Subcontractor default insurance: A cautionary tale

Reprinted from the October 2013 BrickerConstructionLaw.com Newsletter

Download the complete October 2013 BCL

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.