Subrogation 101 (and Why Should I Care?)

What is subrogation? Why am I being asked to waive it? Should I care? To answer that last question, let’s take a quick run at the first two.

What Is Subrogation?
“Subrogation” refers to the act of one person or party standing in the place of another person or party. It is a legal right held by most insurance carriers to pursue a third party that caused an insurance loss in order to recover the amount the insurance carrier paid  the insured to cover the loss. This occurs when (i) the insurance carrier makes a payment on behalf of its insured as the result of a covered accident or injury, and then (ii) the insurer then seeks repayment from the at-fault party.

Why Would I Waive Subrogation Rights?
Let’s start with an example of subrogation in the construction context:

• An owner hires a general contractor to build a multistory building.
• The contract between the owner and general contractor contains a waiver of subrogation clause stating that—if the building is damaged and that damage is covered by insurance—the owner and general contractor waive all rights against each other regarding the damage.
• The general contractor hires subcontractors.
• The contract between the general contractor and subcontractor contains a waiver of subrogation similar to the one between the owner and the general contractor.
• While still under construction, the building is set aflame by the carelessness of a subcontractor’s employee.
• If the owner has an insurance policy in place which permits the insured (the owner) to waive subrogation rights in writing prior to a loss, then the owner’s insurer is obligated to pay for the damage caused by the fire (even though it was started by the subcontractor).
• The insurer cannot, in these circumstances, recover the money it paid to the owner from the general contractor or the negligent subcontractor.

This, of course, benefits insureds by shifting risk from the parties to the insurance company—which has collected premiums in exchange for assuming that risk—and shields the parties from having the insurance company later pass the risk of loss back to them. From a purely economic perspective, a waiver of subrogation rights recognizes that it is inefficient for multiple parties to a contract to insure against the same risk. Rather, with the effective use of subrogation waivers, the cost of one insurance policy can be allocated among the various parties exposed to a common covered risk.

What Does It Mean for an Insurance Carrier?
Since the insurance company “steps into the shoes” of its insured, the insurance company can have no greater rights than those of its policyholder. Thus, if the policyholder has previously waived certain claims, the insurance company cannot later revive them. But … always check your insurance policy, local law and consult with an attorney regarding your right to waive subrogation:

• Some courts have held that it is inequitable to bind an insurance company to an agreement it did not join. Such courts therefore require notice or consent of the insurer.
• Other courts have held that where the policyholder has waived its cause of action, the insurer’s ability to bring a subrogation claim was also waived, regardless of notice or consent.
• Some state laws limit the validity of subrogation waivers.

Further, insurers may try to protect themselves against a policyholder unilaterally wiping out their subrogation rights. Insurers might protect themselves by:

• Inserting an exclusion into their policies that permits the insurance company to deny coverage if an insured has waived the insurer’s subrogation rights;
• Raising premiums to offset outlays incurred from the loss of their subrogation rights;
• Inquiring whether a potential insured has already waived any subrogation rights;
• Requiring insureds to warrant at the time a policy is issued that the insured has not, and will not, waive the insurance company’s subrogation rights; and/or
• Obtaining reinsurance to cover any subrogation waivers.

What Can I Do to Protect Myself, and How Does This Affect the Policyholder?

If you’re the insured…
Technically, a waiver of subrogation rights should mean nothing but good things (fewer lawsuits, allocated risk, economic advantages) to the policyholder. The right of subrogation belongs to the insurance company, not the insured. The insured only waives or releases (the insurance company’s) potential claims. An insurer’s right to recover is entirely dependent on the insured’s right to recover. Because a release or waiver of that right to recover is independent of any right of subrogation an insurance carrier may have, the insurer loses its ability to recover from the wrongdoer when the policyholder waives or releases its own claim against that wrongdoer. The right of subrogation “owned” by an insurer comes only because, when it pays out on a claim, it “buys” its insured’s claim, but only if any such claim exists.

But make sure that you read your insurance contract carefully. Consider the scope of the waiver. Be certain that you are only waiving rights if the policy does not bar such a waiver, and only to the extent money has actually been paid by the insurance company. The waiver should not include deductibles or self-insured retentions, which are borne by the policyholder. For a waiving party to make sure that it hasn’t invalidated its own insurance coverage, it has to make sure its insurance policy allows it to waive or release those claims.

If you’re a released party…
If you’re not the insured but are instead a party released by waiver of subrogation, keep in mind that the policyholder who has been paid for its loss (that you caused) through insurance cannot also recover those sums from you. The insurer who has paid out on a claim also has no right of recourse against you. And therefore, you do not need to have your own insurance protect you against that same risk. This is not against public policy since (i) the injured party has been fully compensated; (ii) the party at fault is (indirectly) insured against the loss; (iii) the insurance company provided only the coverage it agreed to provide under the policy (assuming there is no contractual bar against such a waiver); and (iv) the waiver of subrogation rights has no bearing on uninsured losses. Also keep in mind that is not always necessary to be a party to contract to claim its benefits. Other parties that might benefit include:

• Owners, agents, employees, successors and assigns
• Contractors, subcontractors, suppliers and laborers
• Architects, engineers and other design professionals
• Unaffiliated third parties.

That said, you must be someone whom the parties intended to benefit from the waiver. And if you want the releasing party to have insurance in force, make sure the other party has a policy that allows the claims to be released.

Regardless, Make Sure the Waiver of Subrogation Clause Is Written Clearly and Fully
Another example. Consider the following language from a Waiver of Rights clause:

Waiver of Rights. Owner and Contractor hereby waive all rights each might have against the other for damages caused at or in connection with the Project by fire or other perils to the extent covered by insurance, except such rights as they may have to the proceeds of such insurance. Contractor shall require, by appropriate agreement, written where legally required for validity, similar waivers in favor of itself and Owner by subcontractors and sub-subcontractors. With respect to the waiver of rights of recovery, the term “Owner” shall be deemed to include, to the extent by property insurance applicable thereto, its consultants, employees and agents.

All policies of insurance maintained by Owner and Contractor with respect to the Project shall contain provisions whereby the insurer waives its right of subrogation with respect to losses payable under such policies.

Guess who wasn’t covered by this clause but thought that they were? The subcontractor. Guess who the insurance company sued when a subcontractor’s fire suppression system failed and flooded a building? Yes, the subcontractor.

As the Michigan Court of Appeals explained in Michigan Ins. Co. v. Grand Rapids Fire Prot., Inc., “the trial court held that the language in the waiver-of-rights clause did not create a waiver of subrogation to be applied as between [Owner] and defendant [Subcontractor]. Instead, the trial court held that the ‘language protects [Owner] and [Contractor] from claims by subcontractors, but does not preclude claims against subcontractors.’ The trial court’s assertion was correct[.]”

The court further explained that:

According to the clear language of the contract, [Owner] and [Contractor] agreed to ‘waive all rights each might have against the other for damages caused at or in connection with the Project.’ Accordingly, this portion of the waiver applied solely to [Owner] and [Contractor]. Next, the clause states that [Contractor] ‘shall require, by appropriate agreement, written where legally required for validity, similar waivers in favor of itself and [Owner] by subcontractors and sub-subcontractors.’ From this language, [Owner] and [Contractor] agreed to have similar waivers of rights in favor of themselves […] [and] waived their rights as to one another and agreed to have any subcontractors waive its rights against [Owner] and [Contractor]. It did not, however, waive [Owner’s] or [Contractor’s] rights against any subcontractors. The waiver-of-rights clause serves to protect [Owner] and [Contractor] from each other as well as subcontractors, but contrary to the assertions of defendant [Subcontractor], the clear language of the waiver-of-rights clause did not serve to protect the subcontractors from claims by [Owner] or [Contractor].

This is strong medicine. The subcontractor—believing it was fully protected by the language of the waiver—was ordered to pay almost $200,000 in damages. While in the world of large-scale construction this is not the largest sum, the results have been much, much worse in other cases.

In Ending

Keep in mind that:

• Waiver of subrogation is a common feature in construction contracts.
• These clauses are infrequently given much (or appropriate) consideration.
• These clauses should be written clearly and unambiguously.

In preparing construction contracts, you should consult local law (and a qualified insurance coverage lawyer), your risk management department, and your insurance advisor, to ensure that you get the benefit of the deal you intended to make, and do not give your insurer an unintended “out.”

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