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DTCI: Effective risk transfer in a contract

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Lewis Wooton By Lewis S. Wooton

For nearly every major construction project, a construction contract is entered into before construction begins. In almost all of those contracts, provisions are made for the transfer of risk. All too often the parties to the contract fail to effectively transfer their risks in accordance with their intention. As the construction law landscape has evolved, the importance of efficient risk transfer has heightened. The most common methods for transferring risk in construction contracts are indemnity provisions and additional insured provisions. This article discusses the primary considerations to be taken into account when preparing common contractual risk transfer provisions and insuring that the contractual provisions are followed.

1. Indemnity Provisions

Indemnity agreements have been in construction contracts for as long as construction contracts have existed. In its simplest form, an indemnity provision is a clause where one party agrees to answer for liability that another party might incur. Despite the relatively simple purpose of indemnity provisions, careful attention must be paid to indemnity provisions in construction contracts to insure that the provisions comply with the law of the state where the work is to occur. Most states have extensive case law and statutes related to the enforceability of indemnity provisions, and Indiana is no different.

Under Indiana law, a provision in a construction or design contract that purports to indemnify the promisee against liability for the promisee’s sole negligence or willful misconduct is void and unenforceable. See Indiana Code § 26-2-5-1 (2002). Further, a party may agree to indemnify another for the other’s own negligence (not sole negligence), only if the party knowingly and willingly agrees to the indemnification. See GKN v. Starnes, 798 N.E.2d 548, 552 (Ind. Ct. App. 2003). Indiana courts disfavor indemnity provisions because courts “are mindful that to obligate one party for the negligence of another is a harsh burden that a party would not lightly accept.” Id. Indemnity provisions are strictly construed and will not provide indemnification unless the terms of the indemnification are stated in clear and unequivocal terms. Id.

Indiana courts follow a two-step analysis to determine whether an indemnity provision is enforceable. Id. First, the indemnification clause must expressly state in clear and unequivocal terms the area of application. Id. For example, if an indemnification clause is to be applied to a negligence action, the provision must use the “language of negligence,” including words such as liability, damages, actions, omissions, duties, causation, claims, losses, and expenses. Id.

Second, the provision must state in clear and unequivocal terms that it applies to indemnification of the indemnitee by the indemnitor for the indemnitee’s own negligence. Id. There appear to be no exceptions to this rule, and absent express language indicating that the indemnitor agrees to indemnify the indemnitee for the indemnitee’s own negligence, an indemnity provision simply will not be enforced. See Hagerman Construction Corp. v. Long Electric Co., 741 N.E.2d 390 (Ind. Ct. App. 2000) (holding that indemnity provision indicating that promisor will indemnify promisee “to the fullest extent permitted by law” was insufficient language to require promisor to indemnify promisee for promisee’s own negligence where it was not explicitly stated that promisor would indemnify promisee for promisee’s own negligence).

If an indemnity provision contains a clear explanation of the area of applicability and an unequivocal statement that the promisor will indemnify the promisee for the promisee’s own negligence, the provision should be enforceable. However, because of the specific requirements under Indiana law, and the fact that indemnity provisions are disfavored and strictly construed, it makes sense to use an indemnification provision that has already been approved by an Indiana appellate court where possible. The following provision, analyzed in Starnes, was explicitly held to be enforceable:

[Subcontractor] shall indemnify and hold harmless the Owner, the Architect Engineer, and [General Contractor] and their agents and employees from and against all claims, damages, causes of action, losses and expenses, including attorney’s fees, arising out of or resulting from the performance of the work, provided that such claim, damage, loss or expense (1) is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the work itself) including the loss of use resulting therefrom; and (2) is caused in whole or in part by an negligent act or omission of [Subcontractor]or any of his subcontractors, anyone directly or indirectly employed by any of them or for anyone for whose acts any of them may be liable, regardless of whether it is caused in part by a party indemnified hereunder.

Id. at 550.

If the provision shown above accurately portrays the indemnity agreement that your client wants and expects, you should review your client’s contract documents to determine whether the substantial equivalent of the above provision is in the contract. If it is not, consider inserting the indemnification agreement shown above. A little tweaking of your clients’ contracts now may lead to big savings down the road.

2. Additional Insured Provisions

The first step toward insuring that the most beneficial additional insured coverage is provided for your client is to draft a proper additional insured provision into each construction contract. A provision that states “subcontractor shall obtain commercial general liability insurance and name general contractor as an additional insured under the policy” is simply insufficient to reflect the true intent of the parties in most situations.

Additional insured endorsements come in numerous shapes and sizes. The insurance industry has created dozens of endorsements to suit a variety of purposes. Most insurance companies give contractors the option to purchase a “blanket” additional insured endorsement. Blanket additional insured endorsements generally provide additional insured coverage if it is required in a written contract or agreement. Some insurance companies provide additional insured coverage by “schedule” or “endorsement” where the additional insured is specifically named in the declarations page or on the face of the endorsement. Whether a contractor is named as an additional insured in a blanket additional insured endorsement or by schedule, there are several things that an attorney can do to insure that the contractor will be provided with the insurance coverage that he desires.

Because of the significant differences in the various additional insured endorsements used by the insurance industry, the additional insured provision in your client’s contract should specifically state what type of insurance is required. If your client wants to be covered for claims arising out of a subcontractor’s work after the subcontractor has completed the job, the additional insured provision should explicitly state that the insurance coverage must apply to “ongoing operations” and “completed operations.” Many additional insured endorsements terminate coverage for the additional insured the moment the named insured’s work for the additional insured is completed or put to use. The failure to specify that the coverage must apply to completed operations may result in your client being left without the benefit of additional insured coverage immediately upon the subcontractor’s completion of his work. Further, the additional insured provision should indicate that the additional insured coverage is to be “primary and noncontributory.” Many additional insured endorsements provide that the coverage provided to the additional insured is excess over the additional insured’s own coverage unless the contractual agreement requires that it be primary and noncontributory. Thus, unless it is specified in the construction contract that the additional insured coverage is primary and noncontributory, the additional insured coverage may not provide any coverage at all to a contractor until the contractor’s own coverage is exhausted. An additional insured provision in a construction contract should also specify the limits of the insurance to be provided. Otherwise, the available limits under the subcontractor’s policy may be far too low for the risk that will be inherent in the task to be completed. Keep in mind that the inclusion of an additional insured on a policy does not increase the limits. If there is an occurrence, the limits shown on the declaration page must be shared by the named insured and any additional insureds.

Once a proper additional insured provision has been placed in the construction contract and agreed upon by the parties, the next step is insuring that the parties adhere to the terms of the contract. The most common way that owners and general contractors insure that their subcontractors are adhering to the insurance requirements in the policy is through collection of a certificate of insurance. A certificate of insurance should be obtained before allowing the subcontractor to begin work on the project. The certificate should be carefully reviewed to insure that the dates of the respective policies cover the anticipated construction dates, the policies have adequate limits, and there is some indication that the additional insured coverage comports with the requirements of the policy (i.e., includes completed operations coverage, is primary and noncontributory, etc.) If the subcontractor is allowed to start work without providing a certificate of insurance or after providing a certificate of insurance that shows improper coverage, the obligations in the construction contract related to additional insured coverage may be waived.

Whenever possible, the actual insurance policy of the subcontractor or the additional insured endorsement should be obtained before the start of the work because certificates of insurance do not actually provide any coverage. For example, a certificate of insurance that shows an entity as an additional insured will not provide additional insured status to the entity if the insurance policy does not list the entity as an additional insured. See TIG Ins. Co. v. Sedgwick James of Washington, 276 F.3d 754 (5th Cir. 2002). The ACORD 25 form, a standard certificate of insurance form used by insurance agencies, was amended in 2009 to include the following disclaimer near the top of the form:

This certificate is issued as a matter of information only and confers no rights upon the certificate holder. This certificate does not affirmatively or negatively amend, extend or alter the coverage afforded by the policies below. This certificate of insurance does not constitute a contract between the issuing insurer(s), authorized representative or producer, and the certificate holder.

Practically speaking, it may be difficult to obtain insurance policies from every subcontractor for every construction job. The receipt and careful review of the certificate of insurance is the next best thing. However, for especially large jobs, ask to see the additional insured endorsement in the insured’s policy before allowing the subcontractor to begin work.

Finally, take a moment to think about the type of work that your client is performing and whether his work will be covered under the subcontractor’s policy. For example, if your client performs architectural or design work, being named as an additional insured on a commercial general liability policy is unlikely to provide your client with any protection because of the professional liability exclusion found in most commercial general liability policies. If your client provides, “professional services,” you must insure that any policy providing additional insured coverage contains an endorsement for professional liability coverage.

The often unpredictable liability of general contractors coupled with the tough economic times that many contractors are now facing makes effective indemnity and additional insured provisions a critical part of any contractor’s construction contract. As any attorney who has tried to sort out the risk transfer obligations in a construction contract after an event triggering liability has occurred can attest, more often than not, there is significant confusion about the parties’ rights and obligations. The last thing that a client wants to hear following an accident is that the language in his contract that he thought would protect him is meaningless. Following the principles in this article is a good start to drafting effective risk transfer provisions that will provide your client with the protection he seeks in the event of an accident.

____________

Mr. Wooton is an associate in the Indianapolis firm of Lewis Wagner and is a member of the DTCI. The opinions in this article are those of the author.

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