Inside this Issue

A1 - A Demand Letter to an Insured Architect and Others was not Deemed to be “Claim” that had to be Reported to the Professional Insurance Carrier
A2 - Insurance Carrier could not assert the Contractual Liability Exclusion to Deny Coverage for Breach of Contract Claim that arose out of Negligence
A3 - Parties Waived their Contractual Rights to Arbitrate

Article 1

A Demand Letter to an Insured Architect and Others was not Deemed to be “Claim” that had to be Reported to the Professional Insurance Carrier

See similar articles: Claim | demand | Insurance Dispute

Insurance carrier denied coverage under an insured’s professional liability policy because the carrier believed the design professional failed to timely file the claim when it first knew of it, based on a demand letter sent by the project owner to a number of different entities alleging problems with an HVAC system and water intrusion from the floor and roof. The Architect explained that it didn’t report the demand letter to the carrier because it asserted problems with the project caused by others and which were outside the Architect's scope of services. When the Owner ultimately filed a complaint naming all entities, including the Architect, the Architect tendered the complaint of the carrier for coverage. The carrier filed a declaratory judgment action asking the court to declare that it owed no duty to defend or indemnify the architect due to untimely notice of the claim. The court denied the requested judgment because it stated it was not clear whether the demand letters that went to numerous entities contended that the Architect, and not others, performed the defective work.

The carrier argued that the Architect failed to timely report the Owner’s demand letters and therefore did not trigger coverage under the policies. It says that based on those demand letters, a Claim was first made against the architect during the 2016-17 policy period, but only reported the Claim during the 2017-18 policy period after the Owner filed suit. Based on that assertion, the carrier asserted that the initial Claim was made in one policy period but reported in another and, the Architect, therefore, would not quality for coverage under either policy.

In opposition the carrier’s argument, the architect argues that it qualifies for coverage under the 2017-18 policy, as the underlying suit was the first Claim it received and it promptly notified the carrier of that Claim. The court denied the carriers motion of judgment “because a dispute of material facts exists whether the Church’s demand letters amounted to a Claim alleging a Wrongful Act o the part of the [Architect].” The court concluded, “there is only a tenuous link between the issues raised in the [demand] letters – complications with the HVAC system and water leaks – and – Architect’s professional liability.”

In support of its position that the first it knew of a Claim against it was when the Complaint was filed, the Architect submitted an affidavit by one of its principals attesting that the Architect “had no role in the design or construction of the civil sitework for the Project including any landscaping or exterior drainage systems … and at no point during the February 2017 meeting, or at any time afterwards until I was served with the underlying lawsuit, did any person allege any negligent act or any error or omission by [Architect] with respect to the professional services provided by [Architect] on the Project.” In support of its affidavit the Architect attached its “Scope of Services Agreement.”

The court concluded, “it is thus unclear whether the scope of the allegedly defective work outlined in the demand letters claimed any problems with the work [Architect] completed as part of its Professional Services. This coupled with the fact the letters were addressed to multiple recipients allegedly responsible for the identified defects, highlights a material dispute whether the demand letters amounted to Claims against [Architect] by alleging [Architect] specifically completed defective work, rather than one or more of the other individuals listed therein.” For these reasons, the court denied the insurance carriers motion for summary judgment. Architrave, Inc. and Mount Moriah Missionary Baptist Church, Slip Copy , 2021 WL 1863259 (South Carolina 2021)

Risk Management Comment:

When an Insured receives a letter like the one involved here, it may submit that letter to its professional liability carrier as a notice of a “circumstance” that might later turn into a claim. If a later claim is, in fact, made against the Insured, it should be covered because it was reported early as a “circumstance” to the carrier. In addition, some (perhaps many) professional liability carriers provide their Insured design professionals with “pre-claims assistance” or “loss control/prevention” services at no additional cost. When an Insured receives a letter similar to the one sent to the Architect in this case, even if it does not appear to be an actual “claim” against the Insured, the design firm can submit the letter to its insurance carrier and request that it be noted as a “circumstance” of a potential claim, or it may request that it be handled as pre-claim assistance by the carrier. Assistance can then be provided for the Architect and if a “Claim” is later filed, this may help to avoid coverage disputes like the one discussed in this court decision.

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with ConstructionRisk Counsel, PLLC) representing design professionals, contractors and project owners. He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk Report, Vol. 23, No. 7 (November 2021).

Article 2

Insurance Carrier could not assert the Contractual Liability Exclusion to Deny Coverage for Breach of Contract Claim that arose out of Negligence

See similar articles: Contractual Liability | Hiscox | Insurance Dispute | professional liability insurance

The contractual liability exclusion in a professional liability policy is often used by carriers to deny coverage for liability of the Insured design professional (DP) that arises out of the indemnification article of a contract. For example, if the DP agrees to indemnify for damages arising out of all performance instead of limiting the indemnity to damages to the extent caused by its negligence, the contractual liability exclusion applies and there would be no coverage for that. But what about a complaint by a client that alleges the DP breached its contract due to negligent performance of its professional services. Is a claim for such breach of contract action also denied coverage? A federal district court in Oregon decided that the answer is “no” when allegations of negligence are involved. Pinnacle Architecture, Inc. v. Certain Underwriters at Lloyd’s, 2021 WL 2418561 (U.S. D.C., Oregon 2021)

An architect signed a contract to provide professional services to design a psychiatric hospital. The client had executed a guaranteed maximum price (GMP) contract with a contractor to perform the construction. The GMP pricing was increased by change order due to changes in the construction that had to be made due to redesigns to meet requirements of the Oregon Administrative Rules (OARs). The revised design also failed to comply with the OAR requirements. The architect then advised its client that “it would be able to obtain waivers from the OAR to address” the issues. The Oregon Health Authority ultimately rejected some of the proposed waivers and this resulted in the Owner having to incur additional construction costs of over $1 million to complete the project in accordance with the OAR requirements.

Lifeway filed claims in Arbitration against the Architect for breach of contract (count I) and negligence (Count II). The breach of contract count alleged that the architect breached the contract “and fell below the standard of care required by the Contract by, among other things, failing to design the Project to meet the design requirements of the State of Oregon, including the OAR requirements for a licensed hospital.”

The negligence count of the complaint alleged that the architect “owed a duty to Lifeways to perform the design services for the Project in accordance with the ordinary standard of care for a licensed architect.”

Architect provided notice to its insurance carrier of the claim and instead of agreeing to defend the claim, the carrier stated there was no coverage under the Policy for the allegations because the breach of contract exclusion. The exclusion in question provided the following:

“We will have no obligation to pay any sums under this Coverage Part, including any damages or claim expenses, for any claim: ... based upon or arising out of any actual or alleged breach of any contract or agreement, or any liability of others that you assume under any contract or agreement; however, this exclusion will not apply to any liability you would have in the absence of the contract or agreement.”

“[Insurance carrier] argues that the Exclusion applies because (1) all claims against Plaintiffs are based upon or arising out of the alleged breach of Plaintiffs’ contract with Lifeways, and (2) that all damages sought by Lifeways are based on the alleged breach of contract. Defendant also argues that the exception to the Exclusion does not apply because there are no allegations against Plaintiffs in the underlying action for potential liability absent the contract.” The court notes that “[Carrier] argues the negligence claim arises out of the Lifeways-Pinnacle Contract because the second supplement to the contract expressly requires Plaintiff’s to meet OAR design requirements.”

In response to the argument described above, the court found, “Defendant is correct that the [ ] Contract includes a specific obligation to meet OAR design requirements But Defendant misses that [Architect] would have owed Lifeways this, and other duties, even if the parties had not included this obligation in their contract.” “In Oregon, architects owe a professional duty of care to their client that exists independent of contractual obligations.” The court concluded:

“Here, the allegations in the Complaint and Amended Arbitration Agreement, without amendment, could impose liability under a tort or contract theory. As architects, Plaintiffs owed Lifeways a professional duty of care independent of the contract. Although the parties’ relationship arises out of the contact, Plaintiffs’ duty of care and potential liability does not arise out of the contract but is imposed by law and exists because of the nature of the parties’ relationship. Lifeways can clearly establish a breach of contract claim, but the allegations in the complaint also support a negligence claim, that could be broader than the alleged breach of contract.”

The final conclusion of the court was that the complaint “allegations state a claim for negligence which the Policy covers. The exclusion does not apply ….”

Risk Management Comment:

Most insurance policies have what is known as the contractual liability exclusion. It is generally understood that this exclusion addresses liability arising out of indemnification obligations where an Insured agrees to indemnity its client and others for liability the Insured would not have had under common law in the absence of the indemnity agreement. The “breach of contract” exclusion quoted by the court in the instant decision, however, appears to be broader than this. As interpreted by the Insurance carrier, the exclusion was broad enough to bar coverage for any breach of contract claim against an insured even if due to the Insured’s negligence. Defense counsel who have defended design professionals in breach of contract actions where insurance carriers have paid their attorneys fees are probably a bit surprised by this.

Many states have what is known as the economic loss doctrine that prevents design professionals from being sued for “negligence” when the negligent services were performed under a contract with the party bringing the suit. Instead, the injured party is required to file a breach of contract action against the design professional alleging that through its negligent acts, errors and omissions, the design firm breached the contract. When a plaintiff files a complaint containing both a negligence count and a breach of contract count, defense attorneys may file a motion to dismiss the negligence count, and assuming the motion is granted, the case then goes forward to trial only on breach of contract count.

There are numerous advantages to requiring suits to be based on breach of contract instead of negligence. The design firm may by good contract language have negotiated favorable terms and conditions that it wants to apply in defending itself in the suit. Since those are part of the contract, they may control the outcome of litigation on the breach of contract Count. But if a separate count can go forward on negligence, it may be possible that it stands apart from the contract language, and the design firm might, therefore, have greater liability than it would under the breach of contract Count of the complaint.

Article 3

Parties Waived their Contractual Rights to Arbitrate

See similar articles: Arbitration | disputes procedures

A contract between a homeowner and contractor set forth dispute resolution procedures calling for any dispute to be submitted to an Independent Decision Maker within twenty-one days of the occurrence of the event giving rise to the claim. Receipt of an IDM decision was a condition precedent to mediation, and mediation was a condition precedent to arbitration. The Owner, however, brought a complaint against the contractor in court, completely ignoring the contract dispute process. The contractor filed a motion to dismiss the complaint, arguing that the contract stipulated arbitration not litigation, and the trial court granted the motion. This was reversed on appeal. Leder v. Imburgia Construction Services, Inc. 2021 WL 3177338 (Fla. 2021).

The appellate court conclude that the arbitration provision had been waived by both parties. The court found that either party had the ability to initiate a claim with the IDM because the dispute affected both parties and was related to the construction contract. The contractor waived its right to arbitrate based on its pre-litigation action and the language in the contract. Specifically, the contractor failed to file a claim with the IDM and it therefore could not mediate or arbitrate. The court therefore remanded this to the trial court with instructions to order the Contractor to answer the Owner’s complaint and proceed through the litigation.

Comment: It should be noted here that the contractor sought to require this dispute to be resolved through arbitration. Once again I will remind our readers, that our firm ConstructionRisk, LLC reviews and redlines well over 2,000 contracts per year for our clients and we routinely strike out the arbitration clause and replace it with litigation. We think the parties here may ultimately be pleased that this particular dispute is decided through litigation instead of arbitration.

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