Insurance Pitfalls in ADR Clauses
Many real estate and construction contracts now include detailed alternative dispute resolution ["ADR"] clauses stipulating that the parties will attempt to resolve their differences short of litigation by submission of the dispute to mediation, arbitration or both. The impetus for such clauses is the parties' perception that these ADR procedures will lower litigation costs and speed resolution of disputes. This may be so, but the result of their use may be to cause a forfeiture of the allegedly liable party's liability insurance.
Virtually all liability policies contain provisions requiring the insured to give its liability insurer prompt notice of any claim or suit, as well as the opportunity to assume control of the defense of the claim. The policies also contain provisions that relieve the insurer of the obligation to reimburse its insured for any defense costs, attorney's fees or settlement sums made before the insurer has been given notice of the claim by its insured. Recent Texas Supreme Court cases, including National Union Fire Ins. Co. of Pittsburgh, Pa. v. Crocker, 246 S.W.3d 603 (Tex. 2008), make it clear that the Texas Supreme Court does not view these provisions as boilerplate; the Court will enforce these clauses as written and allow insurers to avoid policy obligations where they have been prejudiced by non-compliance.
How can this happen in the ADR setting? Even with pledges of confidentiality, statements or admissions that bear upon liability or damages (e.g., an agreement to make repairs) may well be considered prejudicial, leaving the insured without coverage for what may turn out to be a substantial claim. The insurer may also argue that pre-suit demands for voluntary mediation do not constitute a covered claim for damages under their policies.
In any dispute, particularly those involving a construction or latent structural defect, careful consideration should be given as to how to invoke an ADR clause. Care should be taken to ensure that any demand to use the ADR process is worded so as to be a claim under the allegedly liable party's coverage, and that any party allegedly liable for the loss has put its insurers on notice of the dispute and obtained from those insurers a decision as to whether the insurer will participate. Prospectively, ADR clauses should be drafted so as to require notification of liability insurers by affected parties as a condition of the use of the process. There undoubtedly be disputes that are so small or easily resolved that this level of formality is not necessary, but careful attention should be paid in advance to any situation that may involve a substantial insurance claim. Consultation with counsel and careful handling may avoid the loss of liability insurance proceeds later on.
