October 28, 2015

Managing Project Risk With Enforceable Indemnity Agreements

Most contracts in the construction industry supply chain require the “downstream” project participant to indemnify those “upstream” against a spectrum of losses or claims relating to the project. Upstream participants, such as owners and general contractors, naturally seek the broadest indemnity available under the circumstances. It is not uncommon for owners and general contractors to draft broad indemnity agreements seeking protection from loss due to the indemnitee’s own direct fault. Whether this can be successfully accomplished depends on a number of factors, including the specific language used and the law of the applicable jurisdiction.

Indemnity agreements often are strictly construed against the party seeking indemnification. This places a premium on careful drafting. Moreover, many state governments have enacted legislation that specifically regulates indemnity agreements used in construction contracting. These limitations can spell trouble for contracting participants hoping to use “boilerplate” indemnity provisions. The desire to reuse the same contract language is understandable, as it is the most efficient way to do business. Indemnity provisions are one of the more notable complications to the use of standardized construction contracting language. This is true whether parties use industry forms, such as those prepared by the American Institute of Architects (AIA), or develop their own contract forms. To best ensure the indemnity provisions contained within your construction contracts are enforceable and afford the protection intended, keep the following suggestions in mind:

1. Carefully Choose Your Language

Courts scrutinize indemnity language. Where language is unclear or ambiguous, it generally is construed against the party seeking indemnity. Thought must be given to the specific risks for which one seeks indemnity. A common indemnity provision covers risk of loss due to bodily injury or property damage.

There is a wealth of case law providing guidance on this form of indemnity. Where one strays from this form of indemnity, interpretation challenges mount as one enters less charted waters. If one chooses to employ more than one indemnity provision, there is the added complexity of ensuring the provisions are not in conflict. While short, straightforward declarative sentences are preferable, such language is rarely encountered in indemnity provisions. The complexity of indemnity language places a premium on clarity.

2. Be Mindful of the Applicable Jurisdiction’s Statutory Law Pertaining to Indemnity

It is common for states to regulate the practice of securing indemnity in construction contracting. While these so-called “anti-indemnity laws” derive from a common goal of limiting the form and scope of indemnity, upstream participants can seek from those lower in the contracting chain the specific ways they go about achieving this goal differ. As a consequence, an indemnity provision that is enforceable in one jurisdiction may well prove inadequate in another. Moreover, some states regulate attempts to freely elect which jurisdiction’s law shall govern construction contracts, including indemnity commitments, by mandating the law of the jurisdiction in which the project is located.

These statutes present challenges to parties wishing to achieve enforcement clarity through the designation of a favorable jurisdiction’s law to govern the indemnity obligation. To complicate matters even more, state legislatures often tinker with these laws and state courts find occasion to interpret what they mean. This makes for a changing legal landscape that one must keep an eye on, lest an indemnity provision that worked well in the past will no longer suffice. A common method for addressing an ever-changing legal landscape is to employ language, such as “to the fullest extent permitted by law.” While not bullet proof, this language has been construed as evidencing the parties’ intent to fashion their indemnity obligation in conformance with state law regardless of whether the specific language is in contravention of that law.

3. Consider How to Handle the Defense of Claims

Depending upon the applicable jurisdiction’s law, the obligation to indemnify another against loss may or may not include the duty to defend that party against claims or suits for loss falling within the indemnity obligation. A common practice is to expressly include within the indemnity provision a defense obligation. Whether this approach is desirable in a given situation depends in part upon how comfortable the party entitled to indemnity is with having its defense controlled by another. Whether contracting for reimbursement of one’s legal costs is preferable to the more traditional duty to defend is best approached on a case-by-case basis. Keep in mind that, in most cases, in order to trigger the defense obligation, one must provide notice and tender the suit to the party owing the defense.

4. Coordinate Your Insurance and Indemnity Provisions

A common contracting practice in the construction industry is for upstream participants to require those downstream to name them as additional insureds under required commercial general liability (CGL) policies. In the typical case, a subcontractor on a construction project will, in addition to indemnifying the general contractor, also secure insurance coverage for it under the subcontractor’s liability policy. This is done by way of an additional insured endorsement. Some states, such as Minnesota, regulate the practice of securing additional insured coverage on construction projects. Minnesota law states:

A provision that requires a party to provide insurance coverage to one or more other parties, including third parties, for the negligence or intentional acts or omissions of any of those other parties, including third parties, is against public policy and is void and unenforceable.

Minn. Stat. § 337.05, subd. 1(b) (2013). Conversely, in Illinois such an arrangement is permitted and commonly used. See, e.g. W.E. O’Neil Const. Co. v. General Cas. Co. of Illinois, 321 Ill.App.3d 550 (1st Dist. 2001) (upholding the validity of provisions requiring the party named as indemnitee to be named as an additional insured on the indemnitor’s insurance policy); see also, 740 ILCS 35/3 (specifically exempting insurance contracts and agreements from Illinois’ “anti-indemnity” statute).

It is important to review state law not only with respect to the indemnity provision, but also for the obligation to provide additional insured coverage. Another area where indemnity and insurance intersect pertains to the scope of the indemnity obligation. One of the justifications for transferring risk down the contracting chain by way of contractual indemnity rests on the belief the obligation is insurable. Some anti-indemnity laws permit indemnity only where this is the case. If it is important that the indemnity obligation be insurable, care must be taken to ensure the language fits within the “insured contract” exception of the indemnitor’s CGL policy’s contractual liability exclusion. As a general rule, policy language limits the insured to indemnifying another for tort liability.

5. Consider the Consequences of Breaching the Indemnity Obligation

What are the consequences if the party owing indemnity shirks its obligation? It is, of course, responsible for the damages caused by its breach, but what of the costs incurred to secure recovery from the indemnitor? It costs money, in the form of legal fees and other costs, to recover from a party wrongfully declining to honor its indemnity obligation. These costs can be significant and are considered separate and apart from the obligation to reimburse the expense associated with defending the underlying claim. If one wants to protect against going out-of-pocket to enforce one’s indemnity rights, consideration should be given to including language expressly requiring the party providing indemnity to also reimburse the attorneys' fees incurred by the party having to enforce the indemnity obligation.

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