Subcontractor Default Insurance: The Claims Process and "Other Insurance" Provisions

Subcontractor Default Insurance (“SDI”) continues to capture market popularity since its invention by the Zurich Insurance Company under the name SubGuard.  SDI is an alternative to traditional surety bonding that provides the general contractor (“GC”) protection from subcontractor default through a two-party contract (the GC and the insurer).  

These policies are designed for firms with an annual subcontract volume of $75 million or more, and only then for larger jobs owing to the high deductibles and co-pay layers.  It is not uncommon for policies to require contractors to cover between $350,000 and $2 million as their deductible before any coverage kicks in.  Even after the deductible, SDI policies often have co-pays requiring that the contractor and insurer share up to the first $5 million in costs.  Only after these sums are eclipsed will the insurer fully cover the GC’s costs.  However, these high costs are balanced by shifting the risk of catastrophic loss from subcontractor default away from the GC.  SDI policies also provide a more efficient claims process than bonds by that allows the GC to maintain control in remedying the default.  However, SDI policies contain terms that GCs must be wary of.

I.  SDI Claims

The claims process under SDI is very different from traditional surety bond claims.  In bond claims, an aggrieved GC must submit its notice of subcontractor default to the surety, and the surety then investigates the claim and determines whether a default occurred.  This can be a lengthy and time consuming investigation, and can be very costly to the GC.  SDI, on the other hand, allows the GC to declare the subcontractor in default and then simply proceed with remedying the default without approval from the insurer.  The GC recovers the costs of remedying the default from the insurer, and the insurer pursues its subrogation claim against the defaulted subcontractor.  This process is much quicker than the procedure for bonding claims, and allows the GC to direct the remedies expeditiously to maintain the project schedule.

II.  “Other Insurance” Provisions

Despite the attractiveness of the claims process, GCs entering into SDI policies should take into account that the lack of legal precedent surrounding the use of SDI may leave them open to unknown risks.  Quickly identifying SDI terms that have sparked litigation is key to avoiding the same mistakes.

One of the few cases involving the terms of an SDI policy was decided by a federal judge in the Southern District of Florida.[i]  Issues arose after a subcontractor failed to properly install steel reinforcements in the walls of a high-rise condominium.  Luckily for the GC, this project had three relevant insurance policies.  The first was the commercial general liability policy capped at $2 million each occurrence and $4 million general aggregate.  The subcontractor’s default surpassed this amount.  The second was ACE’s excess liability policy capped at $25 million for each occurrence and general aggregate.  Finally, there was Zurich’s SubGuard SDI policy which was capped at the same $25 million limit.

One of the issues was Zurich’s “Other Insurance” clause, which is uniformly employed in SubGuard’s policy documents, detailing:

This insurance shall be excess only and non-contributing over any other valid and collectible insurance available to you, whether such insurance is stated to be primary, pro rata, contributory, excess, contingent or otherwise, unless such other insurance is written only as a specific excess insurance over the limits of insurance provided in this Policy.[ii]

Essentially, Zurich wanted to ensure its policy remained a last resort of sorts, only granting recovery if all other insurance policies had been exhausted.  ACE sought to preclude the GC’s recovery under ACE’s $25 million policy by forcing the GC to recover from Zurich’s SubGuard policy.  Unfortunately for ACE, its policy did not contain the explicit language required to demonstrate it was the specific excess insurer of the SubGuard policy, and the GC was permitted to recover on the ACE policy instead of Zurich’s policy.

This case illustrates one use of the “Other Insurance” provision, which here allowed Zurich to first reimburse the GC for all the costs of remedying the subcontractor’s default, and second to go after the other insurer (ACE) to recover those costs they reimbursed.  Zurich can now recover from a deep-pocketed insurance company for the costs incurred under the SubGuard policy, instead of going after the subcontractor.  As far as the GC is concerned, the costs of remedying the default are reimbursed.

GCs should be aware of another possible use for “Other Insurance” provisions:  the SDI insurer could force the GC to pursue another insurance company for its losses in remedying the subcontractor’s default.  In the above case, Zurich could have elected not to reimburse the losses for remedying the default up front, choosing instead to hide behind the “Other Insurance” provision and forcing the GC to turn to ACE for its recovery.  While this behavior has not been litigated, it is unsurprising that one of the first SDI terms seeing a courtroom is the “Other Insurance” provision.

COMMENT:  Both general contractors and subcontractors need to be aware of the increased use and utility of SDI policies.  While the claims process may prove advantageous for general contractors, some terms employed in the standard SDI policies should be a red flag, and should be specifically negotiated to ensure parties form a clear understanding of the parameters of the employed language.

[i] Pavarani Constr. Co. v. Ace Am. Ins. Co., 2015 U.S. Dist. LEXIS 22579 (2015).

[ii] Id. at 8-9.

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