Daily Archives: April 12, 2011

A Primer on the Validity and Effect of Waiver of Subrogation Clauses

Waiver of Subrogation Clauses: An Overview

Pursuant to typical “waiver of subrogation” clauses, the parties to a contract will agree to waive any rights of recovery against each other if the damage is covered by insurance. Thus, the risk of loss gets shifted to the insurer.

Courts almost always hold that waiver of subrogation clauses are valid because they advance several important social goals, such as encouraging parties to anticipate risks and procure insurance covering those risks, thereby avoiding future litigation. Waiver of subrogation clauses have been validated even in the face of anti-indemnity, anti-exculpatory and anti-subrogation statutes. See Best Friends Pet Care, Inc. v. Design Learned, Inc., 77 Conn. App. 167, 823 A.2d 329 (2003); May Dept. Store v. Center Developers, Inc., 266 Ga. 806, 471 S.E.2d 194 (1996); 747 Third Ave. Corp. v. Killarney, 225 A.D.2d 375, 639 N.Y.S.2d 32 (1st Dep’t 1996). These courts held that waiver of subrogation clauses are not intended to relieve a party of liability for its own negligence, but are instead risk allocation clauses. Thus, the clauses did not violate the relevant statutes.

Illinois Law on Waiver of Subrogation Clauses

There is relatively little case law in Illinois regarding waivers of subrogation clauses. Although the case is over twelve years old, Intergovernmental Risk Management v. O’Donnell, Wicklund, Pigozzi & Peterson Architects, 295 Ill.App. 3d, 692 N.E.2d 739 (1st Dist. 1998) (“IRM”) remains the premier case in Illinois with regard to waiver of subrogation issues. In that case, the Village of Bartlett (“the Village”) was in the process of expanding its village hall (“the project”). Part of the project entailed constructing a new police station adjacent to the updated village hall. The Village contracted with Defendant O’Donnell, Wicklund, Pigozzi & Peterson Architects (“O’Donnell”) to provide architectural drawings and specification for the project. Pursuant to the contract, the Village purchased insurance from Travelers Insurance Co. through the IRM program. On January 28, 1994, a fire occurred at the newly constructed police station, which caused over $114,000 worth of damage. IRM and Travelers paid the Village that amount pursuant to their policies. IRM and Travelers then filed a subrogation action against O’Donnell, claiming that O’Donnell’s negligence caused the fire and sought reimbursement of the monies paid to the Village pursuant to the insurance policies.

In its motion to dismiss, O’Donnell argued that the plaintiffs’ claims were barred because the Village had waived its subrogation rights in the contracts for the project. The Owner-Architect Agreement between the Village and O’Donnell contained the following waiver of subrogation clause:

“The Owner and Architect waive all rights against each other and against the contractors, consultants, agents and employees of the other for damages, but only to the extent covered by property insurance during construction.”

The plaintiffs argued, inter alia, that the waiver of subrogation provisions could not apply to damage caused by the negligent and wrongful acts of the defendant. The plaintiffs contended that the waiver of subrogation clauses violated public policy by encouraging negligence. However, the court disagreed. It stated that “the purpose of waiver of subrogation provisions is to allow the parties to a construction contract to exculpate each other from personal liability in the event of property loss or damage to the work to the extent each party is covered by insurance.” IRM. at 792. The court noted that waiver of subrogation clause “shifts the risk of loss to the insurance company regardless of which party is at fault.” Thus, it did not matter whether the fire loss was caused by O’Donnell’s negligence so long as the loss was a covered loss that occurred during construction. Id. at 793.

The plaintiffs also argued that the waiver provisions violated of public policy in that they act as indemnity agreements holding the defendant harmless from its own negligence. The court rejected that argument as well. It noted that the waiver provisions do not involve injury suffered by a construction worker or a member of the general public but instead, damage suffered by one of the contracting parties due to the alleged negligence of another. Id. Thus, waiver of subrogation clauses do not violate the public policy considerations which outlaw indemnity agreements. Instead, they merely limit the parties’ recovery to loss sustained to the parties to the agreement and only to the extent that it was covered by insurance. Id. at 794.

The IRM court held that the waiver of subrogation clause was perfectly valid and that it applied to the insurers’ claims. Thus, the plaintiffs’ claims were barred and they could not recover the amounts that they paid to the Village. As mentioned above, IRM is still the preeminent case in Illinois with regard to the validity and effect of waivers of subrogation clauses. Insurers need to be mindful of the effect that such clauses may have on their rights.

Conclusion

Although courts nationwide consider waiver of subrogation clauses to be valid, there are circumstances under which these clauses will not be enforced. For example, in order to establish a waiver of subrogation, it is necessary to show by clear evidence an intentional relinquishment of the right. Thus, if the waiver of subrogation clause is ambiguous or confusing, if the clause conflicts with other contract provisions, or if the intention of the parties is not clear, then courts will not enforce it. See Sutton Hill Associates v. Landes, 775 F. Supp. 682 (S.D. N.Y. 1991); U.S. Fidelity and Guar. Co. v. Friedman, 540 So. 2d 160 (Fla. Dist. Ct. App. 4th Dist. 1989); Charter Oak Fire Ins. Co. v. National Wholesale Liquidators of Lodi, Inc., 2002 WL 519738 (S.D. N.Y. 2002) (applying New Jersey law).

Additionally, courts will not enforce waiver of subrogation clauses where the underlying insurance did not cover the loss at issue. See Gap, Inc. v. Red Apple Companies, Inc., 282 A.D.2d 119, 725 N.Y.S.2d 312 (1st Dep’t 2001);Chelm Management Co. v. Wieland-Davco Corp., 23 Fed. Appx. 430 (6th Cir. 2001) (applying Ohio law). This is of particular importance, as an insurer can craft a condition to coverage that protects its own subrogation rights. As indicated, it is common for insureds to include waiver of subrogation clauses in their contracts with other companies during the course of their business. Waivers under those circumstances will generally take place pre-loss. While these pre-loss waivers may be acceptable, it is important for insurers to make sure the insured does not do anything after a loss which would prejudice the insurer’s right to subrogation. A common condition to coverage that protects an insurer’s subrogation rights will read as follows:

“If the insured has rights to recover all or part of any payment we have made under this policy, those rights are transferred to us. The insured must do everything necessary to secure our rights and must do nothing after the loss to impair them.”

A condition like the one above added into the insurance contract will protect an insurer’s right to subrogation in the event that the insured, after a loss occurs, attempts to enter into an exculpatory agreement that includes a waiver of subrogation clause. While there is little an insurer can do about a pre-loss waiver of subrogation clause (aside from the defenses to enforcement discussed above), a provision similar to the one above will at least protect the insurer from post-loss waivers.

Federal Judge Orders Employer to Reinstate Three Memphis Warehouse Workers and Stop Threatening Union supporters While Case Proceeds at NLRB

A federal judge this week ordered Ozburn-Hessey Logistics, LLC, (OHL) to reinstate three warehouse workers who were fired during a union organizing campaign, and to stop other behavior that interfered with their employees’ rights, pending the final resolution of a case before the National Labor Relations Board.

Judge Samuel H. Mays, Jr. of the U.S. District Court for the Western District of Tennessee issued the temporary injunction on April 5 at the request of the NLRB, stating that “it is necessary to return the parties to the status quo to protect the NLRB’s remedial powers.”

The Agency’s Acting General Counsel has alleged multiple violations of labor law by the company in relation to an organizing campaign by the United Steelworkers Union started in the spring of 2009. An election was ultimately held in March 2010, which the union lost 180 to 119. After an investigation of charges filed by the union, the regional office issued complaints alleging multiple labor law violations.

Two NLRB administrative law judges agreed, and found violations sufficient to overturn the election results. OHL has appealed those decisions to the full Board in Washington. The order issued this week will remain in effect until a final determination is made.

Under the federal order, OHL’s officers and agents are ordered to desist from interrogating employees about their union activities, threatening them with a loss of benefits if the union were to win an election, confiscating pro-union literature from break rooms, warning, and suspending or discharging employees because of their union activities. The company was also ordered, among other things, to offer reinstatement to three employees who were fired during the organizing campaign, and to allow a fourth employee to resume working overtime.

Fifth Circuit Update: Trade Secrets, Fiduciaries in Bankruptcy and Mass Tort Class Actions

Here is the Murphy’s Law of the blogosphere: courts will let fly with all kinds of new opinions when the blogger lacks time to keep up with them.

Lest I fall too far behind, here are three from the mighty Fifth Circuit’s output in the last week that may be of interest to the civil practitioner.

The opinions run the gamut from:

Texas Trade Secrets Composed Of Publicly Available Components

Tewari De-Ox Systems v. Mountain States involved claims of misappropriation of trade secrets under Texas law. The interesting part of the case arose because aspects of the “secrets” weren’t secret at all because they had been part of a patent application which became public 18 months later under the terms of the Intellectual Property and Communications Omnibus Reform Act of 1999, 35 U.S.C. § 122(b)(1)(A). But the Fifth Circuit revived the trade secret claims because

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a trade secret can exist in a combination of characteristics and components each of which, by itself, is in the public domain, but the unified process, design and operation of which in unique combination, affords a competitive advantage and is a protectible secret.

Judge Prado wrote the court’s opinion.

Bankruptcy: Officer Of General Partner Also Acting As Fiduciary To Limited Partnership 

FNFS v. Harwood principally involved the question of whether the debtor had committed fraud or defalcation while acting in a fiduciary capacity such that his debts to a limited partnership were not discharged in bankruptcy under11 U.S.C. § 523(a)(4). The debtor was an officer and director of a company that acted as general partner of a limited partnership to which the money was owed. He argued that while he was a fiduciary to the general partner company, he was not a fiduciary of the limited partnership. Looking to the substance of the business relationship,  the control he exercised and the confidence reposed in him, the court ruled that he was “acting in a fiduciary capacity” to the limited partner.  Some of the key language:

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We conclude that an officer of a corporate general partner who is entrusted with the management of the limited partnership and who exercises control over the limited partnership . . . owes a fiduciary duty to the partnership that satisfies Section 523(a)(4). We emphasize that it is not only the control that the officer actually exerts over the partnership, but also the confidence and trust placed in the hands of the controlling officer, that leads us to find that a fiduciary relationship exists sufficient for the purposes of Section 523(a)(4).

Here, the test was satisfied because, as a factual matter, there was evidence that the debtor had exercised near-complete control over both tiers of the entity until a few months prior to his termination, and the general partner’s board entrusted the debtor with the sole and plenary authority over the day-to-day management of the partnership enterprise. Judge King wrote the court’s opinion.

Mass Tort: No Class Certification Without A Trial Plan To Deal With Individual Issues

Finally, Madison v. Chalmette Refining represents another attempt to certify a class of plaintiffs claiming injury from a mass accident, here the emission of petroleum coke dust from a refiner. According to the Fifth Circuit, the trial court had not done the “rigorous analysis” and “close look” that is necessary before determining that common issues predominate and the case would not degenerate into mini-trials.

The court reversed the district court’s class certification order and cast some doubt on its pre-Amchem mass-tort precedents in language indicating (as in Texas state court) importance of a trial plan for dealing with individualized issues:

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Whether Watson has survived later developments in class action law–embodied in Amchem and its progeny–is an open question, but even in Watson, the district court had “issued orders detailing a four-phase plan for trial.”. . . . In Turner v. Murphy Oil USA, Inc., . . .  [c]ritical to the court’s predominance inquiry was the fact that “Plaintiffs submitted a proposed trial plan to the Court. The plan provides for a three-phase trial.”  * * *

We must reverse because, “[i]n its certification order, the [district] court did not indicate that it [had] seriously considered the administration of the trial. Instead, it appears to have adopted a figure-it-out-as-we-go-along approach . . . By failing to adequately analyze and balance the common issues against the individualized issues, the district court abused its discretion in determining that common issues predominated and in certifying the class. We do not suggest that class treatment is necessarily inappropriate. As Chalmette Refining acknowledged at oral argument, class treatment on the common issue of liability may indeed be appropriate. But our precedent demands a far more rigorous analysis than the district court conducted.

Judge Clement wrote the court’s opinion.

“Pay Under Protest” Procedure for “Other Exactions” Is Not Applicable to All Development Exactions

A California appellate court has ruled that the “pay-or-perform under protest” procedures of Government Code sections 66020 and 66021 do not apply to all types of development exactions. In its opinion, the Sixth Appellate District narrowed the scope of the statutory pay under protest provisions, and held that they should be interpreted so as to be available for review of exactions imposed by a local agency as a condition of development approval only if the exaction is “for the purpose of defraying all or a portion of the cost of public facilities related to the development project.”

The court held that there was no showing that the City’s affordable housing requirement imposed on the developer (exacting five homes at admittedly “below market” prices set by the City) was intended to serve the purpose of defraying the cost of public facilities related to the development project, so the pay under protest procedure was not applicable and the developer’s protest and action for review were deemed untimely. The court emphasized that its decision was limited to the facts of this case.

The City approved a 42 home development project in 2007, subject to a condition that required the developer to execute a “Below Market Rate” housing agreement prior to obtaining building permits. The BMR agreement required the developer to sell five of the new homes to qualified buyers selected by the City at below market prices, to be adjusted annually. In 2009, when construction was underway and the time for sale of the BMR homes was approaching, the developer sent a written protest of the requirements to convey the new homes at the BMR prices as required by the City, and filed suit for review and relief from the BMR exactions, under Government Code section 66020. The City demurred on the grounds that the action was barred by the short statutes of limitations for either section 66499.37 (for challenges to decisions under the Subdivision Map Act) or section 65009 (for challenges to planning or zoning decisions). Plaintiff argued that neither applied, because the BMR requirement was not imposed as a tentative map condition, but rather as a special permit condition; and because section 66020 was the more specific statute applicable to review of development fees and other exactions. The lower court sustained the City’s demurrer, and the appellate court affirmed, albeit on somewhat different grounds.

The Court of Appeal agreed that if the protest procedure of section 66020 applied to this action for review of the City’s requirement that the developer provide “below market rate” homes, then it would have been error to sustain the demurrer. The “pay under protest” procedure enacted in 1983 (and currently codified at Government Code Section 66020) provides: “Any party may protest the imposition of any fees, dedications, reservations, or other exactions imposed on a development project . . .” by tendering payment, or performance, of the disputed exaction under protest within 180 days of receiving written notification from the City that the protest period has commenced. Since the City had never given that statutory notification, the action would not be untimely if section 66020 were applicable to review of these housing exactions.

The court tried to ascertain the Legislature’s intent in providing for protest of development fees or “other exactions” in section 66020 and 66021. The decision appears to acknowledge that the BMR housing requirements could be viewed as a form of “exaction” for some purposes, but not necessarily for the limited purpose of determining whether the pay under protest statute may apply. The court observed that “not all exactions imposed by a public entity on a development project constitute an ‘other exaction’ within the meaning of section 66020 and 66021.” Noting that the term “other exaction” is not defined in either of the pay under protest statutes, the court concluded that “exaction” should be interpreted for purposes of this protest statute by reference to language from a distinct part of the Mitigation Fee Act (Gov’t Code section 66000(a)) defining “fees” as charges “to defray the cost of public facilities, etc.” Alternatively, the decision appears to hold that the protest statutes also apply to “other exactions” if imposed for the substantially broader “purpose” as stated in a 2005 Supreme Court decision “to alleviate the effects of the development on the community.”

The decision thus requires that “the purpose of the exaction … must be scrutinized,” in order to determine the applicable procedure for seeking review of a development exaction, and the applicable statute of limitations. It may be difficult to definitively identify and conclusively ascertain the “purpose” of an exaction in many cases. In this case, the court took judicial notice of the City’s Municipal Code to determine that the City’s “purpose” for its below market rate housing requirement was to “enhance the public welfare” by mandating that future housing development contribute to attaining the City’s housing goals, rather than to defray the cost of public facilities related to the development. (The decision did not examine whether the housing exactions here met the alternative purpose test, i.e., “to alleviate the effects of the development on the community.”) Despite announcing a new pleading requirement to be met by parties seeking to follow the pay under protest procedure (i.e., the “purpose” of the challenged exaction), the court affirmed the denial of any leave to amend, and apparently accepted “the express language of the City’s below market housing ordinance” as being conclusive as to the purpose of the exaction in this case. The court concluded by emphasizing that its decision “is limited to the facts of this case.”

To the extent that this decision interprets the pay (or perform) under protest statutes as being applicable only to such “exactions” as may be imposed for one of the newly required limiting purposes set forth in the decision, it raises several questions. The decision ascertains the “legislative intent” for the term “other exactions” as used in the 1983 and 1984 protest statutes, by incorporating a limitation (i.e., for the “purpose” of “defraying the cost of public facilities”) from distinct legislation that wasn’t adopted until 1987. The Legislature amended the protest statute in 1996 to require written notification of the final amount of a fee or exaction and the commencement of the time for protest because of concern that there was uncertainty as to when a fee or exaction might be deemed to have been “imposed” for purposes of timely protests and limitations. By limiting the protest procedures to only such exactions as are imposed for the specified “purpose,” the decision may add to such uncertainty. The decision would apparently require local governments, development applicants, and the courts to try to identify the ostensible “purpose” for each of the many types of exactions imposed as conditions of development approval, in order to determine what method of review and what statute of limitations may be applicable. The new uncertainty inherent in such efforts, requiring applicants to guess as to whether the protest procedure is applicable in any particular case, may limit the utility of a perform under protest process, or fail to achieve the Legislature’s purpose for creating a distinct statutory protest process for fees and other development exactions.