Claims Retrospective: Subrogation Demystified

Meticulous Engineer was hired to do the calculations for the demolition plans in connection with the renovation of Old Warehouse. The drawings indicated that part of Old Warehouse was to be demolished and a small addition was to be added to the remaining part of Old Warehouse. Unfortunately, Destroy Contractors, the demolition contractor, did not follow the demolition plans, causing a collapse to part of Old Warehouse that was intended to be restored and reused.

Upon hearing about the collapse, Meticulous Engineer immediately double checks his calculations. However, with much relief, Meticulous Engineer finds that all of his calculations are correct. Meticulous Engineer is called to the project to assist with determining how to move the project forward in light of the collapse. At the site, Destroy Contractors’ principal tells Meticulous Engineer that Destroy Contractors’ workers messed up and failed to follow the demolition plans. Destroy Contractors’ principal tells Meticulous Engineer not to worry, as he knows Meticulous Engineer is not to blame for the collapse.

A few months later, Meticulous Engineer receives a letter from XYZ Insurance, who states that it insures Destroy Contractors, that it paid money or will be paying money to settle Old Warehouse’s claim against Destroy Contractors, and that it will be pursuing a claim against Meticulous Engineer for that money because his faulty calculations were responsible for the collapse.

The scenario described above involves what is called subrogation. In this context, subrogation is the principle under which “an insurer that has paid a loss under an insurance policy is entitled to all the rights and remedies belonging to the insured against a third party with respect to any loss covered by the policy.”¹ In this example, XYZ Insurance is the subrogee, who assumes the rights of Destroy Contractors, and Destroy Contractors is the subrogor, who transfers its right to collect to XYZ Insurance in exchange for payment. Unfortunately, it is not unusual for an engineer to receive a demand letter from, or be served with summons and a complaint by, the insurer of an interested party (e.g. a contractor, subcontractor, design professional, subconsultant, etc.) on a project. This is because once an insurer has paid out under a policy, it can step into its insured’s shoes and file lawsuits to recover the amount that it has paid on behalf of its insured.

Engineers sometimes find the subrogee insurer’s involvement confusing. Often, engineers do not understand how or why the insurer is making a demand against them, especially in situations where the insured contractor, subcontractor, design professional, or subconsultant has previously denied any fault on the part of the engineer. It is important to remember that once the subrogee insurer has paid, the decision whether to file a lawsuit against the engineer is no longer in the hands of the contractor, subcontractor, design professional, or subconsultant, but rather it is in the hands of the insurer. Therefore, the usual paths to resolution through discussions with the actual parties of interest may no longer be available.

The receipt of demand/notice letters from a subrogee insurer should be reported to your professional liability carrier immediately. Subrogee insurers usually cast a wide net, sending out form demand/notice letters to several parties on a project in an effort to recoup the amounts it paid on behalf of its insured, and these letters are often the first notice of a claim or potential claim with respect to a project. While many of these notice/demand letters are not pursued, at least some of them inevitably are. Accordingly, reporting the notice/demand letters ensures you will not jeopardize your coverage by failing to provide timely notice.

If the notice/demand letters are form letters with very little information, your professional liability carrier may choose not to take any action pending receipt of more detailed information. Thus, you have not incurred any expense in the reporting of these letters while preserving the potential for coverage with respect to the subject matter of letters under the current professional liability policy. Additionally, you should be careful when responding to letters from, or complaints by, a subrogee. If the notice/demand letter is a form letter, responding may only draw attention to you and cause the subrogee to focus its efforts on you. On the other hand, a more focused notice/demand letter may call for a carefully crafted response, which could help you avoid being hauled into protracted litigation.

Most importantly, you should avoid making any admissions that could be used against you later to show liability in the ensuing litigation and jeopardize your coverage. The best practice when receiving demand/notice letters from, or complaints by, subrogee insurers is to report the same to your professional liability carrier so the carrier or counsel appointed with agreement of the carrier can assist you in navigating the situation from the very beginning.