Indemnities and Additional Insured Status—Danger!
How to deal with indemnities and requests for additional insured status in your construction or construction related contracts.
By
Kit Werremeyer
President, Southernstar Consultants, LLC
Contract indemnity clauses that transfer to your company the financial liability arising out of bodily injury and/or property damage claims that are a result of your client’s sole or partial negligence, along with transferring to your company the client’s associated legal defense costs for those claims should be denied.
A contract requirement to add your client as an additional insured on your General Liability insurance policy so that he can be provided with free and unlimited access to your company's general liability insurance policy should be denied.
« Your company is in the construction business: Your company is not in the personal risk transfer business.
« Your company is in the construction business: Your company is not in the insurance business.
INDEMNITIES
Certain types of indemnities contractually transfer to your company the financial liability arising out of claims for bodily injury and property damage that are the result of the negligence of your client, plus the responsibility to pay the client’s full legal defense costs associated with the claim.
There are three general types of indemnities that you will encounter:
1. BROAD FORM INDEMNITY. This type of indemnity transfers to your company, the subcontractor or material supplier, the financial liability arising out of a claim for bodily injury and/or property damage caused by the sole or partial negligence of your client, and your client's legal defense costs associated with the claim. Bad, bad deal. Your client's negligence caused the claim and your company pays everything even if the claim is a result of the client's sole negligence.
In the event this type of indemnity is legally enforced, your company may be exposed to possible bankruptcy or possible loss of your company's insurance coverage. Your company may be able to cover some or all of its potential financial exposure to the client under this type of indemnity with insurance. This type of indemnity may violate the laws of certain states and be deemed void and unenforceable.
2. INTERMEDIATE FORM INDEMNITY. This type of indemnity transfers to your company, the subcontractor or material supplier, the financial liability arising out of a claim for bodily injury and/or property damage caused by the partial negligence of your client, and your client’s legal defense costs associated with the claim. This type of indemnity excludes only claims arising out of the client's sole negligence. Bad, bad deal. Your client's negligence contributed to the cause of the claim and your company still pays everything. In the event this type of indemnity is legally enforced, your company may be exposed to possible bankruptcy or possible loss of your company's insurance coverage. Your company may be able to cover some or all of its potential financial exposure to the client under this type of indemnity with insurance. This type of indemnity may violate the laws of certain states and be deemed void and unenforceable.
3. LIMITED FORM INDEMNITY. This type of indemnity makes both the subcontractor or material supplier and the client financially responsible only to the extent that each company is determined negligent with respect to a claim arising out of bodily injury and/or property damage. In other words: “each company cleans up his own pro-rata share of the mess.” Fair enough. Each company would also pay their own defense costs, if any, that may be associated with the claim. It’s likely your company may be able to cover some or all of that part of the claim that is attributable to your company’s degree of negligence with your company’s general liability insurance policy. Also, it’s very likely your company and the client would have this type of legal responsibility even if the subcontract did not include any sort of indemnity.
So what’s the difference between a broad form indemnity and an intermediate form indemnity? Nothing.
A broad form indemnity covers claims caused by your client’s sole and partial negligence. This means the client could be anywhere from 1% (partial negligence) all the way up to 100% responsible (sole negligence) and your company pays the claim plus the client’s full legal defense costs. Below is an example contract wording of a broad form indemnity:
Article – 25 Indemnity (Example Broad form)
Subcontractor shall defend, indemnify and save Client harmless from all claims for injuries to, or death of, any and all persons, and for loss of or damage to property, regardless of how caused, that arise under or in connection with this Contract.
An intermediate form indemnity is almost exactly the same as a broad form indemnity. The difference is that it excludes only those claims that are attributable to the client’s sole negligence. This means that the client could be anywhere from 1% negligent all the way up to 99% negligent and your company would pay the claim plus the client’s full legal defense costs, plus your company's own percentage portion of the claim. So you still pay 100% of the claim..
Below is some example contract wording similar to what you might see that would create an intermediate form indemnity:
Article – 25 Indemnity (Example Intermediate form)
Subcontractor shall defend, indemnify and save Client harmless from all claims for injuries to, or death of, any and all persons, and for loss of or damage to property, regardless of how caused, that arise under or in connection with this Contract, except those claims arising out of the sole negligence of Client.
In order to drive a stake into the heart of this matter, take a look at the following two examples that demonstrate what could possibly happen:
« Client has a broad form indemnity with defense cost coverage in his contract with the subcontractor. A claim arises and the client is determined to be solely negligent in causing the claim. An award is made in the amount of $1,000,000 and the client’s defense costs are $250,000. Since there was a broad form indemnity with defense cost coverage in the contract, the subcontractor reimburses the client $1,250,000.
« Client has an intermediate form indemnity with defense cost coverage in his contract with the subcontractor. A claim arises for which the client is determined to be 99% negligent and the subcontractor 1% negligent. An award is made in the amount of $1,000,000 and the client’s defense costs are $250,000. Subcontractor reimburses the client $1,240,000 ($990,000 for the claim and $250,000 for legal defense costs). Plus the subcontractor has to chip in an additional $10,000 since he was 1% negligent in causing the claim.
Either way, in the above examples, it’s a real lousy deal for the subcontractor, and just underlines the fact that there is just not any significant difference between a broad form and an intermediate form indemnity. The client dodges the bullet in both cases! But the subcontractor sure doesn’t!
How do you deal with requests for broad or intermediate form indemnities? Here are a few suggestions to consider:
1. Negotiate a limited form indemnity in lieu of the broad or intermediate forms.
Here's some example wording for a limited form indemnity:
Article 25 - Indemnity (Example Limited form)
Subcontractor shall defend, indemnify and save Client harmless from all claims for injuries to, or death of, any and all persons, and for loss of or damage to the property that occurs during the onsite performance of Subcontractor's Work under this Contract, but only to extent caused by the negligence of subcontractor as may be proven in a court of competent jurisdiction.
2. Negotiate a separate clause—separate from the actual indemnity clause—in the contract that limits your company’s liability under the broad or intermediate form indemnity to some maximum and/or aggregate dollar amount, including legal defense costs, to an amount that can be covered under your company’s general liability or other insurance.
Here's some example wording for a limitation of liability clause:
Article 35 — Limitation of Liability (Example)
It is, without exception, agreed and understood by Client and Subcontractor, that Subcontractor's total liability, in the aggregate, regardless of how caused and including any liability arising our of or under the Indemnity in Article 25 shall be limited to $500,000 (or some other number as makes sense).
3. Always put a clause in your proposal to the client for the work that says you can’t agree to any contractual conditions that are uninsurable. If a contractual clause turns out to be uninsurable, then you and your client must negotiate terms that are insurable. You can almost bet your bottom dollar that a broad or intermediate form indemnity that has no financial cap on it will be uninsurable.
4. Consider walking away from the contract. Think that sounds tough? Maybe. A client that wants your company to be financially responsible for claims arising out of his negligent acts may just not be committed enough to running a safe job, since your company may ultimately pay for the consequences of his unsafe and/or negligent acts.
GROSS NEGLIGENCE AND WILLFUL MISCONDUCT — RED HERRINGS
From time to time in some indemnities that the Client would like you to agree to, you will see that the only exclusions in his indemnity are Gross Negligence and Willful Misconduct. These are "red herrings." The idiom "red herring" is defined as an attempt to deceive or mislead.
Gross Negligence and Willful Misconduct are typically separate legal distinctions and may have nothing to do with the legal distinctions of sole negligence or partial negligence as the Client may try his best to transfer to you in a broad or intermediate form indemnity.
During negotiations, the Client will likely state": "Don't worry about the indemnity; we won't hold you responsible for our gross negligence or willful misconduct." This is just an attempt to deflect your attention from the broad or intermediate form indemnity he really wants you to agree to.
Don't fall for this misleading gambit by your Client. Notwithstanding the fact that the indemnity excludes liability for gross negligence or willful misconduct, it still may be a broad or intermediate form indemnity.
Most all legal jurisdictions typically will not allow transfer of liability for gross negligence or willful misconduct; your client knows this, so don't be fooled by it.
LONG, COMPLEX AND WORDY INDEMNITIES
Any indemnity longer than two or three paragraphs and overly lengthy, containing run on sentences, and seemingly cleverly worded is a contracting red flag and the chances of the indemnity being a broad form or intermediate form are very good.
A contracting sage once stated that:". . .these types of indemnities might come from Clients who have two floors of project managers and nine floors of lawyers."
Review these indemnities very carefully, or get some assistance with trying to decipher the inherent risk in them. When in doubt, revise/clarify as necessary to make it a limited form indemnity.
GET OUT OF JAIL FREE CARD — PART 1
Think of broad and intermediate form indemnities as "get out of jail free cards."
- With a broad form indemnity, the Client gets "set free" from the liability for claims arising out of his negligence, including his sole negligence.
- With an intermediate form indemnity, the Client gets "set free" for the liability for claims arising out of his negligence, excluding only those claims arising out of his sole negligence. However, the Client could be 99% negligent and he still gets "set free."
And one last important point about indemnities:
« Join or support a local subcontractors or special interest group in your state and lobby your local congressmen and congresswomen and governor to pass new legislation, or amend existing legislation, to make broad and intermediate form indemnities in construction and construction related contracts against public policy and therefore void and unenforceable.
PROVIDING ADDITIONAL INSURED STATUS
The chances are very good that a Client's insurance requirements in his subcontract form will require that the subcontractor add the Client as an additional insured to the Subcontractor’s general liability insurance policy.
If you agree to do this, you have just given your client full access to your company’s general liability contract—for free!!
As an additional insured, your Client will freely enjoy all the benefits of your company’s general liability policy and maybe more. Here are some important benefits the Client will likely receive:
« Client may be able to use your company’s policy to satisfy the financial liability arising out of claims that are the result of his sole or partial negligence.
« Client will very likely be able to have your insurance company pay for the full cost of his legal defense of a claim that may have been the result of his sole or partial negligence.
« Client will not have to pay any deductible that may be associated with the insurance claim! Remember it’s your company’s policy. Your company is the named insured, and the named insured pays the deductible. Does your company maintain a large deductible to keep premiums down?
« Client may be able to have your company’s insurance policy reimburse him for claims that arose out of the subcontract and he had to pay by filing a lawsuit to obtain reimbursement under the subcontract’s broad form or intermediate form indemnity, even though such indemnity itself may be ruled void and unenforceable! This is called the "insurance loophole."
« Client may use up all the proceeds of your company’s insurance and there may be little or none left in the event your company has another claim arise.
« Client’s loss history for his own company’s insurance premium calculation purposes will likely be unaffected. Remember, it’s your company’s policy. A claim against your company’s policy will likely affect your company’s future premiums, not your Client’s. It may even affect your company’s ability to secure insurance in the future. No insurance, no work.
How to deal with requests for providing additional insured status? Here are a few suggestions to consider:
1. Delete the requirement in the subcontract for naming the client as an additional insured. Remind the client that you are in the construction business, not in the insurance business.
2. Suggest that the client purchase his own project specific general liability insurance policy that will meet his insurance needs for the project. He’s no different than your company in his need to procure appropriate insurance to better protect his company. Many clients do this with "wrap up" insurance policies for their projects.
3. Purchase for the benefit of the client an Owners and Contractor’s Protective liability insurance policy, an OCP. The client will be the named insured, there’s no deductible, it’s his policy and he doesn’t share the coverage with anyone. This type of policy will better protect the client from claims filed by injured employees of the subcontractor for vicarious liability and/or inadequate supervision of subcontractor by client, so called "third party over" lawsuits.
4. Some certain types of additional insured requirements, like providing for claims arising out of the sole negligence of the client, may be uninsurable. So agreeing to provide the client additional insured status as he wants may place your company technically in breach of contract because the coverage required can’t be provided. Always put a clause in your proposal to the client for the work that says your company can’t agree to any contractual conditions that are uninsurable. If a contractual clause turns out to be uninsurable, then your company and your client must negotiate terms that are insurable.
GET OUT OF JAIL CARD — PART 2
Just like the Get out of Jail Card Part 1 comment about, providing additional insured status to your client may allow him to be "set free" from the liability arising out of a claim caused by his sole or partial negligence.
And one last important point about additional insured status:
« Join or support a local subcontractors or special interest group in your state and lobby your local congressmen and congresswomen and governor to pass new legislation, or amend existing legislation, to make contractual requirements to provide insurance to cover broad and intermediate form indemnities in construction and construction related contracts against public policy and therefore void and unenforceable.
Remember: Insurance is an ASSET of your company! Protect it. Don’t give it away.
©2007 Southernstar Consultants, LLC. Revised January 2014
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