It has long been the general rule that, subject to certain statutory exceptions, parties are free to enter into contracts that absolve a party from its own negligence or limit liability to a nominal sum. As a matter of public policy, however, New York law prohibits a party from insulating itself from damages caused by grossly negligent conduct. Accordingly, exculpatory clauses and liquidated damages clauses in contracts are not enforceable against allegations of gross negligence. But despite this public policy protection, a party may nonetheless limit liability for its own gross negligence through "waiver-of-subrogation clauses." Under such clauses, one party to a contract is required to obtain insurance coverage and waive any and all claims for losses as against the other party or parties. As the Court of Appeals has recognized, "[a] distinction [is] drawn between contractual provisions which seek to exempt a party from liability . . . and contractual provisions . . . which in effect simply require one of the parties to the contract to provide insurance for all the parties." Bd. of Educ.,Union Free Sch. Dist. v. Valden Assoc., 46 N.Y.2d 653, 657 (N.Y. 1979).
The Court of Appeals' recent decision in Abacus Fed. Sav. Bank v. ADT Sec. Servs. Inc., 18 N.Y.3d 675 (2012), underscores the significance of this distinction. In Abacus, Plaintiff, a savings and loan association, brought suit against defendants ADT Security Services, Inc. (ADT) and Diebold Incorporated (Diebold) to recover damages under tort and contract theories for losses incurred during an overnight burglary. Prior to the burglary, each Defendant had separately contracted with Plaintiff to supply security services for the branch. The alarm systems did not operate properly on the night of the burglary, and the crime was not discovered until the next morning. Based on the systems' failures, Plaintiff commenced suit against ADT and Diebold, alleging that both were grossly negligent in failing to properly install and maintain the alarm systems, and in failing to investigate and notify Plaintiff of known malfunctions.
In assessing whether Plaintiff could assert such claims, the Court of Appeals focused on the terms of Plaintiff's contract with each Defendant. Both contracts contained clauses that exculpated Defendants from liability for their own negligence and limited their liability, under all circumstances, to $250.00. Significantly, however, only the contract between Plaintiff and Diebold contained a waiver-of-subrogation clause. This clause provided that Plaintiff was required to obtain insurance coverage to cover its losses in the event of a theft; that Plaintiff "shall look solely to its insurer for recovery of its loss and hereby waives any and all claims for such loss against Diebold"; and that Plaintiff's insurance policy would contain a clause providing that such waiver would not invalidate the coverage. Plaintiff's agreement with ADT, on the other hand, provided only that "insurance, if any, covering personal injury or property loss damage" was Plaintiff's responsibility to obtain.
In examining Plaintiff's allegations in light of the respective clauses, the Court held that while Plaintiff had adequately alleged gross negligence against both Defendants, Plaintiff could proceed against only ADT because the waiver-of-subrogation clause in the Diebold agreement fully shielded Diebold from any and all such claims, even those based on gross negligence. Highlighting the critical distinction between Diebold's contract with Plaintiff and ADT's contract with Plaintiff, the Court explained:
ADT's contract with [Plaintiff] does not contain a similar waiver-of-subrogation clause that would act as a total defense to Abacus' claim. We note that the contract between [Plaintiff] and ADT did not require [Plaintiff] to obtain insurance to cover losses stemming from ADT's gross negligence. The decision to obtain insurance, "if any," was discretionary as to [Plaintiff]. Moreover, the contract did not contain an express waiver by [Plaintiff] to waive all rights for damages covered by insurance it may have obtained as against ADT. Thus, we reinstate the breach of contract cause of action as against ADT.
As this result illustrates, the effect of a waiver-of-subrogation clause is significant, especially with respect to insurers' rights. Indeed, where such a clause applies, it can drastically, if not completely, limit an insurers ability to recoup covered losses paid to its insured, even if the responsible party was grossly negligent.
If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact any of the members of the Torts & Products Liability Defense Practice Area.