On July 5, 2016, the United States Court of Appeals for the First Circuit (“First Circuit”) in the case of Pacific Indemnity Company (“Pacific”) v. John Deming (“Mr. Deming”) reversed a decision of the United States District Court for Massachusetts (“district court”) that ruled a condominium association bylaw that required unit owner’s to obtain property insurance with waiver of subrogation clauses barred an insurer from subrogating its $350,000 loss against another condominium owner’s tenant who had negligently caused the loss.
The First Circuit’s ruling is the first case in Massachusetts deciding the extent a condominium’s bylaws and master deed requiring waivers of subrogation applies to tenants of condominium owners. The court ruled that condominium bylaws require waivers of subrogation do not necessarily operate to protect all tenants in a condominium complex from property damage claims arising out of their negligence.
You may want to read why some of your insureds could have a potential uncovered risk from waiver of subrogation agreements as a result of this court decision
The decision also, however, potentially creates uncovered risks for insureds who have contracts requiring insurance policies containing waivers of subrogation. An explanation of this risk appears as the last section of this post.
Leaving a tub’s water running all night leads to $350,000 flood loss to condominium below
When Trinity Place was built in 1999, it established a benchmark in Boston condominium prices. These condominiums, located on Copley Square, next to the Boston Public Library, with expansive views of Trinity Church and the Boston skyline still offer one of the most desirable residential addresses in the city.
In 2010, Mr. Deming leased the eighteenth floor penthouse unit at Trinity Place for $16,000 per month.
On May 27, 2013, Mr. Deming fell asleep after turning on the faucets to fill the bathtub in the condominium’s master bathroom. By the next morning, the running water had overflowed all night and caused considerable damage to the unit below, Unit 1601.
Pacific, a Chubb subsidiary, insured the owners of Unit 1601. As a result of Mr. Deming’s negligence, Pacific paid the owners $351,159.01 for the water damage to that unit.
In 2015, Pacific brought a subrogation suit in the district court against Mr. Deming seeking to recover its loss payment plus interest. Mr. Deming’s tenant’s policy insurer, State Farm, defended its insured arguing that Pacific had no right to recover based on the terms of the waiver of subrogation requirement in the Trinity Place Condominium bylaws and master deed.
Competing clauses for subrogation and waiver of subrogation
In Pacific’s lawsuit, no one disputed that an insurer, such as Pacific, who pays an insured’s claim “succeeds to any right of action the insured may have against the parties allegedly responsible for the loss.” The dispute arose over the provision of Massachusetts law that provides that a subrogating insurer’s rights are “no greater than the rights of the insured” and are “subject to any defenses that would bar” the insured’s right of action.
Pacific’s policy contained the company’s subrogation rights in a section called “Transfer of rights,” that began:
All of your rights of recovery will become our rights to the extent of any payment we make under this policy.
The policy’s transfer of rights section, however, granted the insured the right to waive Pacific’s subrogation rights by its final sentence that stated:
… [the insured] may waive any rights of recovery from another person or organization for a covered loss in writing before the loss occurs.
Mr. Deming’s argued the waiver of subrogation contained in the Pacific’s insurance policy applied in this case and prohibited Pacific’s claim against him. Mr. Deming took the position that “the obligation to secure insurance policies with such waivers is a requirement of the condominium association” and pointed to the Declaration of Trust of the condominium association, Trinity Place Condominium.
The Declaration of Trust provided in Paragraph 3.E of its bylaws:
Each Unit Owner shall carry insurance at his own expense for his own benefit insuring, [the Owner’s personal property].
The bylaw provision also stated that:
all such policies shall contain waivers of subrogation…
Judge in district court finds that waiver of subrogation applies
Mr. Deming argued to the district court that “[b]y agreeing to the requirements of the condominium association, Pacific’s insured purchased an insurance policy that permitted waiving the right of subrogation.”
The district court agreed that condominium unit owners “were required, unconditionally, to obtain insurance with a waiver of subrogation” and that if Pacific’s “insured did not actually obtain insurance with a waiver of subrogation, then at best, its insured breached his or her obligation.”
The district court then ruled that Pacific’s rights to subrogation were waived based on the clause in the bylaws of Trinity Place Condominium Trust’s bylaws that unit owners “shall carry insurance,” and that “all such policies shall contain waivers of subrogation.”
Additionally, the district court held that:
…allowing Pacific to recover from another Unit Owner (or in this case a tenant), because its insured breached his or [her] obligation to obtain insurance containing a waiver of subrogation, would frustrate the clear intent of the condominium bylaws and allow Pacific to benefit from its insured’s breach, an untenable result.”
Based on its decision, the district court entered judgment for Mr. Deming and Pacific appealed to the First Circuit.
First Circuit suggests that waiver of subrogation does not apply to condominium owner’s tenant
Initially, the First Circuit suggested that the plain language of the Bylaws, Master Deed, and Declaration of Trust, that required waivers of subrogation did not necessarily apply to condominium tenants. The bylaws did provide that “[e]ach Unit Owner shall carry insurance …all such policies shall contain waivers of subrogation.”
However, the First Circuit noted that the terms of this clause do not specify the scope of the subrogation rights to be waived.
The First Circuit did not, however, find that it had to decide this issue. Instead, the court ruled that the waiver of subrogation in Pacific’s policy required the unit owners of Unit 1601 to have actually executed a waiver of subrogation.
The condominium’s bylaw and the policy’s terms did not amount to an actual waiver of subrogation
Pacific claimed that its policy language, which provided that the insured “may waive any rights of recovery from another person or organization for a covered loss in writing before the loss occurs,” was not “self-effectuating” but rather “merely authorized plaintiff’s insureds/subrogors to enter into separate agreements which waive subrogation against particular ‘persons’ or ‘organizations.'”
The First Circuit agreed finding that “nothing in the record suggests that Unit 1601’s owners actually waived their insured’s subrogation rights.”
Based on this fact the First Circuit found that all the record showed was that:
- Paragraph 3.E of the bylaws required unit owners to procure insurance that contains “waivers of subrogation.”
- Pacific’s policy includes that the insured “may waive any rights of recovery from another person or organization for a covered loss in writing before the loss occurs.”(Emphasis added in opinion).
The First Circuit then reasoned that these two provisions the Bylaw and the policy’s waiver of subrogation clause, when read together, did not amount to an actual waiver of subrogation stating:
Pacific’s policy merely giving the insured the option to waive rights of recovery cannot be read as a waiver of subrogation. And the only way to understand Paragraph 3.E as constituting a waiver of subrogation, as Mr. Deming does, is to read the requirement to purchase insurance with a waiver of subrogation as itself being a waiver of subrogation. But that reading is contrary to the plain text, and we reject it.
The First Circuit then ruled that Mr. Deming presented no evidence that Unit 1601’s owners had actually waived their insurer’s subrogation rights against tenants, such as Mr. Deming, by issuing a writing waiving subrogation. Without this written waiver having been issued to Mr. Deming, the court saw no bar to Pacific pursuing its subrogation suit against Mr. Deming. As a result, the final ruling by the First Circuit was: “We reverse the district court’s order and remand.”
Decision as creating uncovered risk for insureds who are contractually obligated to obtain waivers of subrogation
In this case, the district court found that unit owners “were required, unconditionally, to obtain insurance with a waiver of subrogation” and that if Pacific’s “insured did not actually obtain insurance with a waiver of subrogation, then at best, its insured breached his or her obligation.” As a result, the district court held that “allowing Pacific to recover from another Unit Owner (or in this case a tenant), because its insured breached his or [her] obligation to obtain insurance containing a waiver of subrogation, would frustrate the clear intent of the condominium By-laws and allow Pacific to benefit from its insured’s breach, an untenable result…”
The First Circuit disagree that such a result would be “untenable” since it seemed entirely consistent with the plain language of both the insurance policy and the bylaws.
The potential liability arises out of both the district court and the First Circuit finding that the failure of the insured to actually complete a proper waiver of subrogation would be a breach of contract by the insured. Although the two courts agreed on the breach, they disagreed on the remedy”
- The district court held that the insurer should not “benefit from its insured’s breach.”
- The First Circuit, instead ruled that the insurer could sue because there was no actual waiver of subrogation but that the insured who did not provide a contractually required waiver could be sued for breach of contract.
To paraphrase the out-of-state decision, the First Circuit quoted, “while the [defendant] may counter-claim for breach of contract [against the insured], any alleged breach [of contract by the insured] … in failing to waive subrogation does not preclude [the insurer’s subrogation] suit.”
In view of the First Circuit’s ruling, agents may wish to advise insureds who will likely enter into agreements that require waivers of subrogation about the differing provisions in insurance policies. If the policy allows for waivers of subrogation, the agent and insured should carefully review the conditions precedent to create a valid waiver.
For example, ISO commercial general liability form CG 24 04 10 93, demonstrates a self-actuating waiver of subrogation. This form states, in part:
We waive any right of recovery we may have against the person or organization shown in the Schedule above because of payments we make for injury or damage… This waiver applies only to the person or organization shown in the Schedule above.
In the case of an endorsement form such as this, there is no need for any action by the insured except verifying that the proper parties against whom subrogation is waived appear on the endorsement’s schedule.
In the Pacific policy, the waiver of subrogation required the waiver to be made to a specific party “in writing before the loss occurs.”
Where a policy has waivers of subrogation, like the Pacific policy’s term, an insured who fails to execute and deliver a written waiver of subrogation as required under the policy runs a risk. If a covered loss occurs and that insured’s carrier initiates subrogation against a third-party entitled to have receive a waiver of subrogation, that insured will likely be sued by that third-party for breach of contract.