“That’s a Wrap!” How Wrap-Up Insurance Policies Have Streamlined Construction Defect Litigation

Authored by Michael P. Zech, San Diego Partner

Construction defect litigation was traditionally slow-moving, contentious, and costly for several reasons.

First, the sheer number of parties—the property owner, the general contractor, and many subcontractors—typically involved in the litigation made prompt and efficient resolution difficult.  With so many parties having various interests that sometimes aligned with but frequently diverged from other parties’ interests, it was difficult to quickly come to a resolution that all the parties and their lawyers could agree on.

Second, emotions frequently came to a head.  The owner might have felt betrayed by the general contractor.  The general contractor might have been angry that its workmanship was being called into question and felt betrayed by its subcontractors whose workmanship might have been shoddy.  And the subcontractors, many of whom likely had smaller operations, might have been angry their workmanship was being called into question but also terrified that a key business relationship with the contractor could be irreparably damaged and, perhaps, cause them to go out of business.

Add in the occasional lack of contractual formalities between the parties, lawyers who were involved in the litigation but who rarely practiced construction law, “Right to Repair” laws that were often flouted by litigants and their lawyers, and the various insurance policies held by the litigants that might come into play, and you had all the trappings of a complicated—and messy—litigation.  With litigation already a costly proposition, a complicated and protracted construction defect dispute could have long-term effects on litigants’ finances and ongoing operations.

But today, thanks to the prevalence of wrap-up insurance policies, most construction defect disputes proceed in a more streamlined fashion than disputes of days past, allowing the parties to resolve their disputes quicker and cheaper.  By providing a unified and fixed pool of money to litigants with which to fund the litigation and any resolution of it, wrap-up insurance policies have changed litigants’ strategies and behaviors.  Simply stated, there’s nothing they can do to increase the amount of money available to them to fund or resolve a case.  These altered strategies and behaviors manifest in several ways, all of which have helped to streamline the construction defect litigation process.

This article discusses four ways wrap-up insurance policies have improved the construction defect litigation process by streamlining it.

A wrap-up insurance primer

Before examining how wrap-up insurance policies have streamlined construction defect litigation, a brief overview of wrap-up insurance is in order.

Wrap-up insurance refers to centralized insurance programs that can cover a property owner, a general contractor, and subcontractors under a single insurance policy.  Such policies gained popularity in the mid to late 1990s and have since become increasingly common, if not the norm.  They came about because of the outrageous cost of construction defect litigation and the difficulties many subcontractors had securing the right type and amount of insurance before being able to work on a job.  Wrap-up policies are commonly used for large single site projects but can be adapted to insure multiple projects under a single program.

The programs typically come in one of two forms.  In an owner-controlled insurance program (“OCIP”), the owner sponsors and controls the program and is the first named insured.  Other parties, like the general contractor and subcontractors, are also named insureds.  In a contractor-controlled insurance program (“CCIP”), the general contractor sponsors and controls the program and is the first named insured.  Subcontractors and other parties are often named insureds, but the owner could be an additional insured or a named insured.

Though conceptually simple, wrap-up insurance has changed the face of construction defect litigation when the parties are covered by such policies.

Wrap-up insurance reduces the claims filed in construction defect litigation

One way that wrap-up insurance has streamlined construction defect litigation is by reducing the number of claims filed by the parties.  The litigation process can proceed faster because fewer claims need to be disputed, litigated, and resolved.

In construction defect litigation without wrap-up insurance, a general contractor would typically want to bring in as many subcontractors as co-defendants/cross-defendants as it could based on the plaintiff’s claims.  Many of these subcontractors—but usually not all of them—would have their own insurance policies that could have contributed money towards a settlement of the case and allowed general contractors to minimize or eliminate their potential legal liability and financial contributions towards a global settlement if they could show these additional defendants were liable for the defects at issue.  With these additional claims came more lawyers causing friction and racking up fees, more squabbles, and more finger-pointing.

In litigation where there is wrap-up insurance, these additional claims are usually unnecessary.  With a unified pool of insurance, there need only be one named defendant: the builder/general contractor.  Armed with an insurance policy that covers themselves and all or most of their subcontractors, the builder/general contractor has no reason to bring its enrolled subcontractors into the case.  It doesn’t have to expand the pool of insurance money available, nor does it need to seek indemnity or a defense from its subcontractors.  With fewer parties to the litigation thanks to fewer indemnity and cross-claims being asserted, and fewer lawyers involved, the litigation can proceed faster.

Wrap-up insurance changes the insurance coverage landscape

Another way wrap-up insurance has streamlined construction defect litigation is by changing the insurance coverage landscape.

When working on projects without wrap-up insurance, general contractors would require subcontractors to maintain certain levels of commercial general liability (CGL), workers’ compensation, and auto liability insurance.  Additionally, general contractors would require subcontractors to insure them as additional insureds under those policies.  As a result, the general contractors’ cost of defending themselves in construction defect litigation regarding those projects would be paid, in whole or in part, by those subcontractors’ policies.  Small subcontractors might have had trouble qualifying for, or affording, the levels of insurance required by general contractors.  This could have caused them to miss out on working on jobs or left them exposed to having to self-fund the cost of defense or their share of a settlement.  For those subcontractors who had the required insurance, their insurance companies’ lawyers would likely be actively involved in the litigation in one way or another, creating perhaps another roadblock on the way to promptly resolving the litigation.

With projects that have wrap-up insurance, defense costs and settlements are paid for by one insurance carrier.  Subcontractors do not have to carry the levels of insurance that would be required of them if there was not wrap-up insurance.  This allows them to work on a job at a lower cost to them than if they had to carry those levels of insurance.  But more importantly, with wrap-up insurance policies, there are fewer insurance companies—usually only one—that need to be involved in the litigation and in settlement negotiations.  This helps streamline the litigation.

Wrap-up insurance reins in the discovery process

In most types of litigation, the discovery process is the costliest phase thanks to the time and resources needed to request, review, and produce relevant information and documents, and to take and defend depositions.  While wrap-up insurance doesn’t eliminate the cost of discovery in construction defect litigation, it can reduce it dramatically.

In construction defect cases without wrap-up insurance, the discovery process would often quickly spiral out of control.  Even though judges issue case management orders to keep the discovery process from going off the rails, with so many parties to a litigation, discovery would more closely resemble herding cats.  At any one time, there could have been dozens of outstanding (and duplicative) information and document requests, notices of depositions, and motions arising from both.

Because the parties might have had unique records regarding the work they did on a project, even a relatively small construction defect case could have seen thousands of documents exchanged during discovery—all of which would have needed to be reviewed by each party’s counsel, many of which might have had no bearing on the case.  Making matters worse, small subcontractors with limited resources may have been represented by lawyers lacking in construction litigation experience. Without such experience, a lawyer might have engaged in common business litigation strategies that are rarely employed in construction defect litigation, such as protracted discovery and motions practice.  These strategies were expensive and time consuming for both a court and the parties.

Wrap-up insurance streamlines the discovery process and promotes judicial efficiency.  First, case management orders are simpler and more efficient when there are only two parties to the case—the plaintiff owner and the builder/general contractor.  This means there will be just two sets of experts, two witness lists, and two parties litigating discovery disputes.  Second, when there is a single insurance policy or set of policies at issue, the parties can avoid extensive discovery into which parties are covered by what insurance and who is obligated to defend and indemnify whom.

Wrap-up insurance shortens the time required to resolve a construction defect case

Given the complexity of the typical construction defect case (for the reasons mentioned throughout this article), it is not surprising that these cases were rarely resolved promptly.  Wrap-up insurance has changed this aspect of these cases as well.

Wrap-up insurance reduces the time it takes for the parties to resolve a construction defect case because there are fewer moving parts.  Gone are the days of protracted settlement negotiations and serial mediations involving a multitude of parties and their insurance carrier(s) all jockeying to minimize their respective contributions towards a global settlement of the plaintiff owner’s claims.  More often than not, wrap-up insurance helps cull those negotiations down to the owner, the builder/general contractor, and the wrap-up insurer.  The latter is particularly motivated to convince the parties to resolve their case as soon as possible to reduce the amount of legal fees that will be incurred and it will have to pay for.

In addition, when there is wrap-up insurance, a construction defect case is more likely to be resolved during the pre-litigation process.  Many states have enacted “Right to Repair” laws that require those that would be parties to a construction defect case to first engage in a prelitigation process that provides an opportunity for an early resolution of the dispute without the parties ever having to see the inside of a courtroom.  However, the difficulty with those processes is that, absent an ongoing relationship between the builder/general contractor and the subcontractors, there is frequently little incentive for the subcontractors to willingly and actively participate in the “Right to Repair” process.  Indeed, builders/general contractors would often resort to litigation to force the subcontractors to take an owner’s claims seriously during the pre-litigation process and to enforce their contractual and indemnity rights.  But with wrap-up insurance, such actions are unnecessary.  Because the insurance policy covers subcontractors, they do not necessarily need to be involved in a claim during the pre-litigation process or need to be part of the settlement negotiations.  This helps move the resolution process along faster than in a traditional construction defect case without wrap-up insurance.

Will wrap-up insurance become the norm for the construction industry?

Wrap-up insurance policies streamline the often-messy world of construction defect litigation. By limiting the number of parties in a construction defect case, simplifying the question of insurance coverage, turning down the heat during the discovery phase, and shortening the time it takes to resolve such a case, wrap-up insurance has helped countless owners, general contractors, and subcontractors alike reduce the legal uncertainty and costs involved in such cases.

An owner or contractor wishing to purchase wrap-up insurance coverage for a project will need to consider several factors before making a final decision, most of which revolve around their business practices and the project at issue.  But if there is a concern about the costs—both in time and money—associated with a potential construction defect lawsuit arising from a project, a wrap-up insurance policy would go a long way in alleviating it.

Michael P. Zech is a partner in the San Diego and Austin offices of Koeller, Nebeker, Carlson & Haluck, LLP. His practice is focused primarily in the representation of developers, general contractors, and subcontractors in construction defect litigation, but he also routinely handles litigation matters from inception through trial in the fields of personal injury, product liability, state and federal workers’ compensation, toxic tort, and general insurance defense.