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A False Sense of Security?
Contractual Risk-Shifting Agreements May Not Always Be Enforced

By Andrew M. Hansell
Lindquist & Vennum P.L.L.P.

In today’s business world, agreements attempting to shift responsibility for certain liabilities from one party to another are common. These agreements typically contain terms that require one party to add the other as an additional insured on its insurance policy and agree to hold harmless and indemnify the other. These types of indemnity agreements are particularly common in lease, subcontractor, franchise and distribution agreements. The purpose of these agreements is to shift the liability for certain risks from one party to the other party.

Despite these risk-shifting agreements, many companies take a “belt and suspenders” approach and decide to obtain their own separate insurance as a back up in case the indemnitor’s insurance lapses or is otherwise unavailable. This can create a situation where multiple insurance policies potentially cover the same loss.

Where multiple policies cover the same loss, the insurance policy’s “other insurance” clause may be triggered. “Other insurance” clauses attempt to limit or excuse an insurer’s liability where multiple insurance policies apply to a loss. Therefore, despite the parties’ risk-shifting agreement, the indemnitor’s insurer may still seek to compel the indemenitee’s insurer to pay all or a portion of a loss based on the “other insurance” clause contained in its policy.

The majority of jurisdictions will reject an insurer’s attempts to apply the “other insurance” clause and will uphold a risk-shifting indemnity agreement between two policyholders shifting responsibility to one insurer. However, some jurisdictions will refuse to apply these indemnity agreements and will apply the insurance policies’ “other insurance” clauses instead.

The refusal to enforce a risk-shifting agreement can result in adverse consequence to the indemnitee. For example, the indemnitee could face increased premiums, a less favorable risk profile, gaps in coverage, or reductions to its aggregate limits under its insurance policies as a result of a loss not being shifted to the indemnitor’s insurance policy. Accordingly, parties entering into risk-shifting agreements should carefully review the applicable laws to determine whether the risk-shifting provisions of their agreements will have their intended effect.

“Other Insurance” Clauses

Most insurance policies will contain a provision commonly referred to as an “other insurance” clause. The purpose of the “other insurance” clause is to eliminate or limit an insurer’s liability where another insurance policy provides coverage for the same loss.1

“Other insurance” clauses take three basic forms:

• Pro-rata—A pro-rata clause may provide that the insurer will not be liable for more than its proportion of the total amount of coverage of all applicable insurance policies, or that it is only liable in equal shares with other insurers.2
  
  
• Excess—An excess clause may provide that the insurer is only liable for the amount of the loss that exceeds the limits of all other insurance policies.3
  
  
• Escape—An escape clause may provide that an insurer has no liability if any other insurance policies apply.4

Because most insurance policies contain these provisions, courts are often faced with considering “other insurance” clauses that each contain language purporting to shift the loss to another policy. When faced with conflicting “other insurance” clauses, courts will often hold the clauses are unenforceable and the loss will be proportioned among the insurers based on their policy limits. Entire lines of cases have developed around attempting to reconcile different “other insurances.”5 Because courts may ignore competing “other insurance” clauses, the indemnitor’s insurer may be able to compel some proportional contribution to a loss from the indemnitee’s insurers if the risk-shifting agreement is not enforced.

Policyholders’ Risk-Shifting Agreements vs. “Other Insurance” Clauses—Who Wins?

The majority of jurisdictions will uphold express indemnity agreements between two policyholders over the “other insurance” clauses contained in their insurance policies and will shift responsibility to the indemnitor’s insurer based on the risk-shifting agreement.6

Some jurisdictions may not uphold these indemnity agreements. For example, a New York court held that the risk-shifting agreement between a contractor and a subcontractor did not supersede the “other insurance” clause contained in the subcontractor’s insurance policy to shift the loss entirely to the subcontractor’s policy.7 The court found that the contractor’s own insurance policy and the subcontractor’s insurance policy each insured the same party (the contractor) for the same risk and therefore both policies had to share in liability.8 Other New York courts have issued similar decisions.9

A federal court in Arkansas also held that that a vendor’s risk-shifting agreement with its distributor did not override the express “other insurance” provision in the indemnitor’s insurance policy, and that both the indemnitor’s policy and the indemnitee’s own policy must share in the loss.10 However, the Federal Court of Appeals later reversed this ruling.11 Similarly, a Pennsylvania federal court held that a risk-shifting agreement was valid between a lessor and lessee, but that it did not shift the liability to the indemnitor’s insurer.12

Enforcement of policyholders’ risk-shifting agreements is not a certainty. Parties entering into such indemnity agreements should seek competent advice regarding applicable laws to determine whether the risk-shifting provisions of their agreements will have their intended effect or if the agreement will only create a false sense of security.

Notes
1 Marcy Louise Hahn, The ‘Other Insurance’ Clause, 19 Forum 591, 591 (June 1984).
2 Id. at 594.
3 Id. at 594-95.
4 Id. at 595.
5 See generally, Hahn, supra, 600-610, discussing the application of competing “other insurance” clauses.
6 See, e.g., Wal-Mart Stores, Inc. v. RLI Ins. Co., 292 F.3d 583 (8th Cir. 2002); American Indem. Lloyds v. Travelers Prop. & Cas. Co., 189 F. Supp.2d 630 (S.D. Tex. 2002); Chubb Ins. Co of Canada v. Mid-Continent Cas. Co., 982 F. Supp. 435 (S.D. Miss. 1997); J. Walters Constr. Inc. v. Gilman Paper Co., 620 So.2d 219 (Fla. App. Ct. 1993); Truck Ins. Exchange v. Liberty Mut. Ins. Co., 428 N.E.2d 1183 (Ill. App. Ct. 1981); Rossmoor Sanitation, Inc. v. Pylon, Inc., 119 Cal. Rptr. 449 (Cal. 1975); See generally, Randall L. Smith & Fred A. Simpson, Excess Other Insurance Clauses And Contractual Indemnity Agreements Shifting An Entire Loss To A Particular Insurer, 30 T. Marshall L. Rev. 215 (2004).
7 National Union Fire Ins. Co. of Pitts., PA v. Hartford Ins. Co. of the Midwest, 677 N.Y.S.2d 105, 109 (N.Y. App. Div. 1998).
8 Id.
9 See U.S. Liability Ins. Co. v. Mountain Valley Indem. Co., 371 F. Supp. 2d 554, 559-560 (S.D.N.Y. 2005) (holding risk-shifting agreement between lessor and lessee did not supersede “other insurance” clause); USF&G Co. v. CNA Ins. Cos., 618 N.Y.S.2d 465, 467 (N.Y. App. Div. 1994) (holding risk-shifting agreement between contractor and sub-contractor did not supersede “other insurance” clause).
10 Wal-Mart Stores, Inc. v. RLI Ins. Co., 163 F. Supp. 2d 1025, 1038 (W.D. Ark. 2001).
11 Wal-Mart Stores, Inc. v. RLI Ins. Co., 292 F.3d 583 (8th Cir. 2002).
12 Allstate Ins. Co. v. General Fire & Cas. Co., 348 F. Supp. 682, 688 (E.D. Pa. 1972).

ABOUT THE AUTHOR

Andrew Hansell advises clients on commercial litigation, products liability, public law and insurance coverage. He can be reached at ahansell@lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

riskVue | The webzine for risk management professionals
June 2006