LET THE BROKER BE(A)WARE:
AN INTRODUCTION TO ILLINOIS LAW OF EMPLOYER LIABILITY
AND
COVERAGE ISSUES ARISING FROM THE WAIVER OF KOTECKI

By: Richard T. Valentino
McKenna, Storer, Rowe, White & Farrug
200 North LaSalle Street, Suite 3000
Chicago, IL 60601
312-558-3900

Illinois law governing an employer’s liability for an on-the-job injury to its employee is among the most complex of the Fifty States. The complexities present potential pitfalls not only for employers, but also for their insurance brokers. To aid in the understanding of these pitfalls, this article will examine employer liability exposures under Illinois law and coverage issues that arise in connection with these exposures. Among other things, the issue of potential gaps in coverage for "Kotecki waiver" exposure will be examined. The article will conclude by applying the law to several hypothetical factual settings in order to better illustrate the exposures.

In Illinois, an employer faces several avenues of liability exposure for on-the-job injuries to its employees. First, and most common, is the employer’s exposure to pay benefits to an injured employee pursuant to the Illinois Workers’ Compensation Act. The Act provides a schedule for computing appropriate compensation for particular injuries and essentially places financial limits on the employer’s liability. The employer gives up its common law defenses to the employee’s claim, such as the employee’s contributory fault in causing his own injuries, in exchange for the limited liability.

In addition to having a claim under the Workers’ Compensation Act against his or her employer, an injured employee may also have the right to file a civil lawsuit against a third party to the employment relationship — such as a general contractor or a manufacturer of a product — whose negligence is alleged to have caused or contributed to the employee’s injuries. Unlike a claim against the employer, the employee’s recovery from a non-employer defendant in a civil suit is not limited by the terms of the Workers’ Compensation Act. The employee may recover whatever sum is awarded by the judge or jury hearing the case. Although the employee is barred from bringing a civil suit directly against his employer, the defendant may implead the employer by filing a third-party suit against the employer for "contribution" toward the employee’s damages. Such a suit for contribution presents a second avenue of exposure for the employer.

The concept of contribution contemplates that each party whose fault contributed to an injury should pay its "pro rata" (fault-based) share of the loss. Until 1978, employers were immune from contribution suits as well as from direct civil suits by an injured employee. Thereafter, through judicial decisions and the enactment of the "Contribution Act", Illinois employers became potentially liable for unlimited contribution — in other words, the employer could be "third partied" into its employee’s suit against a non-employer tortfeasor and be required to pay an amount commensurate with its full share of fault in causing the employee’s injury. Prior to 1991 an Illinois employer enjoyed limited liability to its employee under the Workers’ Compensation Act, but was exposed to unlimited contribution liability for the same injuries as a third-party defendant in the employee’s civil suit. The net effect was to deprive the employer of the limited liability conferred by the Workers’ Compensation Act.

Finally, an employer may incur a liability exposure for an employee’s injury if the employer fails to procure contractually required insurance for the benefit of another party, typically an upper-tier contractor or owner. Claims for breach of contract to procure insurance are often brought against the employer in the same suit in which contribution is sought.

There was a philosophical conflict between the public interests which motivated enactment of the Workers’ Compensation Act (limited liability for employers and "no-fault" coverage for employees) and those behind the Contribution Act (liability of responsible parties, including employers, divided according to each party’s share of fault). In 1991 the Illinois Supreme Court attempted to balance the competing interests of these statutory schemes in the case of Kotecki v. Cyclops Welding. In Kotecki the court held that an employer’s maximum liability in a third-party suit for contribution is limited to an amount no greater than its liability to its employee (the plaintiff) under the Workers’ Compensation Act. This balance allowed non-employer defendants, such as manufacturers or general contractors, to recover limited contribution from the employer, but still gave the employer benefit of the limited liability protection of the Workers’ Compensation Act.

In the mid-1990s a series of judicial decisions from the Illinois Appellate Courts and Supreme Court were handed down, holding that an employer may waive its Kotecki protection by contract, and thereby be liable for its full share of contribution. These "Kotecki waiver" cases are based upon judicial construction of what might loosely be termed "indemnity provisions" contained in contracts to which the employer was a party. Typically, an "indemnity provision" will require a subcontractor to "indemnify and hold harmless" upper tier parties, such as a general contractor or owner, for the upper tier party’s liability for injury to person or property happening in connection with the subcontractor’s work.

At this point, brief comment regarding the Illinois Construction Contract Indemnification for Negligence Act ("Anti-Indemnification Act") is required. The Anti-Indemnification Act renders void any agreement in a construction contract to indemnify or hold harmless a person from that person’s own negligence. By way of example, the Anti-Indemnification Act would render void a provision in a contract by which a subcontractor agreed to pay the full cost of an injury to its employee, even if the general contractor was held to be partially or fully at fault for the injury in a lawsuit. The Anti-Indemnification Act is premised on the belief that allowing a party to insulate itself from liability through the use of contractual indemnification provides that party with a disincentive to exercise care for the safety of workers. However, the Act does not prohibit, for example, a general contractor from requiring that the subcontractor provide liability insurance which would cover the general for its own negligence.

In one of the leading cases on "Kotecki waiver", Braye v. Archer Daniels, the Illinois Supreme Court found that an "indemnity provision" in a construction contract did not require a contractor/employer to indemnify a premises owner for the owner’s negligence. Rather, the provision was construed by the court as merely allowing for "unlimited contribution" from the employer to the owner. Therefore, the provision did not violate the Anti-Indemnification Act. The owner had been sued by the employer’s employee for a job site injury, and filed a third-party complaint for contribution against the employer. The employer was deemed to have waived its Kotecki protection and thus could be held liable in contribution for its full share of fault in causing its employee’s injuries. There appears to be a trend in Illinois courts to construe "indemnity clauses" in construction contracts in a manner that does not violate the Anti-Indemnification Act, but renders the employer liable for unlimited contribution — in other words waives the employer’s "Kotecki cap".

Also, most construction contracts will contain two types of provisions which are relevant in determining the contracting parties’ rights and responsibilities with respect to each other in event of injury. The first type of provision is the "indemnity provision" described above. The second type of provision may be referred to as an "insurance procurement" provision. This clause will typically require the lower tier contractor to provide liability insurance for the higher tier contractor or owner. Failure to provide the contractually required insurance will leave the lower tier contractor exposed to a claim for breach of contract.

In the late 1990s, two Illinois Appellate Court decisions were handed down which, collectively, indicate that "Kotecki waiver" exposure — the employer’s liability in contribution above its "Kotecki cap" — may be uninsured under both the standard commercial general liability policy and the standard employer’s liability policy.

The first of these cases, Hankins v. Pekin Insurance, arose in a non-construction setting. It involved an "indemnity provision" which was construed by the court as calling for unlimited contribution. The court ruled that the "indemnity provision" did not constitute an "insured contract" under the CGL’s definition of that term because, by agreeing to be held liable for unlimited contribution, the employer was simply agreeing to accept the full share of its own "tort liability" and was not accepting the tort liability of another party. Because the employer’s potential liability under the provision did not come within the employer’s CGL’s "insured contract" coverage, the CGL insurer had no obligation to defend or indemnify it with respect to a third-party claim for indemnification based on the provision.

Next, in Christy-Foltz v. Safety Mutual Ins. Co., the Appellate Court found a "Kotecki waiver" in a contract between an employer and the owner of a work site. One of the employer’s employees was injured, and brought suit against the owner. The owner filed a claim for unlimited contribution against the employer, asserting that a "Kotecki waiver" was contained in the contract which the employer had signed. The court found that, by agreeing to waive the right to invoke Kotecki as an affirmative defense, the employer had "voluntarily assumed liability" for its pro rata share of damages proximately caused by its own negligence. As a result of doing so, its liability in excess of Kotecki would be allocated pursuant to the Contribution Act. Any such liability would constitute a "loss" under the terms of the policy and would not be covered because the policy excluded coverage for "loss" which was "voluntarily assumed" under contract.

Although the employer’s liability policy in Christy-Foltz was not standard, the standard NCCI form, Exclusion C1, states that the insurance does not cover "liability assumed under a contract". In addition, the standard EL policy requires that the insured not "voluntarily make payments (or) assume obligations...except at your own cost". Thus, the rationale of Christy-Foltz may be applicable in the context of a standard EL policy.

Together, Hankins and Christy-Foltz provide a basis for CGL and EL insurers to argue that "Kotecki waiver" exposure — the gap between the employer’s "Kotecki cap" and its full liability under the Contribution Act — is uninsured. This uninsured exposure presents a potentially serious financial threat to many Illinois employers, particularly trades companies which act as subcontractors at construction sites. These employers routinely enter into contracts containing "indemnity provisions" which are easily construable as "Kotecki waivers". Although they are probably unaware of it, these employers may be taking on uninsured exposure by executing such contracts.

As stated earlier, there are typically two types of loss allocation provisions in construction contracts — the indemnity provision and the insurance procurement provision. Typically, in addition to agreeing to indemnify the "upper-tier" party, a subcontractor will also be required to procure insurance for the benefit of that party. As these upper tier parties grow more sophisticated, their contracts increasingly call for "primary and non-contributory" liability insurance to be provided for their benefit by the subcontractor.

Insurance procurement provisions contain a "silver lining" for the employer who complies with them. The procurement of liability insurance by an employer (for example a subcontractor) for the benefit of an upper-tier party (for example a general contractor) can have significant (and favorable) ramifications for the subcontractor’s contribution liability in a case brought by its injured employee. In the leading case of Briseno v. Chicago Union Station, the Appellate Court held that where parties to a contract agree that insurance will be provided as part of their bargain, the contract must be interpreted as providing "mutual exculpation" from personal liability to the bargaining parties. In other words, the law will deem that the parties have agreed to look solely to the insurance in the event of a loss, and not seek to impose liability on each other. In practical terms, the rule of Briseno can provide a subcontractor/employer who has provided the general contractor with liability insurance with a full or partial defense to the general’s claim for contribution.

Note that Illinois case law following Briseno requires that the general contractor’s loss (i.e. its liability to the subcontractor’s employee) be fully covered by the insurance provided by the subcontractor/employer in order for the Briseno rule to apply. The general contractor is allowed to obtain contribution from the employer to the extent that the general’s own insurer must pay a part of the loss. However, in the event that the general contractor is fully defended and indemnified for a loss by the insurance which was supplied by the employer, the action for contribution against the employer must be dismissed. This should be so even if the employer has waived Kotecki.

Another key case is the Illinois Supreme Court decision of Burns v. Indiana Insurance, released in 1999. Under Burns, a party which is insured under more than one liability policy may select which insurer it wishes to defend and indemnify it for a loss. Typically, a general contractor who is the named insured on its own liability policy and is also an additional insured on a subcontractor’s liability policy will "select" or "target" the sub’s policy to defend and indemnify it in a suit brought by the subcontractor’s injured employee. When this type of "targeted tender" occurs, the likelihood that the employer will be able to assert a "Briseno defense" to the general’s claim for contribution increases.

It cannot be over-emphasized, however, that a Briseno defense is not "perfected" until the general contractor has been fully defended and indemnified by the insurance provided by the employer. The general’s contribution action against the employer will remain pending until that time, and contribution from the employer will be allowed up to the extent that the general’s own insurer must pay toward the loss.

Employers face an uninsured exposure if they fail to procure liability insurance for the benefit of the upper tier party as required by contract. Several Illinois decisions hold that a party’s liability for damages arising from a "breach of contract to procure insurance" is uninsured and is in the amount of the loss which the contractually-required insurance would have paid on behalf of the party whose liability was to have been insured. Although insurance requirements may be "waived" by the upper tier party, through allowing the employer to commence and complete operations without demanding proof of insurance, compliance with the contract and procurement of required insurance is the preferable course of action for the employer. It eliminates the risk of one uninsured exposure (failure to procure insurance) and may mitigate or eliminated risk of another (Kotecki waiver).

VII. Applying the Law to Hypothetical Facts

To aid in understanding this complex area, consider these hypothetical scenarios in which the rules of law set forth above are applied to various factual settings.

Common Facts: Injured employee ("Plaintiff") is employed by an electrical subcontractor ("Employer"). The Employer has a contract for work with the general contractor ("General"). Plaintiff is injured when he slips and falls on debris located in his work area. Some, but not all, of the debris was created by the Employer’s operations. The rest of the debris was created by the operations of other contractors at the site.

Plaintiff brings a workers’ compensation claim against the Employer and recovers benefits of $150,000. The claim has been settled and closed.

The plaintiff also brings a civil lawsuit against the General, alleging that the General was negligent in failing to maintain the workplace in a safe condition. The Employer (or its EL insurer) holds a lien for $150,000 against any recovery made in this civil suit.

The General files a third-party suit against the Employer, seeking contribution based on the Employer’s creation of debris and failure to maintain its work area in a clean and safe condition. The Employee’s suit and the third-party suit are tried to a jury, which renders a verdict in favor of the plaintiff in the gross amount of $500,000.00. The jury finds that the plaintiff was 25 percent at fault for his injuries because he failed to exercise due care for his own safety. The jury further finds the General 25 percent at fault and the employer 50 percent at fault for the plaintiff’s injuries.

In all scenarios, the court will enter judgment in favor of Plaintiff and against the General in the sum of $375,000 ($500,00 minus 25% - Plaintiff’s share of fault). The judgment in the General’s contribution suit against the Employer, however, will vary significantly, depending on (1) whether the Employer waived Kotecki and (2) whether the Employer was required to, and did, provide insurance for the General.

Scenario No. 1: The Employer’s contract with the General was a simple work order, with no indemnity or insurance procurement provisions. The Employer is therefore entitled to assert its "Kotecki cap" as a partial defense to the General’s claim for contribution. The General is required to pay the plaintiff $375,000. The plaintiff is required to repay the Employer’s lien of $150,000. (Thus, the plaintiff’s net recovery is $225,000 in addition to the $150,000 in workers’ compensation benefits which he has already received for a total of $375,000.) The General may only recover contribution of $150,000 from the Employer. The General’s net payment will be $225,000.

Scenario No. 2: The contract for the work contains an "indemnity" provision which is found to be a "Kotecki waiver". The contract has no insurance procurement requirements. The General is required to pay the plaintiff $375,000. However, the General may seek contribution from the Employer in the sum of $250,000 — the Employer’s full share (50% of $500,000) of liability. The first $150,000 is paid by the Employer’s EL insurer. The remaining $100,000 may be uninsured based on Hankins and Christy-Foltz and the Employer may be personally liable for this portion of the judgment. The Employer has no Briseno defense because it procured no insurance for the General. Again, the Plaintiff must repay the lien and will make a net recovery of $225,000 from his suit.

Scenario No. 3: The contract for the work contains an "indemnity" provision which is found to be a "Kotecki waiver". The contract also requires the Employer to provide liability insurance for the General, and the Employer complies by adding the General to the Employer’s CGL policy. The General makes a "targeted tender" (pursuant to the Burns case) of the plaintiff’s lawsuit to the Employer’s CGL insurer which accepts the General’s defense and pays the $375,000 judgment in its entirety, with no payment from the General’s own insurer. Once this occurs, the General’s contribution claim against the Employer is subject to being dismissed under the Briseno line of cases. Even though the Employer has waived Kotecki, it should not be held liable in contribution to the General. The Employer’s EL carrier will recover its entire $150,000 lien from the plaintiff, who again nets $225,000.

Scenario No. 4: Same as No. 3, but, the General’s own CGL defends and indemnifies the General concurrently with the Employer’s CGL. Each CGL insurer contributes $187,500 toward the $375,000 judgment. The plaintiff must repay the Employer’s lien. The General (for the benefit of its own CGL insurer) is entitled to seek contribution from the Employer in the amount of $187,500. The Employer’s CGL is not entitled to recover any contribution. The Employer’s EL carrier pays $150,000 (the amount of the "Kotecki" cap), leaving the Employer uninsured for $37,500.

Scenario No. 5: Same as No. 3, but the Employer breaches the term of the contract requiring it to procure liability insurance protecting General. Therefore, in addition to suing the Employer for unlimited contribution, the General also claims a breach of contract to procure insurance. The General’s CGL insurer pays the judgment of $375,000. The General is able to collect $150,000 on its $250,000 judgment for contribution from the Employer’s EL insurer. The General or its insurer may be required to collect the balance of the contribution judgment ($100,000) from the Employer personally.

As to the General’s claim of failure to procure insurance, the Employer may raise an affirmative defense that the General waived the right to insurance by failing to enforce that right. If the Employer prevails on the defense, the General collects nothing on its breach of contract claim. However, if the defense of waiver fails, the Employer may be held liable for an additional $125,000 for failing to procure the insurance. This exposure is uninsured.

Lien Waiver and Set-Off: As stated earlier, the Employer holds a lien for the workers’ compensation benefits which it has paid to its employee. In the hypotheticals, that lien is in the amount of $150,000 and it is actually held by the insurer which paid the benefits — the Employer’s Workers’ Compensation/Employer’s Liability insurer. In the examples, the plaintiff must repay the lien. However, Illinois law also allows the WC/EL insurer to waive its lien, even after entry of judgment against the Employer, and receive "dollar for dollar" credit toward satisfaction of the Employer’s contribution liability. In cases where Kotecki is not waived, lien waiver can fully satisfy the Employer’s contribution liability. In cases where Kotecki has been waived, lien waiver may or may not be adequate to cover the contribution liability depending on the Employer’s relative fault for the loss. When the lien is waived, the General is entitled to a set-off from the judgment against it for the full amount of the lien. Thus, in the hypotheticals, if the Employer’s lien was waived instead of recovered, rather than being responsible to pay the plaintiff’s verdict of $375,000 and collect contribution of $150,000 from the Employer, the General would be entitled to a set-off from the verdict of $150,000 and only be required to pay the plaintiff $225,000.

Under Illinois law, an insurance broker is often held to be the agent of the insured rather than the agent of the insurer. The insurance broker has fiduciary and tort-based duties to its client, requiring that due care be exercised in the procurement of insurance. In some respects a broker is an easier "target" for a disgruntled client/insured than is an insurance company. While an insurance company can raise specific policy language as a defense to a claim by an insured, a broker may not be able to rely on the same language if the insured pleads "ignorance" of terms of the policy and reliance on the broker’s expertise.

In the context of an insured’s "Kotecki waiver" exposures, it is important for the broker — for both his own protection and that of his client — to inform the client of the uninsured risk which may arise as a result of entering into contracts containing "Kotecki waivers". In this way the client will be able to make informed decisions prior to entering into contracts for work in the future. This setting is fraught with the potential for the intermingling of "legal issues" (such as contract interpretation) with "insurance issues" (such as selecting the best policy for the risk). Therefore, it may be appropriate for the broker to suggest that his or her client consult with legal counsel regarding the legal effect of the contracts.

Also, as we have seen, "Kotecki waiver" exposure can be mitigated or eliminated through procurement of insurance pursuant to contractual requirement. Thus, it is of utmost importance that "insurance procurement" provisions be strictly complied with by the insured. This places a great responsibility on the broker to obtain the required insurance, and not a product which is non-compliant with the contract. In the event that the insurance procurement provision requires both the client’s primary and excess insurance policies to be primary and non-contributory with the other party’s own insurance, or if the provision requires primary and non-contributory coverage for the other party in an amount which will exceed the client’s primary policy limit, the client’s primary and excess policies must each be endorsed to make their layers of coverage primary and non-contributory with the other party’s own insurance.

The responsibility to obtain the proper insurance transcends protecting against "Kotecki waiver" exposure. If the broker sees uninsured or uninsurable obligations being placed on his client by the terms of the contract, he should so inform the client. If there is any doubt regarding the legal requirements of the contract, the broker should recommend that the client consult with counsel, since contract interpretation is a legal issue.

As of the preparation of this article, it appears that at least one major insurer (St. Paul) is contemplating making a "Kotecki waiver" coverage endorsement available in its employer’s liability insurance program. Unconfirmed information suggests that another major insurer is formally adopting the position that "Kotecki waiver" coverage will be covered by the "insured contract" coverage under the CGL. However, at present, it appears that the "gap" in coverage created by a Kotecki waiver remains a very real threat to many employers whose standard policies may have the vulnerabilities pointed out in Hankins and Christy-Foltz. The onus is on the broker to advise his or her clients of the gap and the availability of insurance to cover that gap.

While the article attempts to provide certain fundamentals which are pertinent to the commercial insurance broker, it is not comprehensive and should be relied on only for general educational purposes. That said, the author wishes to thank Chuck Schramm of the Lamb, Little & Company Agency for the opportunity to present this material to you, his co-workers, colleagues and friends.

ABOUT THE AUTHOR:

Richard T. Valentino is a 1984 graduate of The John Marshall Law School and was admitted to practice in Illinois in the same year. He is an attorney at the law firm McKenna, Storer, Rowe, White & Farrug in its Chicago office, where he concentrates his practice in insurance coverage and employer civil liability defense matters. Mr. Valentino is a member of the Illinois State Bar Association and the Illinois Association of Defense Trial Counsel.

This article is reprinted with permission of Richard T. Valentino.

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