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    Subcontractor default insurance: A cautionary tale

    Reprinted from the October 2013 Newsletter
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    A recent New York County, New York, appellate decision highlights the potential inadequacies of subcontractor default insurance (“SDI”). These products are sometimes referred to as “Subguard” insurance based on the name given to one such product offered by Zurich North America Insurance Company.

    SDI is meant to provide coverage for damages that result from a subcontractor’s default in its performance of work on a construction project. In Waterscape Resort LLC v. McGovern, 2013 NY Slip Op 04709 (June 20, 2013), a project owner claimed that its construction manager represented that the owner was fully protected by the construction manager’s SDI policy against any default by the largest subcontractor on the project. When the subcontractor defaulted, however, there was no SDI coverage for the owner’s damages that resulted from the default. In fact, most SDI policies only protect the prime contractor or construction manager and not the owner.

    The owner filed a lawsuit against its construction manager (“CM”), claiming the CM had falsely represented that it had adequate SDI coverage for that subcontractor to protect the owner. The court noted that the named insured on the SDI policy was the CM, not the owner, and therefore the owner had no protection under the policy. The court also found that the owner had not asked the subcontractor itself or the insurance provider if the owner was protected by the SDI policy. Accordingly, the court held that the owner could not recover its losses from the CM based on the alleged false representation.

    This case demonstrates that SDI policies do not normally provide the coverage an owner might expect and indicates that it is the owner’s responsibility to determine whether or not it is covered. Moreover, even if an endorsement naming the owner is provided, the circumstances under which protection is provided to the owner may be extremely limited, often requiring that the CM or prime contractor be legally determined to be insolvent or in bankruptcy before coverage for the owner becomes available.

    Although it is a New York case, Waterscape should serve as a warning to construction project owners who would like to rely on SDI policies in lieu of a bond or other forms of protection for the owner. Moreover, some prime contractor default policies have restrictions on coverage requiring insolvency of the prime contractor and/or severely limiting the time frame during which there is coverage. Owners need to be sure that there are not large holes in their protection, or at a minimum, make an informed decision regarding their willingness to accept gaps in coverage in order to realize up front savings.

    This is for informational purposes only. It is not intended to be legal advice and does not create or imply an attorney-client relationship.

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