contract and not the conduct of the injured person. Thus, if the indemnitee was negligent in causing the injury but that negligence did not relate to the indemnitee's responsibilities under the contract with the indemnitor, there was no right to indemnification from the indemnitor even if the injured person was performing his or her responsibilities under the contract at the time of injury.

Where the indemnity agreement uses specific terms in describing the required relationship between the injury and subject matter of the contract, for example, where it limits coverage to injuries occurring in a particular area or location, evidence that the injury took place outside that area may establish that the plaintiff's claim lacks the requisite relationship. Gaines v Illinois Central Railroad, 796 FSupp 313 (ND Ill 1992) [although agreement provided for indemnity for injury on or about sidetrack, defendant shipper was not required to indemnify railroad for injury to worker on adjoining passing track since passing track had no connection to sidetrack covered by agreement];

Where an indemnity agreement which limits indemnity to claims arising from injuries related to particular products or items, evidence that the injury did not involve the stated products or items will ordinarily be sufficient to show that the claim lacks the required relationship to the subject matter of the contract. TLB Plastics Corp v Procter & Gamble Paper Products Co, 542 NE2d 1373 (Ind App 1989) [although indemnity agreement covered injury or loss from products shipped, this did not encompass machines provided by owner for manufacturer to use in fulfilling manufacturing contract since machines were not products manufactured for shipment elsewhere; fact that owner could recall machines did not make them shipped products].

Indemnity agreements commonly limit covered injuries in terms of their causes or causal agents. The most frequent limitation of this type conditions the obligation to indemnify on the indemnitors' having caused or contributed to the underlying injury. Frederickson v Alton M Johnson Co, 402 NW2d 794 (Minn 1987) [subcontractor agreed to indemnify general contractor for injuries to persons arising out of subcontract when cause of injury was event or act within control of subcontractor]. In such a case, the defendant may be able to show that the injury does not fall within the scope of its obligation to indemnify the plaintiff by evidence that it was not at fault or negligent in connection with the injury.

Some indemnity agreements may impose limitations relating to the indemnitee's as well as the indemnitor's role in causing the underlying injury, denying or limiting indemnity where the indemnitee was wholly or partly responsible. Doran v Corn Products-US, Division of CPC International Inc, 776 FSupp 368 (ND Ill 1991) [Illinois law; electrical worker performing maintenance on precipitator was injured by electrical shock due to malfunction of automatic safety device on precipitator and lack of proper grounding; injury was attributable to negligence of owner of precipitator who was therefore not entitled to indemnity]; Argueta v Baltimore & Ohio Chicago Terminal Railroad Co, 224 Ill App3d 11, 166 Ill Dec 428, 586 NE2d 386 (1991)app den 144 Ill2d 631, 169 Ill Dec 140, 591 NE2d 20 (1992) [failure of railroad to repair potholes in cement surfaces on which crane traveled and failure to inspect and replace crane parts which failed was negligence which prevented railroad from recovering indemnity from crane operator].

Provisions found in some indemnity agreements may require or appear to require the indemnitor to indemnify the indemnitee for the consequences of the indemnitee's own negligence or fault. As noted below, however, in the construction context many states bar indemnity for one's "own" or "sole" negligence. Although such a provision may be valid under appropriate circumstances in some cases the defendant may be able to rebut the plaintiff's argument that the agreement requires the defendant to indemnify the plaintiff where the agreement does not clearly and unequivocally so provide. This may be possible where the language of the agreement required indemnity for "any and all claims" but did not specifically refer to loss or damage that was the plaintiff's fault. Maxon Corp v Tyler Pipe Industries Inc, 497 NE2d 570 (Ind App 1986) [indemnity clause did not clearly and unequivocally indicate that buyer was to indemnify for negligence of seller where clause required indemnity for seller for loss or damage arising out of any claim of any nature involving use or misuse of goods under contract since primary concern was for proper installation and use of unit and buyer's acts in that regard]; Argueta v Baltimore & Ohio Chicago Terminal Railroad Co, 224 Ill App3d 11, 166 Ill Dec 428, 586 NE2d 386 (1991)app den 144 Ill2d 631, 169 Ill Dec 140, 591 NE2d 20 (1992) [agreement which called for operator to indemnify railroad from loss and damage in connection with injury of all persons caused by negligence of operator in performing under agreement was not construed to indemnify against railroad's own negligence]

Apart from considerations involving the existence, validity, and application of the indemnity agreement, in some circumstances the defendant may be able to show conduct by the plaintiffs that may preclude its assertion of a contractual right to indemnity. For example, the defendant may be able to show that the plaintiff engaged in conduct amounting to a waiver of any right to indemnity under the contract. The defendant may establish the plaintiff's waiver by evidence that the plaintiff acted inconsistently with an intent to pursue indemnity. Similarly, evidence of failure to assert a right to indemnity in circumstances in which it would be natural to do so may support a defense of estoppel against the plaintiff.

In some circumstances the doctrine of acquiescence may be invoked to limit the plaintiff's right to indemnity where the plaintiff has acquiesced in the condition which gave rise to the underlying liability. Hader v St Louis Southwestern Railway Co, 207 Ill App3d 1001, 152 Ill Dec 859, 566 NE2d 736app den 139 Ill2d 595, 159 Ill Dec 107, 575 NE2d 914 (1991). However, this doctrine may apply only where the defendant can show serious fault on the part of the plaintiff; mere knowledge of a dangerous condition may not be sufficient.. Moreover, it may be argued that the defense of acquiescence should not be available at all in a case in which there is a contractual indemnity agreement, since the rights of the parties should be determined first by their contract..

A defendant should also raise the argument that the plaintiff was not responsible on the underlying claim. If the terms of the indemnity agreement require actual rather than merely potential liability on the part of the plaintiff, the defendant may be able to avoid liability by showing that actual liability on the underlying claim has not attached or been determined.

In addition, many states have statutes that expressly either forbid or limit contractual indemnity in the construction context.

Illinois

Illinois law bars indemnity agreements in construction contracts where the indemnity agreement seeks to hold harmless another for that person's "own negligence." ^[1] For example, where a general contractor negligently supervises a construction site causing injury to an employee of a sub-contractor, the general contractor cannot rely on an indemnity agreement to shift the loss to the sub-contractor. However, pursuant to the statute, a contract to procure insurance is not considered an indemnity contract. ^[2] To use the same example as above, the general contractor would be able to shift the loss to the sub-contractor by use of insurance, i.e by requiring the sub-contractor to name the general contractor on the sub-contractor's CGL policy.

We note that the statute is not applicable outside the construction context. For instance, in a maintenance contract, the indemnity provision may be upheld. Further, in such circumstances, the loss may be a covered loss under the "insured contract" provisions of the CGL policy.

Michigan

Michigan has an indemnity statute that appears to be substantially similar to the Illinois statute. ^[3] However, rather than barring a shift of a contractor's "own negligence", the statute bars a shift of "sole negligence." Under that statute, loss for a contractor's "sole negligence" cannot be shifted. As noted below, there is a difference between "own negligence" and "sole negligence."