A Trap for the Unwary Contractor: The New AIA Insurance Exhibit and Its Most Confounding Requirements

While the drafters of the new Exhibit purport to limit uncertainty and address the growing complexity in the construction-insurance marketplace, they may have created another set of problems: namely, the new insurance forms require contractors to procure insurance coverage that may not exist in the marketplace.  This article highlights five of the most problematic new requirements and suggests modifications to the proposed Exhibit to remedy problems resulting from its sets of form promises.

A. Protecting Against Expensive or Unavailable CGL Policy Provisions

Arguably the most drastic new requirements relate to the Contractor's promise to procure CGL coverage. The Exhibit states that the CGL policy may not include certain provisions and endorsements that operate to limit coverage. Notably, the Exhibit  prohibits (1) eliminating the subcontractor exception to the work-performed exclusion; (2) endorsements that exclude coverage for prior work and prior injury; and (3) exclusions related to earth movement, habitational construction, and exterior insulation finishing systems. This all sounds great on paper--what Contractor wouldn't prefer broader CGL coverage?

The trouble is that the Exhibit does not account for adverse insurance market conditions. In some geographic areas, a CGL policy lacking one or more of these exclusions or endorsements is completely unavailable. In others, a Contractor will often lack sufficient bargaining power to make such a policy commercially feasible. The AIA drafters also take for granted that all Contractors will be sophisticated enough to understand what coverage their CGL policy even provides. The insurance industry is unlikely to change its tune simply because the AIA contract documents say it should.

These potential pitfalls can be largely avoided by amending the Exhibit Section A.3.2.2.2 to mandate CGL policy language only "where commercially available and reasonably priced."

B. Avoiding a Requirement to Procure Decade-Old AI Forms

In addition to requiring expensive and potentially unavailable CGL coverage, the Exhibit mandates that the Contractor's CGL policy name the Owner, Architect, and Architect's consultants as additional insureds. Although the general demand for AI coverage is not new, the CGL policy now specifically states that the AI coverage must meet or exceed that granted by the 2004 ISO AI forms. Why the 2004 forms? Because those forms provided the broadest level of coverage to additional insureds. Unlike the 2004 forms, the current ISO AI forms provide that any applicable state statutory or case law purporting to invalidate AI coverage trumps the AI endorsement. The current forms further provide that limits of coverage are controlled by the construction agreement rather than the CGL policy.  Additionally, the insurance market resists adding architects and other professionals as additional insureds, meaning that the contractor may be forced to provide AI coverage to parties with whom the Contractor is not in contractual privity, or face the potential for breach of contract for failure to comply with the contract documents.

To prevent a wild goose chase to find the fourteen-year-old forms, Contractors should amend the Exhibit Section A.3.1.3 to make clear that the current ISO AI forms are acceptable to satisfy the Contractor's obligations under the agreement.

C. Protecting Contractors from Extended Coverage Periods

The CGL policy coverage problems described above are exacerbated because not only must the Contractor obtain policies that may not be commercially available and at an increased cost, it must now maintain the policy "until the expiration of the period for correction of Work as set forth in Section 12.2.2 of the General Conditions." This extends the Contractor's time for maintaining a CGL policy for at least one year, as the General Conditions include a one-year corrective period after substantial completion. Thus, the Contractor may be required to maintain CGL coverage several years after the building has been put to its intended use.

The problem is that the CGL policy is an occurrence-based, year-to-year policy and is not project specific. So, not only are contractors being forced to pay more for coverage under the Exhibit, that coverage must be held for what may be a substantially longer period. Moreover, CGL policies are constantly changing, so the contractor's obligation to maintain CGL coverage may become even more onerous depending on future market conditions.

Contractors may avoid this risk by amending the Exhibit Section 3.2.1 to require coverage only through substantial completion, or to a specified future date that does not require the Contractors to purchase an additional policy.

D. Protecting a Contractor's Rights as an Insured Under Builder's Risk Policies

It is not surprising that the AIA drafters would seek to increase comfort and certainty for owners with respect to required Builder's Risk insurance--coverage that protects insurable interests in materials, fixtures and/or equipment being used in construction or renovation. The new AIA insurance exhibit attempts to do this in a variety of ways.

First, it requires in Section A.2.3, "Required Property Insurance," that the Owner procure builder's risk coverage and that such insurance will "include the interests" of the Owner and others including Contractors "as insureds." Second, an optional series of form sections further require that the insurance products for loss of use, business interruption, delay and soft costs coverages (typically all as part of a BRI policy) act to "reimburse the Owner." Finally, in the event that the Contractor acts to purchase BRI coverage, the Exhibit requires that the Owner adjust and settle the loss, omitting the Contractor completely from this process.

The risks of these combined exhibit terms should be clear to any Contractor.  Facing a large loss in the middle of a construction project, a Contractor will want more than simply its "interests" protected by an Owner--a party with whom it may be at odds yet will have complete control over the adjustment and settlement of insurance proceeds under the AIA Insurance Exhibit. To the contrary, contractors should seek to obtain "insured" status under any BRI policy, an outcome that is uncertain under the ambiguous wording of the new AIA form. Contractors require such status in the AIA Insurance Exhibit so they may have all the rights of insureds, including the ability to adjust any loss directly through an insurer without having to count on the Owner to do so.

These changes can be accomplished through a few simple edits to the Exhibit.  Namely, Contractors should strike from Section A.2.3.1 the phrase "the interests of the" to simply include the listed parties, including Contractors, as insureds.  Second, Contractors should also strike the sentence in Section A.3.3.2.1 which provides that the Owner will adjust and settle losses.

E. Protecting Against Unobtainable Umbrella and Excess Insurance Requirements

In an attempt to secure bulletproof insurance protection, the AIA drafters inserted a provision in the Exhibit which states that Contractors may achieve the required limits for CGL coverage by procuring a combination of primary and umbrella or excess policy provisions.  None of that is surprising--contractors have been satisfying their insurance obligations on construction projects with combined primary and excess or umbrella policies for many years. But there's a catch: the Exhibit only allows combination of these policies to reach an overall coverage amount if the excess policies never "provide narrower coverage than the primary policy."

For several reasons, this directive, while incredibly optimistic, is nearly impossible to satisfy in the insurance marketplace. First, anyone who has dealt with "follow form" excess insurance policies knows that such policies rarely if ever actually follow form.  Even when such policies are issued by the very same insurers as those on the primary risk, such policies often contain conditions which vary from the primary forms and thus offer differing, and in many instances lesser, coverage than the primary policy.  Second, even where Contractors are able to obtain excess coverage which appears to actually follow form, there is no guarantee that courts which interpret such policies will agree.  The decisional law on excess policies is varied, depends upon which jurisdiction is interpreting the policy language, and often leads to unpredictable results.

Picking out any inconsistencies as between primary and excess policies is difficult, requires time intensive review and expertise, and is not the type of searching review that an average Contractor would go through with respect to its common insurance policies. The result is a form promise in the Exhibit which may be impossible to satisfy.  But perhaps the biggest problem with the new excess policy provision is a prohibition on procuring an excess policy that contains a true "exhaustion" condition. Such a policy may be difficult, if not impossible, for a Contractor to negotiate with its carrier. Contractors should therefore be wary of promising to procure an excess policy that will waive the condition of exhaustion prior to providing drop-down coverage.  But a simple change to the current form can act to remove this illusory promise and it is one contractors should consider making to the Exhibit. The Contractor should --(1) prevent the need to harmonize primary and excess or umbrella policies and (2) eliminate the need to procure a policy without an "exhaustion" condition.  This can be accomplished in one fell swoop by cutting all of Section A.3.2.4 after the phrase "[t]he Contractor may achieve the required limits for Commercial General Liability\u2026through a combination of primary and excess or umbrella liability insurance..."

Conclusion

The new Exhibit places Contractors in the difficult position of being required to obtain coverage that is impossible or impracticable to find. With a few carefully placed amendments, however, Contractors can avoid most of the potential pitfalls of the new Exhibit while still agreeing to a reasonable and effective series of insurance procurement obligations.

* The authors thank James Duffy O'Connor for his thorough analysis of this issue and helpful review of a draft of this article. See also James Duffy O'Connor, A Critical View of the AIA's New Insurance Exhibit, J. Am. C. Construction Law. (forthcoming Winter 2018).