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K A T Z   &   S T O N E ,  L . L . P .
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Construction Newsletter
January/February 2008 Volume XVIII  Number 1

WAIVER OF SUBROGATION RIGHTS IN A NEW JERSEY
AIA CONSTRUCTION CONTRACT APPLIES TO POST-CONSTRUCTION LOSSES

Often, owners and contractors on construction projects use the American Institute of Architects' ("AIA") standard form agreements to identify each party's contractual obligations. In Argonaut Great Central Insurance Company v. Di-Tocco Konstruction, Inc., 2007 U.S. Dist. LEXIS 93846 (D. N.J. December 21, 2007), a New Jersey chain restaurant owner ("Owner") entered into an AIA construction contract (the "Contract") with DiTocco ("Contractor") to renovate and remodel a restaurant (the "Project"). The Contract included a general conditions clause providing for the waiver of all subrogation rights between Owner, Contractor and any of Contractor's subcontractors for damage to the restaurant that was covered by insurance.

Five years after completion of the Project, a fire broke out and destroyed the restaurant. An investigation revealed that a subcontractor on the Project had negligently installed a broiler which caused the fire. The Owner's insurance company ("Insurer") covered the loss and paid Owner over $3.2 million on the claim. Shortly thereafter, Insurer sued Contractor and several subcontractors in an attempt to recover the money it paid to the Owner. Contractor and its subcontractors moved to dismiss the lawsuit, asserting that the waiver of subrogation in the Contract precluded Insurer's action. The issue before the U.S. District Court for the District of New Jersey, therefore, was whether the waiver of subrogation applied to post-construction losses.

Broadly, subrogation occurs when an insurance company pays off its insured and assumes any and all rights the injured may have against responsible third-parties; in essence, the Insurer steps into the shoes of the insured. Under the Contract, the parties waived all rights of subrogation against each other and their subcontractors. Thus, when Insurer sued Contractor and its negligent subcontractor, Contractor moved to dismiss the lawsuit on the basis that Insurer could not step into the shoes of the Owner and assert a claim against Contractor because of the waiver of subrogation. Insurer, however, argued that the waiver applied only to losses that occurred during the Project, not to losses occasioned five years after construction ended.

Insurer supported its argument with a string of Massachusetts cases standing for the proposition that a waiver of subrogation did not extend to post-construction losses. Additionally, the insurance company asserted

that a waiver of post-construction losses applied only in situations where the contracting parties agree, in advance, that the owner assumes the cost of post-construction insurance. In Argonaut, the parties did not contemplate post-construction insurance as part of the Contract and, therefore, Insurer reasoned the waiver could not apply to post-construction losses.

The court disagreed with Insurer's position and summarily dismissed its lawsuit, finding the terms of the Contract clear and unambiguous as to the existence of a waiver of subrogation rights. Specifically, the Contract provided for a waiver of subrogation should a loss occur "after final payment" to the general contractor. As such, under New Jersey law the court had no choice but to enforce the terms of the Contract as written. Further, the court examined commentary by the authors of the AIA contract documents instructing that a waiver of subrogation applies not only to policies covering the construction period, but also to property insurance that may replace such construction policies. The waiver was not displaced simply because the Owner purchased a different policy for post-construction liability. Accordingly, the insurance company could not sue to recover any of the $3.2 million paid to the Owner for the loss.

The lesson taken from Argonaut for owners and contractors is an important one. A contract containing a waiver of subrogation generally applies to losses during and after construction. As a contractor may be protected from having to repay an owner's insurance company for a claim arising from that contractors' work on a project, owners should be wary of the full scope of a waiver of subrogation clause before agreeing to it.
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