Grossly Unfair Insurance Clauses Can Put Subcontractors Out of Business: Predatory OCIPs, CCIPs and Builder’s Risk Insurance Flow-Downs

March 2019 Edition

by Jonathan Mitz, Ennis Electric

Are you too busy to read an Owner or Contractor Controlled Insurance (wrap-up) document? No problem. That is, it’s no problem if there isn’t a loss event, and if the insurance terms are fair and reasonable. This article focuses on grossly unfair terms found in some wrap-up programs that subcontractors should avoid signing at all costs.

The purpose of insurance is to reduce your business’ exposure to the effects of risks. Predatory wrap-ups work in an opposite way by placing the risk on subcontractors at levels so high that a single claim could put them out of business, even if they are not at fault.

Here are some insurance clauses from actual wrap-up programs in my local area. (I’m not making this stuff up.)

Guilty by Association

In the event that an unidentified subcontractor is responsible for a covered loss, and it is not possible to determine who was responsible, then all subcontractors working on site at the time will be responsible for a pro-rated share of the deductible based on subcontract volume.

This reminds me of the way the Nazis reacted to an act of sabotage. They would round up a bunch of villagers and, if no one fingered the culprit, the Nazis would shoot them all.

Responsible for God

In the event of a covered loss due to an Act of God all subcontractors working on site at the time will be responsible for a pro-rated share of the deductible based on subcontract volume.

What’s interesting to note here is that neither the owner nor the general contractor are at risk for an angry God.

Fix it for Free

In the event of repair or replacement work due to a claim, subcontractors will not be reimbursed for profit, tax, interest, overhead, insurance or bond costs.

All the subcontractors, whether they were at fault for the loss or not, are obligated to do the rework at less than cost.

Subcontractors Pay Supersized Deductibles via Flow-Down Clauses

Predatory wrap-up programs can save a pant load of premium money for the owners and general contractors when they establish sky-high deductibles. The owners and general contractors save another pant load by flowing down these outrageously high deductibles to the subcontractors—instead of maintaining a contingency fund.

General Liability:

$50,000 for each occurrence. But that’s not all. Subcontractors are also responsible for investigative fees, court costs, attorney fees.

I’ll bet your regular GL policy doesn’t have a deductible or a similar requirement to pay for separate investigation, attorney or court costs.

Builders Risk:

$100,000 for each claim unless the loss was due to water, then multiply the deductible by five so it’s $500,000.

Owner’s Property that’s not part of the construction project:

$100,000 for each claim.

Pollution Liability:

$250,000 for each claim.

Spin Doctor at Work

What one owner said in defense of super high deductibles:

The deductible “serves as an incentive to encourage contractors to exercise the highest level of safety on the job”. Okaaaay … Try to manage for that hurricane or another subcontractor’s incompetence across the jobsite!

Applying These Predatory Clauses: A True Worst-Case Scenario

Let’s pretend that a project is nearing completion. The weather has been perfect for construction—it hasn’t rained for a couple of months. It’s just down to the mechanical subcontractor doing air balancing and the painter doing touch-ups. Suddenly a gully washer thunderstorm unloads over the jobsite. Water starts streaming into the finished space because some skylight flashing had been damaged weeks ago by one of the many trades that had worked on top of the roof. A million dollars of damage occurs. Who is obligated to pay what, based on the wrap-up conditions described above? First, the $500,000 deductible would have to be paid by the only two subs working at the time of this Act of God—the balancing contractor and the painter. Secondly, the repair and reconstruction would have to be done by all the finish trades but at a reimbursement rate less than their cost. How many of these subs do you think will end up going out of business from this claim?

Don’t Sign Predatory Change Order Mark-Up Clauses!

In addition to wrap-up clauses, don’t forget to look at the owner and contractor mark-up clauses. One owner not only had a creative way with insurance, it also established terms for extra work that will put subcontractors out of business.

In this project there are 10 classes of change orders, with my favorite being for the remedying of design defects. Keeping in mind that the project is not design-build, the mark up to subcontractors for fixing the designer’s errors and omissions is a whopping 3 percent for overhead plus 3 percent as profit.

Find the Flow-Down Documents—Especially on Public School Projects

Sometimes it’s not that easy to ferret out all the unfair insurance flow-downs. My experience is that public school construction projects are the exception: most school districts will provide subcontractors access to insurance and flow-down clauses.

  • Where a single construction manager or a short list of general contractors is selected before the public school project is bid by the subcontractor community, the CM or GC solicitation document will contain the school district’s requirements for insurance, particularly builder’s risk.
  • Most school districts mandate the CM or GC to buy a builder’s risk policy with a zero deductible. Watch out for CMs and GCs who then try to save money by buying a builder’s risk policy with a $10,000 deductible. Their subcontract agreement will then flow-down the $10,000 deductible to the subcontractors instead of honoring the school district’s contract requirement for a zero deductible. Since the school districts don’t see the subcontracts, they don’t realize this subcontractor abuse is occurring. However, when it is discovered, we have had good success in having the school district set the general contractor straight. School districts as clients of construction services respect the role and value of subcontractors.

Me First?

Let’s say you read all the bid documents and validate that the project you are considering has favorable builder’s risk terms that cover material in transit, material stored, and the labor and material for work installed, all at no deductible. You submit a competitive bid and are awarded the project. You celebrate and sign the general contractor’s agreement. Then something happens at the jobsite which causes damage to your work, equipment or materials. At this point in time the GC informs you that in the subcontract agreement you signed it says that it is your insurance that pays first before any insurance purchased by the GC kicks in. Gotcha!

How Do Good Subcontractors Get Caught in a Bad Wrap-Up?

The answer is simple and sad.

  • Subcontractors assume that nothing is going to go wrong on a project.
  • Subcontractors assume that the general contractor and owner will be fair and reasonable if something does go wrong. (Yeah, right!)
  • Subcontractor estimators are too rushed to dig into the bid documents looking for insurance and mark-up land mines.
  • Some subcontractors, especially lower tier subs, might not have even been given access to the complete set of bid documents.

Avoiding Predatory Terms and Conditions

How do you bid a project that has predatory wrap-up or insurance terms? Simply condition your bid by specifically excluding or modifying all the terms that are not fair. You can do so with a blanket statement or with both blanket and specific statements. Let GCs know that your price will go way up if you must accept higher risks or low change order mark up rates.

Will there be a competitor who needs work so badly they’ll sign anything? Who is too rushed to read the fine print? Who has such a long relationship with the GC they don’t need to condition their bid? (Ha, ha!) Sure. So let them gamble by signing these outrageous wrap-up, mark-up, and flow-down clauses. You’re in business to make money, not go broke.

Who Can Help You Review the Documents?

You’ve heard it before—review all the documents before bidding and read the entire subcontract agreement, including all that small print, before signing.

  • Good insurance brokers will be happy to read all the insurance requirements in advance of every bid you prepare. Have a simple checklist that forces you to ascertain what the deductibles and change order mark-ups are before you bid. Bidding a new GC and haven’t seen their standard subcontract agreement? Then condition your bid to negotiating mutually acceptable terms and conditions.
  • When you see a project with predatory insurance or unreasonable mark-ups, let your local subcontractor association Let them advocate and educate the GC or owner about being fair to subcontractors.
  • Network with other subcontractors and share information.

Jonathan Mitz is vice president of Ennis Electric, an employee-owned company in Manassas, Va.



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