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Appeals Court Bars Recoupment Claims by Insurers on Policies Purchased After Project Completion

In an August 2010 decision, the Massachusetts Appeals Court held that a standard American Institute of Architects (“AIA”) waiver of subrogation clause in a construction contract applies to insurance policies obtained after completion of a project to bar insurers’ subrogation actions against architects, contractors and subcontractors. In so holding, the Appeals Court in MiddleOak Ins. Co. v. Tri-State Sprinkler Corp. explicitly rejected the contrary view followed by a federal court in Massachusetts in 2007.

Construction contracts typically include provisions requiring the purchase of property insurance to protect contracting parties (i.e., owners, architects, contractors and/or subcontractors) from losses by placing the risk of loss on insurers. To achieve this goal, construction contracts also often include provisions waiving the parties’ rights against each other for damages to the extent such damages are covered by property insurance. These clauses are known as subrogation waivers. If a loss occurs, an insurer covering the loss cannot sue any of the parties protected by the subrogation waiver.

Under the AIA subrogation waiver in MiddleOak, the owner and contractor waived all rights against each other and their respective subcontractors, as well as against the architect, for damages caused by fire to the extent covered by property insurance. In addition, the contract provided that “if after final payment property insurance is to be provided on the completed Project through a policy or policies other than those insuring the Project during the construction period, the Owner shall waive all rights in accordance with the terms [of the subrogation waiver].” Two years after construction of an apartment complex was completed, the owner of the complex purchased property insurance from MiddleOak Insurance Company. During the following year, a fire damaged one of the buildings in the complex. MiddleOak paid the owner nearly $5 million under the policy, and then brought suit (as subrogee of the owner) against the project architect, the general contractor, and the sprinkler subcontractor.

A central dispute in the MiddleOak litigation was whether the waiver of subrogation clause in the AIA construction contact applied only to property insurance obtained during construction, or whether the clause also applied to property insurance purchased after construction was completed. The Massachusetts Appeals Court, in a brief decision, held that the AIA waiver of subrogation provisions “are not limited to losses during the construction period and apply as well to post-construction losses that are covered by insurance.”

In reaching this conclusion, the Appeals Court rejected the reasoning set forth in Lumbermans Mut. Cas. Co. v. Grinnell Corp., a decision of the federal district court in Boston. In Lumbermans, the court concluded that the waiver of subrogation language applies to insurance obtained after completion of the work only if the parties agreed in advance that post-construction property insurance would be provided. According to the MiddleOak court, this interpretation of the contract language was “too crabbed a reading.” The MiddleOak court took a different view and held, instead, that the AIA contract language reflected the parties’ expressed intent to extend the applicability of the subrogation waiver to post-construction policies and losses.

The MiddleOak decision is certain, in the short term, to have negative effects for¬†insurers and positive effects for parties to construction contracts. While the MiddleOak decision establishes the meaning of the AIA’s waiver of subrogation language in Massachusetts, the long-term implications of the decision are less clear. With respect to property insurance policies that have already been issued, property insurers will likely bear losses sustained after completion of construction with no recourse against parties that might otherwise have been held responsible for the loss. Going forward, however, insurers will likely raise premiums and/or adapt their policy forms to account for the decision in MiddleOak and include, for example, policy exclusions for prior projects in which ongoing subrogation waivers were promised and/or granted. In turn, contracting parties may, over time, limit contract language providing for a waiver of subrogation with respect to after-acquired policies and/or postconstruction losses if the parties find that procuring such insurance becomes difficult or expensive. As a result, market forces may ultimately limit the effect of the MiddleOak holding, and the protection afforded to contractors and subcontractors by the decision may be short lived. For the present, however, the decision limits claims by insurers against contractors, subcontractors and/or engineers when construction contracts contain provisions that waive subrogation against these parties with respect to after-acquired insurance policies.

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