Contractual Liability - Are You Really Covered?
Contractual liability coverage is likely a component part of your
construction company’s commercial general liability insurance
policy, or it may be provided by an endorsement. It is designed to
provide coverage for the financial liability you assume under a
broad or intermediate form indemnity in the construction contract
with your client. Have you read it and do you really understand its
coverage? Do you even have coverage?
By Kit Werremeyer
President, Southernstar Consultants, LLC
Construction contractors are continually faced with the extremely difficult commercial challenge of having to accept the unlimited financially liability for bodily injury and property damage claims arising out of the negligence of their clients.
Clients try to achieve this by trying to force contractors to accept broad or intermediate indemnities.
• A Broad Form Indemnity makes a contractor responsible for the financial liability for bodily injury, including death, and property damage claims arising out of the negligence of the client, including the client’s sole negligence (the client is determined to be 100% negligent).
• An Intermediate Form Indemnity makes a contractor responsible for the financial liability for bodily injury, including death, and property damage claims arising out of the negligence of the client, except for those incidents caused by the sole negligence of the client (the client could be determined to be up to 99% negligent).
Frankly, there’s not any difference at all between the two. In the event of a successful claim by the client, a small or medium sized contractor may now be forced into bankruptcy absent a combination of insurance protection and strong contract risk mitigation negotiation skills.
To make matters worse, both broad and intermediate indemnities typically will require the contractor to be additionally responsible for reimbursing the client’s defense costs associated with defending claims, even if such claims are ultimately determined to be groundless, without merit, or fraudulent.
An example: contractual liability coverage for indemnities is provided by the widely used standardized language of the ©ISO (Insurance Services Office) Commercial General Liability policy CG 00 01. This CGL policy provides coverage for the named insured’s liability for bodily injury and property damage and legal defense arising out of an indemnity in a construction contract. Coverage is provided as an exception to an exclusion (just to make non-insurance people go crazy!).
The ISO standard CGL language for contractual liability is broad and appears to provide for broad or intermediate form and perhaps some other types of indemnities where the liability of someone else—like the Owner of his GC/EPC contractor for example—is transferred.
However, ISO standard language is not used by all insurance providers. Some insurance providers have their own idea of the type of language they are willing to accept, either as a component part of their basic CGL policy or by endorsement to the policy, as to providing coverage for contractual liability.
Article 25 – Indemnity
25.1 Contractor shall defend, indemnify and hold harmless Owner and his employees for all claims for bodily injury and property damage arising in any way out of the Work.
Clearly this is a broad form indemnity where the Contractor contractually accepts financial liability for bodily injury and property damage claims arising out of the negligence of the Owner, including those claims arising out of the sole negligence of the Owner. The clause also requires the contractor to pay for the client's defense costs.
Let’s say the Contractor has a basic $2,000,000 CGL and some form of an excess or umbrella policy in the amount of $4,000,000. Both policies provide contractual liability coverage on the same basis. The contractor has insurance in the amount of $6,000,000 that will cover claims arising out his acceptance of an indemnity in a construction contract.
During the course of the work a person other than an employee of the Contractor is severely injured and permanently disabled. During the lawsuit that follows, the Owner is determined to be the sole cause of the accident. The jury awards the injured individual $10,000,000.
The Owner’s defense costs for the claim are $500,000.
The Contractor’s CGL and excess/umbrella insurance policies include contractual liability coverage for indemnities in construction contracts.
The Owner now files suit against the Contractor claiming indemnity as provided in the above Article 25 of the construction contract and in the amount of $10,500,000 (the sum of the award plus defense costs). Too bad for Contractor—Owner prevails.
Barring any exhaustion of Contractor’s CGL and excess/umbrella insurance limits for other claims, the decision blows right through all of Contractors underlying CGL policy limits and all the limits of his excess/umbrella insurance and leaves the Contractor holding the bag for another $4,500,000 out of his own resources, if he still has any.
The road to bankruptcy is paved with poor contracting by Contractor!
The important thing to remember here is that such an indemnity as shown in the example Article 25 is an uninsurable obligation. Given the litigious nature of our society and the tendencies for juries to make multi-million awards, the award could have been much larger than the $10,000,000 in the example.
Contractor could have negotiated language similar to the following to limit his liability:
Article 26 – Limitation of Liability
26.1 Contractor’s total liability under this contract, including the liability and defense costs assumed in Article 25 – Indemnity, shall be limited to an amount not to exceed $1,000,000 in the aggregate.
26.2 This limitation shall survive the contract.
Such a limitation on liability would at least create an insurable obligation under Contractor’s underlying CGL policy and be well within the policy’s limits. Contractor’s insurance would pay $1,000,000 of the $10,500,000 claim. Still a lousy deal but better than becoming bankrupt.
Here are some additional considerations regarding contractual liability coverage:
1. Does the language of the contractual liability coverage provide for some sort of prior review and approval of the construction contract indemnity by the insurance provider?
2. Does the language of the contractual liability coverage exclude coverage for broad form indemnities?
a. For example: ISO Endorsement CG 24 26 2004 Edition or later eliminates coverage for broad form indemnities.
3. Does the language of the contractual liability coverage exclude all coverage for both broad and intermediate form indemnities?
a. For example: ISO Endorsement CG 21 39 2004 Edition or later completely eliminates the contractual liability you assume under an indemnity in a construction contract.
Take the time to have your insurance broker or agent provide a written description of the contractual liability coverage provided in your CGL policy, along with any and all exclusions and conditions. Make sure this information is provided to everyone in your organization who has responsibility for negotiating construction or construction related contracts where indemnities are included.
Finally, make sure it is the policy and practice of your company to contract only for commercial terms and conditions and other risks that are insurable.
As the contractor from Toledo, Ohio says: “There is no price for bad terms.”
©Southernstar Consultants, LLC, May 2012. Revised January, 2014