Subrogation Against Subcontractors During the Course of Construction: Examining the “Unnamed Insured” Defence

A.        What is the “Unnamed Insured” Defence?

The “unnamed insured” defence is commonly asserted in subrogated actions brought with respect to builders risk policies. This defence arises from the fact that in Canada, builders’ risk policies tend to be treated as a unique species of insurance contract whose practical purpose can only be served if subcontractors are considered to be unnamed insureds.[1] Since an insurance company cannot bring a subrogated action against its own insureds, subcontractors are generally protected from subrogated actions.

In any construction project, there is always a risk that a subcontractor will damage the property of another or the construction project as a whole. Canadian courts regard the primary purpose of builders’ risk policies as being to ensure that funds are available for the completion of a construction, without the various sub-trades having to resort to protracted litigation in the event of negligence by anyone connected with the construction. In other words, the practical purpose of extending insurance to cover all the subcontractors who are working to complete the construction is that they are spared the necessity of fighting between themselves. Courts have held that this is a risk accepted by the insurers at the outset.[2] 

It is nevertheless incorrect to assume that all subcontractors will automatically obtain the status of unnamed insured under a builder’s risk policy. There are important exceptions to this rule. Subrogation professionals should be alert to the circumstances in which it may be possible to challenge the “unnamed insured” defence.

 

B.        When is a Subcontractor an Unnamed Insured?

Ultimately, the issue of whether subcontractors are included as insureds in a policy which does not expressly name them is one of contractual interpretation; courts will look at both the construction contract and the wording of the insurance policy in order to make this assessment. It is largely irrelevant whether a contractor has agreed to obtain the insurance for the benefit of the subcontractor. The intention of the contractor to insure the subcontractor under the builder’s risk policy is not determinative of how an insurance policy will be interpreted.[3] Rather, there are two features of builder’s risk policies that appear to give rise to the unnamed insured defence:  

 

i)          “Property Owned by Others”

 

Where an insurance policy insures an entire construction project, including “property owned by others,” Canadian courts have interpreted the policy as inferring that it actually insures parties other than just the named insureds.[4] In the context of construction contracts, subcontractors are seen as having such an “identity of interest” with the general contractor (in that it will stand to gain from the project’s existence and will lose from any damage to it), that they are considered unnamed insureds by necessary implication.[5] Thus, a subcontractor’s interest in the project may be considered insured even when he is not named as an insured on the policy and his interest is not disclosed.

In this regard, however, there has been an important new development. In May 2010, the B.C. Court opined, in Brookfield Homes v. Nova Plumbing,  that where property damage coverage for contractors and subcontractors is limited “to the extent of the Insured’s legal liability for insured physical loss or damage to such property”, the unnamed insured defence may not apply. In other words, where a subcontractor is insured only to the extent that the named insured is found legally liable for the loss or damage, it may be that a subcontractor cannot be regarded as an unnamed insured, even in the context of a builder’s risk policy.[6]

 

ii)         Waivers of Subrogation for any “interest with respect to which insurance is provided by this policy”

Where a policy provides that no subrogation lies against a “corporation, firm, individual, or other interest with respect to which insurance is provided by this policy”, courts have held that, having regard to the special nature of builder’s risk policies, judicial pronouncements on the commercial necessity for including subcontractors; and the language of the clause itself, subcontractors must be taken to be unnamed insureds by necessary implication.[7] Any doubt on this issue is resolved against the insurance company.[8]

C.        Two Case Examples

 

Below are two cases that illustrate the application of the above principles. In the first case, the subcontractor was considered to be an unnamed insured under the insurance policy. In the second case, on very similar facts, the defence was held not to apply.

i)          Janeland Developments Inc. v. Michelin Masonry Inc.[9]

A general contractor’s insurer brought a subrogated action against a defendant masonry subcontractor who negligently caused the collapse of a wall at a building project. The construction contract contained a hold harmless clause in favor of the home builder and required that the subcontractor was required to obtain its own comprehensive general liability insurance. There was no corresponding obligation on the general contractor to obtain insurance of any kind. The general contractor had obtained a “Builder’s Risk Broad Form” policy which contained the “Property Insured” and “Waiver of Subrogation” wording referred to above. On these facts, the Ontario Court found that the subcontractor was an unnamed insured under the policy:

  • The wording in the policy, in stating that it covered “property owned by others”, extended coverage to the masonry subcontractor as an unnamed insured.

 

  • The fact that the agreement for masonry services did not require the general contractor to insure the subcontractor was not sufficient to convince the court that the subcontractor was not intended to be an unnamed insured under the insurance policy.

 

  • The wording in the waiver of subrogation clause constituted a general waiver of all claims by the insurer against the subcontractor, who was an “interest with respect to which insurance is provided by this Form.”

 

  • Finding that the subcontractor was an unnamed insured was in keeping with the court’s desire to reduce the litigation which flowed from losses of this type. It also recognized the reality of complex industrial life and provided comfort and security to owners, builders and subcontractors involved in commercial projects. [10]

 

ii)         Brookfield Homes v. Nova Plumbing[11]

In this May 2010 decision, the ONtario Court was asked to decide whether a subrogated action could be brought by a home builder’s insurer against a plumbing contractor whose negligence with a welding torch caused fire damage to several homes under construction. The home builder had contracted the plumber to provide plumbing services for a new subdivision that was undergoing construction. As in Janeland, the contract contained a hold harmless clause in favor of the home builder and required the plumbing subcontractor to obtain liability insurance, and to waive the subrogation rights of its insurers against the home builder. There was no corresponding obligation on the part of the home builder to obtain insurance of any kind or provide any subrogation waivers.

Unlike in Janeland, however, the home builder argued that it did not take out “builder’s risk” policies on behalf of its contractors. Rather, it obtained “all perils” property insurance, and contractually required its contractors to take out liability insurance. The subcontractor described the policy as a builder’s risk policy. The Court, in finding that the subcontractor was not an unnamed insured, made the following findings:

  • The label of the policy, be it “builder’s risk”, “all-risks” or “all perils”, is not determinative. Rather, it is the policy language that matters.
  • In this case, the “property damage” coverage for contractors was explicitly limited, stating that the policy “also insures the interest of contractors and subcontractors…during construction of an insured location…to the extent of the insured’s legal liability for insured physical loss or damage to property”.  In other words, the subcontractor was insured only to the extent that the home builder was found legally liable for the loss or damage.
  • Although the Court’s decision did not set out the wording of the policy’s subrogation clause, the policy provided that the insurer’s right of subrogation was preserved and required the home builder to cooperate in any subrogation proceeding.
  • The Court concluded, based on the considerations set forth above, that both the construction agreement and the policy allocated the risk of loss caused by a contractor to the contractor, rather than the home builder. As such, the plumbing subcontractor could not be regarded as an unnamed insured.

 

Conclusion

Although subcontractors may often be regarded as unnamed insureds with respect to property policies that provide coverage for construction projects, this is not always the case. The issue of whether a subcontractor can rely on an “unnamed insured” defence to a subrogated action requires an analysis of both the construction contract and the policy in question. Significantly, as noted in the recent case of Brookfield Homes, a subcontractor may not be able to utilize this defence where the property coverage for subcontractors has been expressly limited to amounts for which the named insured is legally liable.


[1]               Sylvan Industries Ltd. v. Fairview Sheet Metal Works Ltd., [1994] B.C.J. No. 468 at para. 6.  (B.C.C.A.) [“Sylvan”].

[2]               As stated by Grandpre J. in Commonwealth Construction Company v. Imperial Oil Limited, [1978] 1 S.C.R. 317 (S.C.C.), at p. 328:

“Whatever its label, its function is to provide the owner the promise that the contractors will have the funds to rebuild in case of loss and to the contractors the protection against the crippling cost of starting afresh in such an event, the whole without resort to litigation in case of negligence by anyone connected with the construction, a risk accepted by insurers at the outset. This purpose recognizes the importance of keeping to a minimum the difficulties that are bound to be created by the large number of participants in a major construction project, the complexity of which needs no demonstration. It also recognizes the reality of industrial life.”

[3]                See for example, Sylvan Industries Ltd. v. Fairview Sheet Metal Works Ltd., (1994) 89 B.C.L.R. (2d) 19 (C.A.).

[4]               Madison Developments Ltd. v. Plan Electric Co.,[1997] O.J. No. 4249 (Ont. C.A.) [“Madison”].

[5]               For example, in Madison, ibid, the Court of Appeal stated: “…the policy insures property owned by others, suggesting that others than those named in the policy are insured. The contractor obtained that insurance, a loss occurred, and payment was made under the policy. The insurer must be taken to be aware of the contractor’s contracts with subcontractors, or to have some control over them if not yet entered, because the insurer’s subrogation rights can be eliminated by such a contract…” The Court concluded that the subcontractor was an unnamed insured by necessary implication.

[6]               Brookfield Homes v. Nova Plumbing, 2010 ONSC 2131 (CanLII).

[7]               Sylvan, supra note 16 at para. 17; Esagonal, supra note 21 at p. 9 of 10.

[8]               Ibid.

[9]               [1996] O.J. No. 513 (Ont. Gen. Div.).

[10]             Ibid at para. 15.

[11]             Supra, note 6.

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Does the Anti-Subrogation Rule Exist in Canada?

What is the Anti-Subrogation Rule?

In its narrowest form, the anti-subrogation rule is a legal principle that an insurance carrier has no right of subrogation against its own insured. In other words, an insurance carrier cannot sue its own insured in a subrogated action to recover payments made for a risk that is covered by the insurance policy. In the United States, however, the bar against suing one’s own insured has been extended by some courts to preclude subrogated actions beyond situations in which a single insurance policy is involved, to encompass multiple policies. Consider a situation where a subrogating insurer has, by happenstance, issued a separate liability policy to a defendant in the action. The argument for precluding subrogation in such cases is that the insurer is “suing its own insured”, even though it is clear that the suit is not against the same insured to whom it made the payments giving rise to the insurer’s subrogation rights.

Does the Anti-Subrogation Rule Exist in Canada?

To date, there is one Canadian case that has applied the anti-subrogation rule – Lacombe v. Don Phillips Heating Ltd. [“Lacombe”], a 2005 Ontario decision of Master Beaudoin. In Lacombe, the plaintiffs, Mr. and Mrs. Lacombe, claimed for damages arising from an oil spill at their residence. Most of the loss was borne by Lacombe’s insurer, Aviva, which had paid for the costs of cleanup under a homeowner’s policy of insurance. Together, the Lacombes and Aviva sought recovery of insured and uninsured losses totalling $300,000.

The action was brought against a contractor for whom Aviva had issued a liability insurance policy that responded to the subrogated claim. Aviva brought a motion on behalf of the contractor to strike the subrogated claim before a Master, arguing that the anti-subrogation rule should be applied in Canada. Importantly, Aviva’s subrogation counsel did not challenge the motion – the Court was presented with a one-sided argument.

In the result, the portion of the action advanced on behalf of Aviva alone was dismissed, despite there being no real exposure to the insured contractor. Master Beaudoin adopted the reasoning of Home Ins. Co. v. Pinski Bros, Inc. 500 P.2d 945 (Mont. Sup. Ct. 1972) [“Pinski”], a decision of the Montana Supreme Court, which held that permitting an insurer to sue its own insured for a liability covered by the insurance policy would violate basic principles of equity and public policy by:

  • allowing the insurer to expend premiums collected from its insured to secure a judgment against the same insured on a risk insured against;
  •  giving judicial sanction to the breach of the insurance policy by the insurer;
  • permitting the insurer to secure information from its insured under the guise of policy provisions available for later use in the insurer’s subrogation action against its own insured, allowing the insurer to take advantage of its conduct and conflict of interest with its insured; and
  •  constituting judicial approval of a breach of the insured’s relationship with its own insured.

As a Master’s decision, however, Lancombe is not binding on Ontario judges, nor has the decision been followed by another court. The one-sided nature of the arguments presented to the Court provides a good basis for challenging the persuasiveness of the Master’s reasoning. Additionally, there are very good reasons to argue that the anti-subrogation rule, in its broader form, should not form part of Canadian insurance law:

1. The anti-subrogation doctrine misapplies the equitable principles of subrogation. Where a defendant is coincidentally covered under a policy issued by the same carrier as the plaintiff, the plaintiff is not “suing itself”. The carrier’s rights as a subrogee under a property policy are wholly separate and distinct from the duty owed to an entirely different party under a separate contract of liability. The subrogating insurer is not simply ‘bringing an action against itself for damages’ when it happens to provide liability insurance to a defendant under a separate and distinct policy.

2. The anti-subrogation rule is contrary to established goals of tort law and principles underlying Ontario’s Insurance Act. Subrogation is based on considerations of equity and good conscience. Subrogation is viewed as serving the ends of justice by placing economic responsibility for injuries upon parties who are at fault for causing a loss. The goal of tort law to place the burden of payment for negligently causing harm does not disappear due to the introduction of insurance in the modern world. Insurance is not, in and of itself, a risk transfer mechanism between parties unless they specifically agree to such an intent. This fundamental principle should not change due to the fortuity that the same insurer writes a property policy for one insured, a liability policy for a separate company, and the one company negligently causes harm to the other. The anti-subrogation doctrine, even in its most restrictive form, would result in what has been correctly characterized by some U.S. courts as an “unbargained for, unpaid for, windfall” because a risk not otherwise insured against is, in effect, due to the “fortuitous fact” that liability is asserted against the insured by a party that also happens to be covered by the same carrier”.

3. Those who incur higher losses should pay higher premiums. Premiums for such insurance are determined, in large part, by the loss history of an insured. An individual with many losses will, and should, pay more than those who have few or none. For example, section 412(6) of Ontario’s Insurance Act provides that a system for calculating premiums must be just and reasonable, be reasonably predictive of risk and distinguish fairly between risks. Underwriters calculate the total anticipated losses for policy periods in determining the premiums to charge insureds for each policy period. The anti-subrogation rule would have the effect that the victim, rather than the tortfeasor, would bear the costs of higher insurance premiums and the possibility of becoming a less insurable entity.

4.  The anti-subrogation rule presumes bad faith conduct on the part of insurers. The concerns expressed in Pinski, adopted by Master Beaudoin, presume that insurers will breach their duties of good faith to their insured with respect to the provision of insurance under the policies in question. It anticipates that insurers will act in bad faith and then seeks to impose a ‘blanket’ remedy without regard to the circumstances of a given case. The anti-subrogation rule therefore “puts the cart before the horse”. There are other, more appropriate, remedies available to deal with any bad faith conduct on the part of an insurer. For example, the concerns expressed in Pinksi and Lancombe with respect to potential conflicts of interest and the sharing of an insured’s confidential information are not insurmountable. “Chinese walls” are a favoured technique for dealing with conflicts of interest that arise from carrying on business by large financial institutions as well as many legal and accounting firms. Chinese walls are designed to insulate sensitive documentation from the wider firm in order to prevent conflicts of interest by restricting the flow of information between different departments of the same organization.

5. The adoption of the anti-subrogation doctrine in Canada represents a marked departure from common law principles. The anti-subrogation doctrine is a recent product of American common law that is not recognized in Commonwealth countries. There is no such bar in the United Kingdom.

6. Insurers have valid reasons for pursing such claims. As recently noted by Campbell J., a duty of good faith, and in some circumstances fiduciary duty, does exist between primary insurers, excess insurers and reinsurers. This may arguably include an obligation on the part of insurers to subrogate losses for the benefit of the insurance group. Additionally, policies of reinsurance may contractually oblige primary insurers to pursue subrogated claims for the benefit of the re-insurers.

7. The anti-subrogation rule is open to exploitation by savvy defendants. As noted by the Court in Fashion Tanning, “a potential defendant could contrive to avoid being held accountable for the full measure of its product liability by merely securing small liability policies from a host of carriers, thereby frustrating any subrogation action brought against it by any of those insurers”.

8. A variety of factual patterns suggest that the anti-subrogation rule expressed in Lancombe should rejected. Consider, for example:

  • Insurance carriers with similar names are not “the same”. Some insurers are separate companies with the same parent or have related names but are really operated as separate companies. To what extent are related companies considered to be the “same entity” for the purposes of this rule?
  • What if ABC Insurance Company pays $500,001 to its insured plaintiff, but also happens to write an excess policy covering the defendant for liability limits above $500,000? Is ABC Insurance Company completely barred even though most of its claim falls below the excess limits?
  • What if ABC Insurance Company writes the first $10,000 of coverage to a tortfeasor who has adequate excess or umbrella coverage with another liability carrier? Can ABC Insurance Company collect for an amount above the first $10,000 layer of coverage?

Conclusion

Lacombe is an Ontario and the first Canadian case to consider the anti-subrogation doctrine. Although it is a 2005 decision, it has not been followed in Ontario or applied in other provinces. This effort to import the anti-subrogation rule in Canada is at the expense of historically sound tort and insurance law risk allocation schemes. As such, the reasoning underlying this decision is ripe for challenge in Canada. We will see what the future brings.