The Who, What and How of Additional-Insured Requirements: Part I

A standard requirement in many commercial contracts is that one party must be added as an "additional insured" to the other party's insurance policies. What is not well understood, however, is that one size does not fit all additional insureds. Yet all too often, that is exactly what we see. In the most unfortunate cases, the problems are not evident until it is too late.

In general, to be an additional insured on someone else's insurance policy means that you are covered for losses for which you might be legally liable because of your relationship to the "named insured." Typically, an "upstream" party (e.g., a building or business owner) wants to be an additional insured on the insurance policies of "downstream" parties (e.g., tenants, service providers, contractors and subcontractors). Other examples include staffing agencies and other service providers who must name customers as additional insureds and manufacturers, wholesalers and distributors who must do the same for retailers.

We will cover this complex topic in two installments. In Part I, we present a few examples of additional-insured language or endorsements that failed to accomplish what the parties intended, as well as what might have been done at the outset of the relationship to avoid the problem. Next month, Part 2 will discuss some pitfalls in the administration and coordination of insurance programs, as well as the additional-insured requirements in commercial contracts.

Case Study 1: Not All Additional-Insured Endorsements Are Created Equal

While there are dozens of additional-insured endorsement forms in the marketplace, not all meet the needs and expectations of the parties involved. Thus, it is not enough for the party seeking additional-insured status to require the other party to obtain an additional-insured endorsement without spelling out the scope of coverage required. For example, the most current version of the standard-form endorsement covers the additional insured only if the loss was "caused by" the named insured. The nature of the relationship, however, may justify the additional insured's request that an endorsement be used that provides coverage for losses "arising out of" the named insured's work or operations in connection with the contract.

Many of these endorsements provide that additional-insured status ends when the named insured completes operations for the additional insured. If coverage is required for completed operations as well, that requirement should be made explicit. If the available form endorsements don't meet the parties' needs, then a manuscript (i.e., custom) endorsement may be necessary to spell out the scope of coverage appropriate for the project.

The following case study is a good example of the consequences of failing to think through the scope of coverage the additional-insured party actually requires:

Your Neighborhood Drug Store (YNDS), a retail pharmacy, required that it be named as an additional insured on the general liability insurance policies issued to the commercial pharmacies from which YNDS buys its drugs. YNDS did not, however, specify the coverage terms it would require and never reviewed the terms of the additional-insured endorsements before accepting them.

YNDS purchased certain drugs (which it would dispense to its customers one prescription at a time) from SleazyCo, a commercial pharmacy that repackages large volumes of drugs into smaller lots. Unbeknownst to YNDS, SleazyCo was diluting drug solutions before repackaging and reselling them. A number of consumers, including customers of YNDS, became ill, allegedly because they took diluted doses of their medicines. A number of these consumers sued SleazyCo and its retail customers, including YNDS.

When YNDS sought coverage as an additional insured under SleazyCo's general liability insurance policy, coverage was denied because the relevant endorsement stated that YNDS was an additional insured only if it was liable for bodily injury due to the sole negligence of SleazyCo. But the lawsuits also alleged negligence and other errors and omissions on the part of YNDS. Furthermore, the additional-insured endorsement stated that coverage was limited to liabilities arising out of ongoing operations. Here, all the injuries occurred after YNDS completed its operations (i.e., filling the prescriptions).

In this instance, a review of the contract requirements and the additional-insured endorsements, as well as some forethought about what could go wrong, might have revealed the gaps in coverage and afforded YNDS an opportunity to negotiate better terms.

Case Study 2: "Additional Insured" and "Contractual Indemnity" Provisions
Are Not the Same Thing

Many contracts require that one party do two things: name the other party as an additional insured and defend, indemnify and hold harmless the other party. These provisions have the same purpose in mind: to protect the upstream party from liability because of the downstream party's operations, work or products.

Courts in various states treat these provisions differently, however, because the standard general liability policy (which primarily covers liability for bodily injury and property damage due to accidents or occurrences) excludes (among other things) coverage for liabilities assumed under a contract. Furthermore, to many courts, agreements to extend additional-insured status to a contracting party and/or indemnify that party look like liabilities assumed by contract. Here is an example of how this can go wrong:

CementPour Co. is a subcontractor on projects in many Midwest states. Under its contracts, CementPour must name as an additional insured the general contractor on each project. To satisfy these obligations, CementPour obtained an additional-insured endorsement covering bodily injury or property damage arising out of its ongoing and completed operations for work performed in connection with "insured contracts."

At two project sites in different states, cement mixers malfunctioned. Unbeknownst to CementPour, the concrete was faulty. Several months after completion of each building, the faulty concrete cracked so severely that it was necessary to tear out and rebuild major portions of both buildings. As additional insureds, both general contractors sought coverage for the property damage caused by CementPour. In both instances, the insurer denied coverage. CementPour sued its insurer in both states.

The court in one state held that the defective concrete caused property damage to the finished building and, therefore, the loss was covered. In the other state, the court held that the claim was for breach of warranty rather than property damage and, therefore, was not covered.

In order to overcome the exclusion for contractual liabilities, and to reduce the risk that a court will hold that an additional insured's liability arising out of the named insured's operations is a breach of contract, representation or warranty, additional-insured endorsements need to include suitable definitions of "additional insured" and "insured contract," and must explicitly include coverage for "insured contracts." Furthermore, companies operating in multiple states should understand how the laws in those states differ and draft their insurance requirements accordingly.

Case Study 3: Additional Insureds and the Duty to Defend

One of the key benefits under a general liability policy is that the insurer has a duty to defend the named insured as long as the lawsuit alleges something that, if true, would be covered. The extent to which an additional insured is entitled to a defense, however, depends on the terms of the additional-insured endorsement. Courts have interpreted the scope of the duty to defend differently depending on the form of the endorsement. Accordingly, a weak form can lead to a poor outcome, as the following example shows:

BigBuilder was the prime contractor on an office tower and was an additional insured under the general liability policy issued to SubCo, which was responsible for securing the curtain wall. The additional-insured endorsement covered BigBuilder's liability for bodily injury solely due to the fault of SubCo. The endorsement excluded coverage for bodily injury arising out of any act or omission of BigBuilder or its employees.

While securing the curtain wall, one of SubCo's employees fell several stories and was paralyzed. In an effort to get around the "workers' compensation bar," the injured employee only sued BigBuilder and alleged no negligence on the part of his employer, SubCo. BigBuilder sought a defense from SubCo's insurer, who denied coverage on the ground that the endorsement only covered BigBuilder if the injury was solely SubCo's fault. Because the employee alleged nothing of the kind in his complaint, coverage was denied.

Had BigBuilder and its advisors looked at the endorsement at the outset of the relationship, the contractor could have requested an additional-insured endorsement with stronger protection.

Lessons Learned

Additional-insured requirements are a necessary part of doing business, yet they are widely misunderstood or, worse yet, completely overlooked. Accordingly, companies should remember the following guidelines when negotiating commercial contracts:

  1. Think about your risks so that you can better align the additional-insured provisions of your contracts with those risks;
  2. Read and understand the terms and conditions of your additional-insured endorsements before you accept them; and
  3. Obtain copies of the insurance policies to which the additional-insured endorsements will be attached, for without them you will never really know the extent and limits of your coverage as an additional insured.

Ultimately, to obtain the additional-insured language that meets your particular needs, consult with your lawyer and insurance broker before signing on the dotted line.

Next month, in the conclusion of this two-part series, the Litigation & Counseling Alert will look at pitfalls in the administration and coordination of insurance programs, as well as the additional-insured requirements in commercial contracts.

As an experienced policyholder attorney, Dan Struck advocates on behalf of corporate and individual insurance policyholders throughout the United States.  He represents clients in insurance coverage litigation, and counsels clients facing contested claims and other complex insurance concerns.

Neil Posner successfully counsels his clients on the complexities of buying and maintaining insurance, and using insurance as part of an overall risk-management program.  Co-chair of the firm's Policyholders' Insurance Coverage group, Neil focuses on insurance recovery and dispute resolution, risk management, loss prevention and cost containment. His clients include public and private companies, organizations, boards of directors, individual officers and other policyholders.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under professional rules, this content may be regarded as attorney advertising.