Insurance Academy

5 Reasons the ‘Primary and Noncontributory’ Requirement is Unethical, Ironic and Ridiculous

By | May 2, 2016

Several weeks ago I released an article questioning the need for the “primary and noncontributory” (PNC) requirement found in most construction contracts. I followed that article with a piece stating that the insurance industry should band together to save the little guy (the lower tier contractor).

Readers went crazy, both in the site’s comments section and in personal emails to me. These posts and emails were on both sides of the issue – for and against the requirement. The most “passionate” were those who felt I threatened their way of life (and the advice they give clients). A few acted as if I had kicked their dog or called their kid ugly – it was very entertaining. To be fair, a few were very professional in their responses, which allows for open discussion and debate.

As I read the responses sent by those most vehemently opposed to the article’s suggestion, it quickly became clear that they were blinded by anger, accusing me of all kinds of ills. I was accused of saying things I never said; improperly defining terms (and when they defined the term, it was the same as I had used); I was even accused of blasphemy – OK, maybe I’m being a bit facetious with this one. Suffice it to say, many who had a major issue didn’t read the article in full or very closely before attacking.

However, as a result of those opposing responses, I did learn that there is some bad case law in various states that may actually make the “primary and noncontributory” requirement necessary. To those who pointed this out – thank you. This information was given in a professional manner, free of attacks or accusations; in other words, they didn’t take the article personally, but saw it as a chance to have a professional and adult dialogue.

Those who responded in favor of the article were just as passionate. Some responses went even further than the article and made some interesting points of their own. Some in favor and supportive of the article’s goal even responded directly to the detractors. Again, this became quite entertaining.

So obviously we have folks on both sides of this issue. Both sides are very passionate about their personal belief. But is either willing to have a professional discussion without taking “it” personally? This is business after all.

During the recent unpleasantness, several points were made (in public responses and private responses) that were fascinating. The responses called into question the ethics, irony and ridiculousness of the primary and noncontributory contractual requirement.

The Ethics of Primary and Noncontributory Requirements

The Ethics of the Construction Contract

A contract is a formal, private agreement between two or more parties intent on accomplishing a specific task, purpose or goal. The Second Restatement of Contracts further defines a contract as “a promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty.”

Construction contracts are “contracts of adhesion.” The contract is created by the upper tier contractor and the lower tier rarely, if ever, has the opportunity to negotiate the terms and conditions of the contract. In short, the contract is offered to the lower tier on a “take it or leave it basis.”

Yes, the lower tier could walk away (leave it), but because of the ubiquity of the PNC requirement the lower tier would go bankrupt. Trade contractors are stuck, with no ability to say “no.” That is an abuse of power resulting from unequal bargaining positions which is unethical.

Although some try to assert the Doctrine of Reasonable Expectation to support the ethicalness of the use of primary and noncontributory requirement, this is a false claim. When first introduced, PNC was not reasonable or expected; only because the lower tiers and the insurance industry caved in did PNC become “reasonable” and “expected.”

(IMPORTANT SIDENOTE: Most construction contracts specify that the lower tier will show proof of complying with all insurance and contractual risk transfer requirements prior to beginning work. However, the reality of many (not all) construction projects is that the work is begun before the final contract is ever signed – meaning the upper tier has violated its own contractual provisions. But even though the upper tier has ignored and violated its own contract, it still holds the lower tier to all the requirements – and withholds payment until it does. Lower tiers are stuck. Again, an unethical use of power – and maybe in some states a violation of law.)

Anti-indemnification Statutes and the Ethics of Primary and Noncontributory

Forty-one states have laws prohibiting the use of contractual wording that requires a lower tier contractor to indemnify another party for that party’s negligence. Most of these states, 27 in fact, prohibit any contractual provision requiring the lower tier to indemnify the upper tier for ANY of the upper tier’s own negligence. These are known as “limited transfer states.”

In limited transfer states, the upper tier cannot require the lower tier to pay for any part of a claim that results from the upper tier’s own actions. Basically, the only “indemnification” allowed is the upper tier’s vicarious liability for the actions of the lower tier. If the upper tier is partially or wholly at fault, it must pay for that cost itself.

The other 14 “anti-indemnification” states allow the upper tier to contractually require the lower tier to indemnify it (the transferor / upper tier) for actions the lower tier and the upper tier contribute to jointly. These are “intermediate transfer” states. In these states, the only liability that cannot be transferred to the lower tier is responsibility for the sole negligence of the upper tier.

In the nine remaining states, there are no specific anti-indemnification statutes, but case law may apply.

What does all this have to do with the ethics of the primary and noncontributory requirement? I’m glad you asked. If the PNC requirement is artfully written, it may (or be an attempt to) circumvent statute.

Many anti-indemnification statutes include a phrase similar to this, “This section shall not affect an insurance contract, workers’ compensation, or any other agreement issued by an insurer….” Some assert (and some believe) this means a primary and noncontributory endorsement added by the insurer allows broader protection to the additional insured than is allowed in statute. Such interpretation is incorrect; this wording within these statutes applies to the contractual relationship between the insurer and its named insured only – not to any additional insured.

Although legal standards are lower than ethical standards, the principle is the same. Any attempt to bypass statute is unethical – even if pseudo legal.

Referring to Another Carrier/Agent and Ethics

Well, if your insurance carrier (or agent) won’t or can’t provide you with a primary and noncontributory endorsement, I will refer you to one who can.” This is completely legal, but it is unethical.

This is the upper tier being nothing short of self-serving. They certainly don’t do this for the benefit of the lower tier or the agent/carrier from whom they are recommending the business be moved.

The Irony of the Primary and Noncontributory Requirement

Some general contractors play both sides of the fence relative to insurance coverage. For small to mid-sized jobs, the upper tier wants everyone else to be responsible for and provide coverage on a primary and noncontributory basis. For large jobs, they want to provide coverage for everyone under one policy – called a “Controlled Insurance Program” a CIP.

It’s ironic, in one instance, they don’t want to be responsible for anything. In another, the upper tier wants to be responsible for everything. Pick a side!

“Well, you just don’t understand the purpose and benefits of a controlled insurance program.” OK, let’s take a look. The stated purpose and benefits of a CIP include:

  • Uniform coverage and limits for all participants;
  • Allows the consolidation of insurance policies into one uniform program;
  • Allows for single-entity defense rather than the involvement of many lawyers and carriers;
  • The reduction in insurance costs because the costs are excluded from the lower tier’s policies; and
  • The avoidance of cross claims.

So for smaller projects, the upper tier is obviously OK with variations in coverage (since the policy language isn’t reviewed); the involvement of multiple lawyers in a large claim; and a higher bid cost (because the cost of required endorsements is included in the bid). Seems odd.

Why the two ends of the spectrum? I want to control all the coverage…. No! Wait; I want you to provide all the coverage and protect me.

Isn’t the PNC requirement the upper tier’s attempt to control the coverage provided by the lower tier while shifting all the cost to the lower tier? And isn’t the CIP the upper tier’s desire to control all the coverage and lower the cost because it’s all paid for by them? How ironic.

Maybe there should be a “primary and subragatory” provision in the construction contract stating, “We (the upper tier) shall provide coverage on a primary basis for all bodily injury and property damage that occurs while the project is ongoing and after project completion ending upon the expiration of the statutes of limitation and or repose. We wholly reserve and shall fully exercise the right to recover (subrogate) against the at fault party or parties, including the undersigned, causing or contributing to the bodily injury or property damage.”

Such a provision accomplishes the same thing as a CIP except that it allows the upper tier’s insurance carrier to subrogate against and recover from any lower tier that is at fault. There are several benefits to this approach: 1) every party pays for its responsibility; 2) the injured party gets paid quicker without having to wait through all the court battles; 3) only one carrier/lawyer is involved in the initial claim; and 4) no additional endorsements are required for the lower tier’s policy making premiums lower and thus bid costs lower (theoretically).

Yes, every other contractual risk transfer provision except primary and noncontributory would still apply to the lower tier:

  • Indemnification requirements;
  • Hold harmless requirements (only for the injury or damage caused by the lower);
  • Waiver of subrogation requirements; and
  • Additional insured requirements (maybe).

The Ridiculousness of Primary and Noncontributory

An upper tier being willing to submit its defense and protection to a lower tier trade contractor seems the most ridiculous part of the primary and noncontributory requirement. It seems ridiculous that a large, multi-million (or billion) dollar general contractor would be comfortable with allowing a three-man electrical contractor, who is barely making ends meet, provide its defense and coverage seems rather strange.

The lower tier’s attorney is working primarily for its named insured and secondarily for the additional insured. Further, once the limits are exhausted, the insurer walks away. If the “primary and noncontributory” provision is not self-limiting (limited to the amount of insurance carried), the lower tier could be on the hook for any amounts over the insurance limits (but likely can’t pay).

Further, if the “primary and noncontributory” wording is not tied to the breadth of insurance protection provided, the lower tier could be on the hook personally. Does the upper tier really want to depend on this for its risk financing?

Transferring risk to one financially less capable of sustaining the loss is false security. Loss allocation, originally, was about assigning loss to the party either responsible for the loss or most capable of sustaining the loss. If an entity wants to better control the financing of its risks then it would want its own limits, be a named insured on its own policies and have primary representation by claims in the event of a loss. Relying on others to protect you is potentially dangerous.

A second area of ridiculousness is that few other industries seek to assign responsibility for damages up front. Most make each responsible party make the injured party whole to the level of their fault – after the injury or damage has occurred.

Oh, but if we did this, there would be more court battles. Maybe initially, but then some attorney would figure out how to get rich by creating and gaining approval in every state an alternative dispute resolution program in the contract that would avoid the time and expense of a lawsuit. Besides, since there will be a “primary and subrogatory” provision in the contract, who cares – the at fault party’s insurance carrier will eventually pay.

The End…Maybe

As I said before, we can’t end this conversation here (note I said conversation, not blind rage, unprofessional attacks). Just because “we’ve been doing it that way for years,” doesn’t mean we should continue down that road.

Let’s go!

Topics Carriers Contractors Construction

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