Duty to Obtain Insurance and Third-Party Beneficiary Status–Drury Co. v. Jackson R-2 School District

In the ongoing saga of a governmental entity’s claims a subcontractor cannot sue the governmental entity for failure to obtain insurance covering the subcontractor (discussed previously concerning a brief at 2013 WL 6169464), we now have a brief on behalf of the governmental entity.  Drury Co. v. Jackson R-2 School District, 2014 WL 462916 (Mo. Ct. App., E.D. Jan. 13, 2014). The brief discusses a claim brought by a subcontractor against the governmental entity.  The basis for the claim on which we will focus is the entity entered into a written contract with a prime contractor.  According to the subcontractor’s brief, the written contract provides:

[Respondent] shall purchase and maintain… insurance written on a builder’s risk “all-risk” or equivalent policy… [that] shall include the interests of the. . Subcontractors… in the Project.

More after the break …

The client’s brief (at pages 13-15) provides the following analysis of whether the subcontractor is a third-party beneficiary:

First, Drury is not a third-party beneficiary to the written contract between Penzel and the School District. A third-party beneficiary is one who is not privy to a contract but who is benefited by it and who may maintain a cause of action for its breach. Stephens v. Great S. Sav. & Loan Ass‘n, 421 S.W.2d 332, 335 (Mo. App. 1967). The doctrine, however, does not allow all those who benefit from a contract to sue. Rather, only those third parties for whose primary benefit the contracting parties intended to make the contract may maintain an action. Laclede Inv. Corp. v. Kaiser, 596 S.W.2d 36, 41 (Mo. App. E.D. 1980). Intention is to be gleaned from the contract itself and if it is uncertain or ambiguous, from the surrounding circumstances. Id. at 41. The contract terms must clearly express that the contracting parties intended the third party to be the beneficiary of performance of the contract and have the right to maintain an action on the contract. Id. at 42. Inasmuch as people usually contract and stipulate for themselves and not for third persons, a strong presumption arises that such was their intention, and the implication to overcome that presumption must be so strong as to amount to an express declaration. Id. In other words, the court may not  speculate from the language in the contract that the contracting parties wanted to make the plaintiff a third-party beneficiary. Laclede Inv. Corp., 596 S.W.2d at 42.

In considering indemnification agreements, the court in Sw. Bell Tel. Co. v. J. A. Tobin Const. Co., 536 S.W.2d 881, 884-85 (Mo. App. 1976), recognized that courts in Missouri have not (and should not) construe indemnity contracts to protect against negligence in the absence of such clear expression or where any doubt exists as to the intention of the parties. Id. at 885. The court proceeded to state that “the terms of such indemnification should be scrutinized with even more critical vigor where the benefit accrues to a third-party beneficiary rather than to an original contracting party. Broad, indefinite or general terms are not sufficient to impose contractual indemnification.” Id. This same requirement for clear, unequivocal and unambiguous terms applies here. Laclede Inv. Corp., 596 S.W.2d at 42.

Here, the Contract simply provides that the all-risk insurance “shall include interests of the Owner, the Contractor, Subcontractors and Sub-subcontractors in the Project.” This language is insufficient to support the conclusion that the parties intended that unknown subcontractors would be third-party beneficiaries under the Contract or that they would have a right to bring a breach of contract action against the School District. While the Contract does not define what the term “interests” means here, it is apparent that the provision identifies the type of damages the owner School District might become obligated to pay and not to provide unknown subcontractors with either the right to bring a breach of contract action against the School District or the right to bring a direct action against the School District’s insurer. If the parties’  intention was to allow subcontractors the right to bring direct actions against the insurance company, then they could easily have been listed as additional insureds. They, however, were not. There is insufficient basis to conclude that Drury was a third-party beneficiary under the Contract.

That’s interesting. The subcontractor’s brief cites Knob Noster R-VIII School Dist. v. Dankenbring, 220 S.W.3d 809 (Mo. App. W.D. 2007), in support of third-party beneficiary status.  Knob Noster merely references third-party beneficiary status in a conclusory footnote.  220 S.W.3d at 818 n.3.  The subcontractor’s brief also cites South Tippecanoe School Bldg. Corp. v. Shambaugh & Son, Inc., 395 N.E.2d 320, 323 (Ind. App. 1979) (emphasis added).

Enhanced Deference to Precedent in Construing Certain Form Contracts

These are form provisions.  When courts construe this type of form provision–one that governs numerous transactions (we will here elide attempting to detail the contours of the types of provisions to which this approach applies)–they give greater deference to prior interpretations, even from other jurisdictions.  The court in Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039, 1048 (2d Cir. 1982) (emphasis added), in construing a security, famously noted deference to precedent, “whether it be correct or not as an initial proposition”:

Whereas participants in the capital market can adjust their affairs according to a uniform interpretation, whether it be correct or not as an initial proposition, the creation of enduring uncertainties as to the meaning of boilerplate provisions would decrease the value of all debenture issues and greatly impair the efficient working of capital markets.

Other precedent follows this approach, e.g.:

  • Feaz v. Wells Fargo Bank, N.A., 2014 WL 503149, at *5 (11th Cir. 2014):

In a case interpreting boilerplate contract language required in trust indentures, we held that “uniform interpretation of standard contract language” was important because it “ensures effective functioning of our financial markets, and begets stability.” Akanthos Capital Mgmt., LLC v. CompuCredit Holdings Corp., 677 F.3d 1286, 1298 (11th Cir.2012) (citing Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039, 1048 (2d Cir.1982)). The same is true of standard-form uniform contract language in federally insured mortgage loans. Consistent interpretation of a standard-form contract provision required for all FHA-insured mortgage loans across the country is important to the effective and stable functioning of the mortgage market.

  • Mass. Mutual Life Ins. Co. v. Certain Underwiters at Lloyd’s of London, 2010 WL 2929552, at *5 (Del. Ch. 2010):

Because fidelity bonds are instruments of commerce with relatively standardized terms, their language should be construed with appropriate regard for the value of uniform interpretation.

This author will leave it to the interested reader to pursue more supporting authority.

So, What Does the Precedent Say?

So let us put the client’s brief in the context of the discussion in Shambaugh–authority cited by the subcontractor.  Shambaugh discusses the following provisions.

11.3.1 Unless otherwise provided, the Owner shall purchase and maintain property insurance upon the entire Work at the site to the full insurable value thereof. This insurance shall include the interests of the Owner, the Contractor, Subcontractors and Sub-subcontractors in the Work and shall insure against the peril of Fire, Extended Coverage, Vandalism and Malicious Mischief. (Subparagraph)

Seem familiar?  As noted above, the subcontractor’s brief at *2 describes the contract in the following language (bullet points omitted):

The Contract, AIA Document A201-97, at §11.4 et seq., provides, in pertinent part:

[Respondent] shall purchase and maintain… insurance written on a builder’s risk “all-risk” or equivalent policy… [that] shall include the interests of the. . Subcontractors… in the Project.

So, it should not be surprising that the language would be the subject of litigation elsewhere. OK, so what does Shambaugh state concerning the import of this language?  First let us turn to the court’s discussion of the arguments–the defendants include the contractor and subcontractors:

The Defendants submit that subparagraph 11.3.1 of the General Conditions obligated South Tippecanoe to purchase and maintain property insurance covering the full insurable value of the project including the interests of the owner, contractor, subcontractors, and sub-subcontractors. In suing the co-defendants, contend the Defendants, South Tippecanoe is suing its own insureds an action South Tippecanoe cannot take according to the weight of authority from other jurisdictions and our Third District’s recent Morsches Lumber v. Probst, (1979) Ind.App., 388 N.E.2d 284 (transfer pending), decision. Defendants further submit that by reason of subparagraph 11.3.6 of the General Conditions, South Tippecanoe waived all rights against the Defendants. Defendants maintain that the contract provisions evince an intent to place the risk of loss which might arise in the course of construction upon insurance, and respecting damage to the Work, an intent to waive rights among the parties for damages to the Work, except rights to the proceeds of the property insurance required under the contract.

Appellant South Tippecanoe contends that the plain meaning of the contract provisions requires conclusions opposite those of the Defendants. In urging that we confirm builder’s risk insurance subrogation against negligent contractors and subcontractors, South Tippecanoe, though acknowledging Morsches ‘s existence, asserts, “There remains no ruling Indiana precedent on this issue.” South Tippecanoe argues that foreign jurisdiction cases, the “prevailing custom and practice in our state, and the strong support in Indiana for subrogation” bolster its position. South Tippecanoe contends that Defendants’ “waiver assertions are also in direct opposition to other specific contract terms and the contract as a whole.” Finally, it is alleged that provision 11.3.6 is either definite or ambiguous: if not ambiguous, South Tippecanoe avers, the language is “clear” and “contains no provision compeling (sic) the Owner to waive rights against Subcontractors and Sub-subcontractors,” nor against the architect, Shaver; if 11.3.6 is found ambiguous, “the question of construction is one of mixed law and fact, precluding summary judgment.”

So, in the court’s view, is this an agreement that inures to the benefit of a subcontractor, so that a claim against the subcontractor would be barred?  Yes (note Shambaugh is a subcontractor):

These tests when applied to the construction contract here require our conclusion that the contract involved is subject but to this reasonable construction: it evinces an intent to place any risk of loss on the Work on insurance; the Defendants are intended “insureds” under the builder’s risk policy; and, the waiver provisions are fully applicable here. This conclusion is consistent with the evolving Indiana rule represented by Morsches and cases from other jurisdictions which represent what we think is the better rule.

We agree with the suggestion of defendant Shambaugh that provisions of Article 11 of the General Conditions reveal a “studied attempt” by the parties to require construction project risks to be covered by insurance and to “allocate among the parties the burden of acquiring such insurance.”

Let us look at a thoughtful discussion of the pertinent provisions of model terms provided by another court, in Temple EasTex, Inc. v. Old Orchard Creek Partners, Ltd., 848 S.W.2d 724, 730-31 (Tex.App.–Dallas 1992):

Section 11.3.6 of the contract operates as a waiver as to all rights of the owner and contractor against the subcontractors for damages caused by fire or other perils to the extent that such damages are covered by insurance obtained pursuant to section 11.3.1. Section 11.3.1 places an affirmative duty upon the owner to procure property insurance that covers the interests of the owner, the contractor, and the subcontractors. Commercial Union Ins. Co., 851 F.2d at 101; United States Fidelity & Guar. Co., 762 P.2d at 642. If the owner fails to purchase adequate insurance and fails to notify the contractor that the project is underinsured, the owner bears the risk of loss to the extent that damages are not covered by insurance. Steamboat Dev. v. Bacjac Indus., Inc., 701 P.2d 127, 128 (Colo.App.1985). The policy underlying these clauses is to avoid disruption and disputes among the parties to the project. The need for lawsuits between the parties is eliminated because all contracting parties are protected from property loss under the owner’s property insurance. Tokio Marine & Fire Ins. Co. v. Employers Ins., 786 F.2d 101, 104 (2d Cir.1986); see also United States Fidelity & Guar. Co., 762 P.2d at 642.

There is other authority to the effect that these provisions are designed for the benefit of a subcontractor, e.g., Cont’l Cas. Ins. Co. v. Darella Elec., Inc., 2010 U.S. Dist. LEXIS 11437 (D.N.J. 2010) (stating, in rejecting a subrogation claim brought against a subcontractor, “Thus, the critical question on this motion for summary judgment is, does the Insurance Provision’s waiver provision run in favor of Darella, such that Darella can assert it as a defense against Continental Casualty’s negligence claim?  The Court concludes that it does.”); Midwestern Indem. Co. v. Systems Builders, Inc., 801 N.E.2d 661 (Ind. App. 2004) (quoting Shambaugh).

By Happy Coincidence, the Traditional Analysis Is Sensible

Finding the subcontractor a third-party beneficiary is a sensible outcome.  Otherwise, the subcontractor needs to check whether insurance benefiting it has been obtained by others.  If it can’t be sure, then one gathers it would need to obtain that insurance itself.  Of course, that cost would need to be priced-into a bid.  Because the subcontractor could not necessarily determine whether someone else would have obtained insurance covering it, the subcontractor when bidding would need to price-in obtaining the insurance (at least if it were adequately informed as to the issue).  So perhaps the client would end-up paying twice.  We’ve discussed this problem before.

We have yet to hear a thoughtful reason why the parties would have bargained for arrangements yielding this inefficient conduct. Nor have we heard a thoughtful discussion of what the client believes the pertinent language actually requires.  And one expects that had the issue even been expressly considered in negotiation as to the engagement of the prime contractor, the parties would not have chosen to alter the form, understanding that prior authority indicates the form provides third-party beneficiary status to subcontractors.

By the way, those interested in seeing an amusing discussion of the extent to which sophisticated parties in fact are reluctant to deviate from accepted form terms should take a look at Mitu Gulati & Robert E. Scott, The 3-1/2 Minute Transaction (2013).

Third-Party Beneficiary for Waiver of Subrogation but Not Agreement to Obtain Insurance?

A final matter merits attention.  It would appear that a number of the cases addressing third-party beneficiary status arise in the context of a subrogation claim by the insurer.  So, those cases may reference the model provision in question in Drury and also a separate provision concerning subrogation.  A thoughtless observation would be that it’s a different provision at-issue in some cases.  So, the argument would go, the subcontractor is a third-party beneficiary as to some clauses but not others.

These clauses are part of an integrated whole, the objective of which is to allocate to an insurer various costs and to put on the client the obligation to obtain that insurance.  Understanding that it the ultimate objective, there is no reason to conclude the subcontractor is a third-party beneficiary of some of these integrated provisions but not others.

More to the Story

There are a number of issues in this case.  One we have not yet addressed is the new brief’s discussion of the writing requirement (which was the subject of the first post on this case).  We’ve gone on enough for this week.  We will perhaps return to this case, to address that issue, in a later post.