Impact of the Insured's Contractual Waiver of Subrogation on its Insurance Carrier's Workers' Compensation Lien

March 2017

By Jeffrey F. Clement

We have recently seen an increase in contractual provisions which seek to limit subrogation rights for losses covered by workers' compensation insurance. Most often, these provisions are contained in construction subcontract agreements between a general contractor and subcontractor. A typical provision might require the subcontractor to waive subrogation claims against the general contractor for losses covered by the subcontractor's workers' compensation insurance. The contract may further require the subcontractor to provide a waiver of subrogation endorsement in favor of the general contractor which waives subrogation rights against the general contractor regarding workers' compensation.

Let's assume an employee of the subcontractor is injured on a construction project giving rise to the payment of workers' compensation benefits. Let's further assume the employee files a third-party civil lawsuit against the general contractor on the project for his or her injuries. Ordinarily, pursuant to Section 5(b) of the Illinois Workers' Compensation Act, the subcontractor's workers' compensation carrier has a statutory lien on plaintiff's recovery against the general contractor in an amount of 75% of its workers' compensation payments, less pro rata share of expenses. If the employee does not file a lawsuit, the Act also gives the subcontractor the right to file a direct subrogation lawsuit against the negligent third-party (here, the general contractor) for the employee's injuries. However, does the aforementioned waiver of subrogation provision have any impact on the ability of its workers' compensation carrier to enforce its statutory lien or file a subrogation lawsuit?

Are Waivers of Subrogation for Workers Compensation Enforceable?

Some states have amended their workers' compensation laws to declare waivers of subrogation for workers' compensation to be contrary to public policy and therefore null and void. See N.H. Rev. Stat. § 281-A:13(VI); Ky. Rev. Stat. § 342.700(3); Mo. Rev. Stat. § 287.150.1.

The Illinois Act does not contain any explicit prohibition on waivers of subrogation. Furthermore, Illinois courts exercise sparingly the power to declare a contract provision void as against public policy. Empress Casino Joliet Corp. v. W.E. O'Neil Constr. Co., 2016 IL App (1st) 151166 at P74.

In property damage cases, Illinois courts have found contractual waiver of subrogation provisions to be enforceable and not contrary to Illinois public policy. Intergovernmental Risk Mgmt. v. O'Donnell, 295 Ill. App. 3d 784 (1st Dist. 1998); Village of Rosemont v. Lentin Lumber Co., 144 Ill. App. 3d 641 (1st Dist. 1986); Empress Casino, 2016 IL App (1st) 151166. According to these courts, the general purpose of the waiver is to avoid protracted litigation by allowing the parties to a construction contract to exculpate each other from personal liability in the event of property loss or damage to the work to the extent each party is covered by insurance. In essence, the insurance clause shifts the risk of loss to the insurance company regardless of who is at fault. Intergovernmental Risk, 295 Ill. App. 3d at 793.

Furthermore, in Illinois, an insurer "steps into the shoes" of its insured. Therefore, any defenses available against the insured also apply against an insurer in a subrogation action. Continental Casualty Co. v. Polk Bros., Inc., 120 Ill. App. 3d 395 (1st Dist. 1983); Safeco Ins. Co. v. Jelen, 381 Ill. App. 3d 576 (3d Dist. 2008). As a result, Illinois courts have found if the subcontractor waived subrogation, so has its insurer, and regardless of whether the insurer consented to the waiver. Intergovernmental Risk Mgmt. v. O'Donnell, 295 Ill. App. 3d 784 (1st Dist. 1998).

The Illinois Anti-Indemnity Act renders void as against public policy any provision in a construction contract to indemnify or hold harmless another person from that person's own negligence. 740 ILCS 35/1. However, Illinois courts have distinguished waivers of subrogation from indemnity agreements. In Intergovernmental Risk, the court held the considerations of the Anti-Indemnity Act are not affected by waiver of subrogation provisions where the provision does "not involve injury suffered by a construction worker or a member of the general public, but instead, damage suffered by one of the contracting parties." Intergovernmental Risk, 295 Ill. App. 3d at 793. Instead, "[b]oth sides benefit from the arrangement and such benefit under the circumstances does not come at the expense of a third party." Id. at 793-94. Furthermore, in Empress Casino, the court held a waiver of subrogation is not an exculpatory clause. Empress Casino, 2016 IL App (1st) 151166 P75. Unlike indemnity clauses, waiver of subrogation clauses "merely allocate risk of loss; they do not immunize the wrongdoer from all liability." Id.

Yet, as stated, all of these decisions discussed waivers of subrogation in the context of property losses, not workers' compensation losses. No Illinois court has yet addressed a waiver of subrogation for workers' compensation. It could be argued the public policy considerations of the Anti-Indemnity Act (i.e. promoting safety on construction sites) are directly at issue because an employee has been injured. However, in Intergovernmental Risk, the court noted, even if the agreement extended to third-party liability, it would not constitute an agreement to indemnify a party for its negligence but, rather, it would be an agreement to procure insurance on that party's behalf." Id. at 794. Agreements to obtain insurance do not violate the Anti-Indemnity Act. 740 ILCS 35/3. Also, as described in more detail in the following section, the waiver of subrogation has no impact on the employee's ability to sue for his or her injuries. In any event, the matter remains unsettled in Illinois. There are compelling policy arguments both for and against the enforceability of waivers of subrogation of workers' compensation.

What is the Scope of the Waiver of Subrogation?

Assuming the waiver of subrogation for workers' compensation is enforceable, that does not end the inquiry. We must next determine exactly what types of claims are barred by the waiver of subrogation.

Direct Subrogation Lawsuit by the Insurer. There is no doubt a waiver of subrogation would operate to bar any direct subrogation action filed by the subcontractor's workers' compensation carrier against the general contractor that obtained the waiver. See discussion supra.

Employee Lawsuit. However, in the vast majority of circumstances, it is the employee (and not the workers' compensation insurer) who institutes the lawsuit against the negligent third-party general contractor who obtained the waiver.

The waiver of subrogation does not prevent the injured subcontractor's employee from filing a lawsuit against the general contractor because the employee was not a party to the waiver of subrogation agreement. The general contractor who required the waiver receives no real benefit because the claim is not barred regardless of it being covered by workers' compensation.

What about the workers' compensation lien? Is the lien erased because of the waiver of subrogation? The statutory lien under Section 5(b) of the Act is on the plaintiff's recovery. Asserting a lien against the employee should be distinguishable from asserting a subrogation interest against the general contractor. No Illinois courts have addressed the issue. However, in Fowler v. Boise Cascade Corp., 948 F.2d 49 (1st Cir. 1991), the United States Court of Appeals for the First Circuit, interpreting Maine law, held a waiver of subrogation did not prevent the employer from enforcing its lien against the employee who made a third-party recovery. While the employer could not enforce its lien against the contractor that required the waiver, it could enforce its lien against the employee who received the third-party settlement/award.

A converse result would be absurd. If the lien was extinguished because of the waiver of subrogation, the injured employee would be able to keep the full award against the general contractor, thus achieving a double recovery for any indemnity and medical payments made by the workers' compensation carrier. This is well beyond the intent of the contracting parties.

In summation, Illinois law is not developed on the enforceability and scope of a waiver of subrogation provision for workers' compensation. We will continue to monitor these issues and advise of any developments. Yet, even if the waiver of subrogation is enforceable, it should only operate to bar the insurance carrier from instituting a direct subrogation suit against the party who obtained the waiver. If the employee files his/her own lawsuit, the waiver of subrogation should not prevent the employer's workers' compensation carrier from enforcing its statutory lien against the employee's recovery.