Summer 2009 • Issue 33, page 3

Receivers (and Foreclosing Lenders) Must Master Complexities of Insurance Issues to Limit Their Exposure to Liens and Downstream Litigation

By Wells, Kirby*

It is our experience that when a receiver is appointed to take over either an existing or partially completed real property development the receiver and lender are thrust into an almost untenable situation relating to insurance issues.

Getting factual and reliable information about the existence of policies, the current status (current or past due premium payments and/or outstanding or future audits) and the scope of coverage is often difficult or impossible to ascertain. Files are often incomplete, insurance policies are in the process of or have been canceled and the ability to reinstate them can be time sensitive.

The receiver often must play an educational role to explain to both the existing agent and the insurance company what a receivership is and why the Receiver needs to be named as an additional insured. The need to acquire straightforward and timely information about the existing policies is absolutely critical especially at the very beginning of the process. Most agents and brokers have had little exposure and have almost no understanding of the receivership process.

During this uncertain period the receiver and lender may be exposed to extremely high levels of liability. The potential of having the physical asset destroyed before insurance can be obtained (if not in place) can pale compared to other expenses of an uninsured or underinsured general liability loss. Liability coverage may not exist or may have been compromised because of either an outstanding audit or the failure of the developer or general contractor to follow requirements within the insurance policy coverage.

Often the most pressing issues a receiver must quickly resolve are (a) what insurance coverage is in place and (b) ensuring that the insurance is indeed valid for the exposure. It is critical for the receiver to secure complete copies of ALL insurance policies, even before accepting the appointment if possible.

Other documents a careful agent will wish to see as part of a review of a receivership (insurance assets and needs) are any leases, any certificates of insurance from subcontractors (with close attention to the “additional insured” language) and plot maps. If the subject property is a condominium or Planned Urban Development, then complete copies of the CC&R’s, bylaws and a complete copy of the homeowners association’s master policies (general liability, property and directors and officers polices) are necessary.

I always recommend that a receiver, immediately after being appointed, request loss runs from each insurance carrier involved on the account for the prior five years (or to original date of project) to determine if there are any current or previous claims for the property in question. Taking these steps provides a fairly good picture of the insurance status of the risk, and can be obtained within a reasonable period of time, typically 10 to 20 business days.

The two biggest areas of concern these days seem to be “wrap” liability policies and “course of construction” real property policies as they relate to receiverships on habitational risks (involving single family, condo and planned urban developments (PUDs)).

A “wrap” policy is a general liability policy, which provides general liability, property damage and, most importantly, “products and completed operations” coverage under one contract. As its name suggests, the goal of a properly executed “wrap” policy is to provide all this critical coverage for a construction project within one policy for all parties involved in the construction and development of a project.

There are multiple benefits to having a “wrap” policy. Having one policy covering multiple contractors allows the insurance carrier to provide a united cohesive response to litigation — one insurance carrier, one adjuster, one defense law firm. It also reduces the expense of cross-complaints that typically arise in litigation between subcontractors and the general contractor/developer in the absence of a “wrap” contract.

To ensure consistency insurance carriers usually mandate the use of a “Wrap-Up Administrator” or “WUA.” One of the key responsibilities of a WUA is to manage the group of subcontractors that are to be covered by the “wrap” policy, verify that the contracts and indemnity agreements between the parties are properly executed, and verify license status and bond verification.

The requirements are policy specific and may differ by carrier and by policy. The cost of the WUA is a separate fee that the contractor/developer is required to pay. Experience shows that many WUA contracts on distressed projects are out of force, ended due to non-payment of WUA fees by the developer.

Since failure to adhere to the WUA requirement may terminate coverage, it is vitally important that the receiver identify these requirements quickly. WUAs do not get involved in claims as part of their role. The insurance carrier will usually provide the names of approved WUAs on request.

For all of the benefits “wraps” provide, the balance is that they also move many of the responsibilities and expenses traditionally managed by the insurance carrier to the developer. Requiring large deductibles allows the insurance carrier to make the policyholder responsible for paying the cost of smaller claims and the cost of defense. Much of the administrative cost is also transferred.

The most important thing to be realized is that there is no standard “wrap” policy. Each has endorsements and contractual requirements unique to the project and the developer. Many policies carry endorsements that void coverage in the event an audit is not paid on the policy after expiration. For example, in one case the failure to pay the audit after the policy expiration deleted all “products and completed operations” coverage in the insurance policy. This is the coverage for construction deficiency claims, codified under California State Senate Bill 800 (SB800), discussed in the 2009 Spring issue of the RN.

Review the policies to verify the type and amount of coverage - another area of concern, and discuss with counsel and interested parties. Keep in mind that many general liability policies reduce the policy limits by amounts spent in providing defense. With long litigation a standard $1,000,000 limit policy can be exhausted in court and legal costs alone.

The property aspect of a development is usually insured through a “Course of Construction” policy, a “COC.” The COC is based on the value of property as it progresses vertically from bare ground to completion. Like “wrap” policies, each COC contract is unique. Endorsements can make two similar looking policies from the same carrier completely different.

Many COC policies contain language that voids coverage if “substantial construction” has not been ongoing for sixty (60) consecutive days. Even if the policy seems to be in force and the premium paid, coverage may well have been voided because the developer failed or stopped work because of the real estate market.

The action of placing a project into receivership and the ensuing “down period” may trigger this exclusion. In most “habitational” receiverships this is the situation on the ground when the receivership takes over the project. A “vacant property” policy must be put in place immediately to protect the asset.

Failure to address these issues properly and timely may exclude current and future coverage for claims. There are concerns within the insurance industry that a landslide of litigation will start affecting lenders, REO’s and receivers where lenders step in on projects, build them out and take the project to sale — a new and growing activity in the current economic and real estate market.

Receiverships will inadvertently be the first in line to make decisions on policies that will either cover or exclude coverage for the various parties. Once coverage is gone (or has not been properly placed) it will be tough or impossible to replace. Claims may not come to light for parties in the chain of responsibility for up ten years after completion. With recent and ongoing consolidation of lenders, it can be difficult to find the documentation (insurance policies), underwriting criteria and the original applications, presentations, binders, certificates and WUAs who managed all of it.

A complete review of all of this critical information should be made and a complete project binder (both hard copy and electronically scanned) be created to retain this critical information (including CAD files from the architect if possible).

These insurance issues and concerns should also be communicated to all involved parties via the receiver’s monthly reports. The required audits (discussed above) have specific deadlines. Missing a deadline may forfeit insurance coverage on already completed work. Notifying everyone – especially lenders and the court – as early as possible about upcoming insurance issues and any premium payments and their due dates will allow the parties time to prepare (and will allow the insurance consultant time to answer questions and get needed documentation to interested parties).

It is not unusual to find that existing agents/brokers have created a host of problems, from the minor (named insured, inadequate limits and/or improper coverage issues) to the major — sophisticated insurance misrepresentation and fraud. The contractor or developer on a particular project may be the single largest client for many agents.

The needs of the receiver and of the receivership property may be of secondary importance to such agents. Or the agent may neither understand nor be able to adequately explain the contractual requirements and nuances of the insurance policy. Many agents and brokers have never worked on a receivership or trustee situation and may lack necessary expertise to provide the information required by the receiver and the Court.

This complexity may be intensified if more than one agent or broker has been involved, each handling different policies for the developer. A careful receiver will identify a lead insurance professional they know and trust, who can serve as a source for assistance and industry guidance and assign control of policies through three possible nominations – a “broker of record,” a “broker of service,” or a “risk manager.”

Insurance carriers vary on their processes and guidelines for designating a “broker of record.” The receiver’s insurance professional can provide guidance based on which carrier is involved. This will replace the existing agent with the agent of the receiver’s choosing. Carriers and policies will remain in place, although carriers may issue a new policy number upon such change.

A “broker of service” selection allows the receiver to appoint a broker or agent of his/her choice, to service the insurance account until the natural renewal date. This leaves the current agent in place but allows the receiver’s insurance professional to request changes directly from the carrier without going through the existing agency. This is a great method for resolving issues quickly.

The Receiver’s designated agent or “broker of service” can quickly address critical issues (premiums, certificates and obtaining copies of the insurance contracts). This designation is usually employed when the existing agent either refuses to provide necessary information or service on the policy in question in a timely manner. The agent designated Broker of Service does not receive commission compensation, and works on a fee basis.

Designating a “risk manager” carries no significant legal weight, but is respected by almost all carriers. In the designating document the receiver notifies the carrier and existing broker/agent that the appointed “risk manager” has authority to request and has access to all of the information normally available to the named insured. This allows the “risk manager” to step in and request information necessary for the initial assessment directly from the insurer. The “risk manager” can then provide comprehensive information and a complete report to the Receiver, usually on a fee basis.

*Kirby Wells is President of Independent Solutions United, which provides a suite of insurance products to receivers. Mr. Wells has almost thirty years’ experience in commercial insurance. He serves on the Board of Pacific Interstate Insurance Brokers and speaks nationally on insurance issues. He may be contacted at e-mail rkwells@insunited.com or telephone 916-635-6760.