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Environmental Damage During Construction

A recent case out of the Indiana Court of Appeals provides some relief for project owners and a big caution for contractors in the area of environmental damage in the construction process. Standard AIA agreements were used, so this case may have broad reaching implications for the construction industry.

The base AIA agreements require the owner to carry all-risk insurance on “the work.” There is also a cross-waiver of subrogation provision with respect to liability for negligence on the project. Established court rulings have held that the basic rule is that if you have a duty to insure it, then you bear the burden of the loss if it is uninsured or underinsured. The developed corollary to that rule is that the waiver of subrogation is a waiver of liability claim for fault underlying the problem condition. For example, if the owner carries insurance that only covers half the loss, it cannot sue even a negligent sub-contractor for the underinsured amount since it was the duty of the owner to buy enough insurance.

Important to note, though, is that the insurance requirement only applied to the work – the structure itself. Early deviations from the strict application of the rule came, for example, when a roof collapsed and materials stored under the roof were damaged. The court held that the owner could look only to its insurance for the damage to the building/roof, but it could sue the negligent party for the damage to the stored materials – since those stored materials were not part of the structure and therefore were not limited to insurance recovery.

In the recent case, the project included an emergency generator with built-in underground diesel tanks to fuel it. Allegedly, the concrete contractor damaged the piping to the storage tank, and several years later the owner discovered that about 3,000 gallons of diesel fuel had escaped. The builder’s risk coverage had only $5,000 of pollution coverage, and the other $485,000 or so of remediation cost was uninsured. When the owner approached the contractors and subs about paying for the mess they caused, they relied on the old rule and suggested that the owner should have carried more insurance and that the cross-waiver of subrogation barred suit for any negligence that may have caused the leakage. They paid nothing, and the owner sued.

The Court of Appeals decided, in effect, that the water and soil beneath the structure was not part of the work and that the owner was, therefore, not limited to insurance and was allowed to proceed with its suit against the general and the subs. The case has not been decided on the merits yet, so we don’t know who was actually responsible, but unless the Supreme Court chooses to get involved to question the law applied to the case, it now appears that there is another big exception to the rule that the owner may look only to its own insurance.

The important takeaway here is that all of this is based on contract interpretation – the court in trying to decide what is meant by the words the owner and the contractors chose to use in their agreement. Careful review of the contract documents (yes, even the standard AIA forms) is very important, as are modifications of those forms in the proper case. Either side could have avoided this situation by a customization of the contract language before the work started.