Insurance Update - Illinois Supreme Court Kajima Decision Impacts Additional Insured Coverage

Attorneys: Guolee, Terrence F.

On November 29, 2007, the Illinois Supreme Court issued its opinion in Kajima Constr. Servs., Inc. v. St. Paul Fire and Marine Ins. Co., No. 103588 (Ill. S.Ct., November 29, 2007). This opinion has far-ranging implications for any company that has entered into or is considering drafting any agreement requiring a contractor, landlord or other third party to maintain insurance naming the company as an additional insured.

Kajima involves a common construction case fact pattern. Kajima Construction Services, Inc., as general contractor, entered into a subcontract with Midwestern Steel Fabricators, Inc. for a construction project. Midwestern then subcontracted a portion of its contract with Kajima to Up-Rite Steel Company. Thomas Jones, an employee of Up-Rite, was subsequently injured while working on the construction project. Per the terms of the subcontract, Midwestern was required to maintain typical CGL coverage naming Kajima as an additional insured and provided Kajima with a certificate of insurance showing Kajima as an additional insured under Midwestern's $2 million primary and $5 million umbrella policies, both issued by St. Paul. Kajima also had its own $1 million primary policy issued by Tokio Marine and Fire Insurance Co.

Following receipt of the Jones lawsuit, Kajima made a "targeted tender" for defense and indemnity to St. Paul, pursuant to Institute of London Underwriters v. Hartford Fire Insurance Co., 234 Ill. App. 3d 70 (1992) and John Burns Construction Co. v. Indiana Insurance Co., 189 Ill. 2d 570 (2000). A targeted tender "allows an insured covered by multiple insurance policies to select or target which insurer will defend and indemnify it with regard to a specific claim." In this respect, the Illinois Supreme Court noted the benefit of the "targeted tender" rule of the London Underwriters and John Burns decisions, noting that a contractor in the position of Kajima may fear that if a loss is attributed to its own policy, the result may be a rise in premiums or cancellation of its policy, and "[t]his factor alone suggests the insured ought to have the right to seek or not to seek an insurer's participation in a claim as the insured chooses when more than one carrier's policy covers the loss." Kajima, supra, citing London Underwriters, 234 Ill. App. 3d at 78-79.

The underlying Jones case eventually settled for $3 million. St. Paul contributed its $2 million primary policy limits, and Tokio contributed its $1 million limits. Kajima and Tokio then filed suit against St. Paul seeking reimbursement of Tokio's $1 million contribution to the Jones settlement. In response, St. Paul argued that, regardless of the "targeted tender" law in Illinois, Illinois' law of "horizontal exhaustion" required Kajima to exhaust all available primary insurance (meaning the $1 Million Tokio policy) before reaching St. Paul's excess insurance. The trial court agreed with St. Paul, as did the appellate court.

In reviewing this issue, the Illinois Supreme Court noted that the appellate court characterized the issue in this case as "whether the selective tender rule supersedes well-settled principles of Illinois law regarding horizontal exhaustion." The court then compared the targeted tender rule to the horizontal exhaustion rule first set out in United States Gypsum Co. v. Admiral Insurance Co., 268 Ill. App. 3d 598 (1994). In that case, Gypsum, the insured, argued that an excess insurer was required to provide coverage once the primary policy underlying its excess policy was exhausted, regardless of whether there were concurrent primary or excess insurance policies. Gypsum, 268 Ill. App. 3d at 653. The appellate court disagreed, noting that allowing Gypsum to pursue such "vertical exhaustion" would allow it to:

effectively manipulate the source of its recovery, avoiding difficulties encountered as the result of its purchase of fronting insurance and the liquidation of some of its insurers. This would permit Gypsum to pursue coverage from certain excess insurers at the exclusion of others. Such a practice would blur the distinction between primary and excess insurance [citation], and would allow certain primary insurers to escape unscathed when they would otherwise bear the initial burden of providing indemnification.

The appellate court therefore held that "horizontal exhaustion" was required, and that Gypsum must exhaust all available primary coverage before proceeding against an excess insurer. Kajima, supra, quoting Gypsum, 268 Ill. App. 3d at 654.

Following considering these competing doctrines, the Illinois Supreme Court in Kajima affirmed the appellate court, setting the rule in Illinois, as follows:

Targeted tender can be applied to circumstances where concurrent primary insurance coverage exists for additional insureds, but to the extent that defense and indemnity costs exceed the primary limits of the targeted insurer, the deselected insurer or insurers' primary policy must answer for the loss before the insured can seek coverage under an excess policy.

As a result of this decision, Kajima, in effect, loses the benefit it may have believed it secured by contract when it required Midwestern to purchase both a $2 Million primary and a $5 Million excess policy and name it as an additional insured in both policies. Indeed, Kajima may have expected that its own insurance would not need to respond to an injury at the construction site unless the claim exceeded $7 Million dollars - and it would then not risk the possible impact of its insurance premiums being raised or its coverage cancelled. Likewise, any other company believing it has contracted away its risks via its contracts on a project may not be as "protected" as previously thought.

Important to note is that Kajima's coverage was not self-insurance, and the Kajima opinion does not involve exhaustion of the additional insured's selfinsurance. However, Illinois courts have required horizontal exhaustion of self-insurance, so it is possible that there may need to be exhaustion of self-insurance before a subcontractor's excess policies can be attached. See, e.g., U.S. Gypsum Co. v. Admiral Ins. Co., 268 Ill. App. 3d 598 (1994).

Likewise, to the extent in pending cases a company has "deselected" coverage by its own insurance carrier for a claim, it may be important to consider whether the company should immediately revise its position in light of the Kajima decision. If a company has placed its own carrier on notice of the claim, but then instructed the carrier not to respond to the loss pursuant to the London Underwriters and John Burns decisions in order to obtain coverage from its subcontractor's carrier(s), the potential now exists that the company could be exposed to direct liability in the event that the subcontractor's primary policy does not cover the loss. In this respect, the subcontractor's excess carrier will now be able to argue that any excess policy does not have to respond to the loss until all available primary policies and, potentially, self-insurance are exhausted. However, the company's own direct insurer may resist responding to the claim based on the prior instructions deselecting them from responding to the loss, asserting that the coverage was waived. Only prompt action may avoid a company falling into this potential "trap."

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Terrence Guolee, a shareholder in our Chicago office, has handled numerous insurance coverage matters and construction and other claims involving contractual insurance clauses. If you have any questions regarding this article, or the exposures to your company following the Kajima decision, please contact Terry via 312-540- 7544 or via This email address is being protected from spambots. You need JavaScript enabled to view it..

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