Legal and Regulatory

Perspectives on Dealing With Indemnity Clauses

Indemnification provisions, the use of additional insured provisions, and the various duties to defend and indemnify must be carefully considered when entering into contracts with other parties.
By Miles M. Masog
September 10, 2018
Legal and Regulatory

Contractual indemnity and issues involving additional insureds each come with their own nuances and potential pitfalls for construction professionals. While it is true that indemnity clauses are risk transfer provisions, the way that indemnity clauses are used and the way those clauses are interpreted by the courts is constantly changing.

This article offers perspectives regarding indemnity, including a look at how some specific states have treated indemnity provisions, anti-indemnity statutes and the ramifications of that treatment in the construction industry.

Indemnification provisions often require a company to not only be indemnified but also to be defended. A California Supreme Court case, Crawford v. Weather Shiled Mfg., Inc. , held that the obligation to defend was separate and distinct from the obligation to indemnify in such a clause. The Crawford case held that the indemnitor could be responsible for the indemnity defense costs, even if it was ultimately determined that the indemnitor was completely without fault. As a result of the various issues that construction professionals (and others) have encountered with indemnity provisions, more than 40 states have enacted anti-indemnification statutes. These statutes seek to restrict or invalidate indemnification agreements in construction contracts. Anti-indemnity statutes generally do such in two primary ways. Twenty-seven states prohibit a contracting party from indemnifying another party for its sole or partial fault. Thirteen states prohibit a contracting party from indemnifying another party for its sole fault.

An indemnity provision that does not run afoul of the anti-indemnity statute in one state, may be a legal nullity in another state. For construction professionals that include indemnity provisions with their material suppliers and/or subcontractors, it is important that the indemnity provision is tailored to the law of each state.

Additional Insured Coverage, Indemnity and Anti-Indemnity Statutes

Successfully navigating around anti-indemnification statutes in a particular jurisdiction is becoming increasingly complex. Indemnity agreements are generally not held to be “insurance,” and the courts in most jurisdictions will not treat them as insurance agreements. Indemnity agreements are simply an “assurance” by one party to another that they agree to step up to bat if certain predetermined elements are met by a situation at a construction project.

Indemnity agreements, therefore, are only as good as the indemnitor's ability to satisfy the obligations it agreed to under the indemnity agreement. As a result, indemnity clauses are often intertwined with additional insured clauses, which require a contractor to amend its liability policy, making another party, such as an owner or general contractor, an insured under one or more of its policies.

Although additional insured clauses are often interwoven with indemnity clauses, they do constitute a legally separate and distinct contractual clause.

For example, a subcontractor may be required by its contract with the general contractor to purchase a policy of insurance naming the general contractor and owner as “additional insureds.” Under such contract, the subcontractor would be required to procure an additional insured endorsement to one or more of its insurance policies. An additional insured endorsement adds the general contractor and the owner as an insured under that policy of insurance covering the subcontractor. It therefore extends the benefits of the policy to the additional insureds and obligates the subcontractor’s insurance carrier to insure them, as well as the subcontractor.

Failure to procure sufficient or the correct additional insured endorsement for the owner or general contractor may open the subcontractor up to additional liability, which is usually not covered by its policy. Thus, it is important for parties that are contractually required to procure an additional insured endorsement to work with their insurance agent/broker to procure the correct additional insured endorsement.

Some states that limit indemnification agreements also limit contractual requirements for insurance coverage that apply in an additional insured situation. Most anti-indemnity statutes apply exclusively to construction contracts. However, that is changing. In some states, like Kansas, the anti-indemnity statute limits statutory indemnity to contractually-required insurance. The result of the changes to anti-indemnity statutes in many states is that additional insured coverage is extremely limited.

There are ways for construction professionals to avoid running afoul of the anti-indemnification statute in their respective state.

First, it is imperative for construction professionals to carefully read the anti-indemnification statute applicable to their state before the process begins of drafting the construction contract. In addition, drafting language that excludes a construction client’s sole negligence and, if necessary, partial negligence, is imperative. Occasionally, the failure to exclude such may result in the entire indemnity provision being found to be a legal nullity. Additionally, ensuring that there is adequate commercial general liability and workers’ compensation insurance coverage is critical. If a loss occurs, there must be the appropriate levels of coverage to ensure that the construction professionals are adequately covered.

When a loss occurs at a construction project, and there are adequate and enforceable indemnity agreements, it is the indemnitee’s responsibility to force the indemnitors to comply. Upon notice of a loss, it is imperative for the indemnitee to draft and forward tenders of indemnification and defense to the indemnitors as quickly as possible.

Safeguards should be taken to ensure that tenders of indemnification and defense are received by indemnitors. If those safeguards are insufficient, it may be necessary to tender multiple times. Additionally, in addition to drafting and forward a tender of defense and indemnification to the indemnitors, a letter tendering the indemnification and defense should also be sent directly to an additional insured carrier. The tender letter sent to an additional insured carrier should also emphasize that the indemnitee requests that the additional insured carrier indemnify, defend and hold harmless the indemnitee. This forces the additional insured carrier to confront all of its obligations at once.

Once tender letters are issued, it is necessary to follow up on such tenders to ensure that carriers keep such tender letters on their radar and responding in a timely fashion. If an additional insured carrier fails to respond, indemnitees must ultimately be prepared to litigate these types of indemnification agreements in court. In addition, a tactic that occasionally works is to forward the additional insured carriers pleadings as if they are already involved. This also provides a factual context to the additional insured carrier beyond what is included within the tender letter, and would most certainly be information required by an additional insured carrier to evaluate whether there is risk in a complex or catastrophic loss.

Hensel Phelps Constr. Co. v. Thompson Masonry Contractor, Inc.: A General Contractor with an Unenforceable Indemnity Provision

Examining the various, specific ways indemnification agreements affect construction professionals is helpful.

Commercial general contractors have different specific needs when it comes to indemnity agreements in its contracts — both with owners and subcontractors. First, from a commercial general contractor’s perspective that does business in multiple jurisdictions, it is necessary for that general contractor to have knowledge of the way that indemnification and anti-indemnity statutes independently operate and cooperate in all of the jurisdictions where it works. A general contractor wants the broadest indemnity permitted by law. It is commonplace for a general contractor to assume indemnity obligations to an owner. In those situations, the general contractor should attempt to pass those responsibilities down to subcontractors and other construction professionals and material suppliers that perform work or supply products at the project.

Indemnity provisions within a contract involving a general contractor may often need to be tailored to account for specific nuances in certain projects. For example, some construction contracts should be specifically tailored, when governmental fines and/or penalties from adjacent public/private partnership may be a concern. From the perspective of a general contractor, tailoring an indemnification agreement to address potential specific future claims is imperative in limiting and controlling risk.

An interesting case involving a general contractor and the ways an indemnity agreement drastically failed to protect a general contractor was decided in November 2016 by the Supreme Court of Virginia.

In that case, Hensel Phelps Constr. Co. v. Thompson Masonry Contractor, Inc., 791 S.E.2d 734 (Va. 2016), the general contractor, Hensel Phelps Construction Company (hereinafter referred to as Hensel), brought an action against subcontractors and sureties. The case turned on whether the subcontractors had waived the applicable statute of limitations through reference to the prime contract between the general contractor and a commonwealth agency that was not subject to the statute of limitations, or, if the statute of limitations was not waived, whether the statute of limitations had expired.

Hensel won a bid to perform over $15 million worth of construction work at a student health and fitness center. Hensel, as the general contractor, entered into virtually-identical agreements with several subcontractors to complete portions of the project. United States Fidelity and Guaranty Company acted as a surety for some of the subcontractors. The contract between Virginia Tech and Hensel included a paragraph titled “warranty of materials and workmanship.” That provision stated that all materials must be in a first-class condition and that workmanship must be of the highest quality. Any work that did not conform to such warranties was defined to be defective.

Additionally, there were also provisions related to final inspection and final payment at the project. In the contract, Hensel and Virginia Tech agreed that no statute of limitations period applied, because Virginia Tech was a Commonwealth agency.

The student health and fitness center construction project was completed under the contract between Hensel and Virginia Tech in 1998. Hensel received the final payment by Virginia Tech in 1999 and, in turn, made final payment to its subcontractors. One of the subcontractors returned to fix some problems covered by the warranty in its subcontract and concluded its work in 2000. Several years later, Virginia Tech discovered defective workmanship in construction at the project. It ultimately elected to remedy such defects.

In 2012, Virginia Tech asserted a claim against general contractor Hensel under the contract between the two parties, seeking in excess of $7 million in compensation for the cost of remedying the allegedly defective workmanship at the project. In response, Hensel demanded that the potentially implicated subcontractors pay the damages attributable to their alleged defective workmanship, pursuant to their subcontracts. Several subcontractors refused. In 2014, Hensel paid Virginia Tech $3 million to settle the claim and then filed an action alleging breach of contract claims against the subcontractors and sureties. In response, the subcontractors and sureties both argued that the statute of limitations barred the breach of contract claims. The Court granted the dispositive motions of the subcontractors to bar the breach of contract claims and dismissed the case against the subcontractors in their entirety.

Hensel argued that there were specific phrases in the subcontract agreements that demonstrated the intent of the subcontractors to waive the statute of limitations.

Specifically, Hensel argued that the subcontractors had agreed that their warranty period in the subcontracts would be equal to Hensel’s warranty period to Virginia Tech under the contract documents. The Supreme Court disagreed, determining that the various provisions Hensel pointed to within the subcontracts did not demonstrate intent sufficient to incorporate a complete waiver of the statute of limitations. Hensel then argued that the claims that it asserted against the subcontractors were timely. First, Hensel argued that the statute of limitations did not begin to run until the date of the settlement of Virginia Tech’s claim in 2014, rendering the suit timely.

The Supreme Court of Virginia disagreed with Hensel’s first argument.

Second, Hensel argued that the statute of limitations in the subcontracts did not begin to run until the subcontractors breached the indemnification provision in the subcontracts. Specifically, Hensel argued that the breach of the indemnification provision by the subcontractor was a separate and independent breach from the original breach for performing deficient work at the project. The Court noted that all of the subcontracts contained numbered paragraphs that were entitled “indemnification.” The Court noted that, within those paragraphs, the indemnification provisions provided for indemnification against Hensel’s own negligence.

In the earlier-decided case of Uniwest v. Amtech Elevator Servs., Inc., 699 S.E.2d 223 Va. 2010), the Supreme Court of Virginia had held that an indemnification provision that provided for indemnity to the indemnitee for claims arising from indemnitee’s own negligence was void for violating public policy.

The Supreme Court held that Uniwest rendered the indemnification provision within the subcontracts completely unenforceable.

Hensel then attempted to argue that several other provisions of the contract taken together constituted an “indemnification” provision. The Court admitted that some of those paragraphs did include indemnification-type language. However, the Court ultimately disagreed that other provisions scattered throughout the contract were contemplated by the parties to act as an indemnification provision, because there was an independent paragraph dedicated solely to indemnification.

Because the primary indemnification provision was unenforceable, the Supreme Court held that all of the other indemnification-type language also similarly unenforceable. The Court indicated in its holding that, as the general contractor, Hensel had the ability to address inferior work performed by the subcontractors pursuant to its subcontracts and could have required subcontractors to fix any faulty or inferior work for five years. Hensel, however, did not claim to sustain any damages until 2014, when Hensel settled its claim with Virginia Tech.

Without a valid indemnity provision, the Supreme Court held that the statute of limitations barred Hensel’s lawsuit against the subcontractors.

The Supreme Court also found that the parties did not intend that the obligations of the subcontractors should be an ongoing obligation. The subcontractors agreed to warranty work as being acceptable and not defective. However, this was a finite obligation, which was tied to performance. The Court also noted that Hensel, as the general contractor, could have required ongoing periodic inspections as the subcontractors’ performance work but failed to do so.

Finally, Hensel argued that the ruling would place all government contractors in a position of unending liability with no opportunity for recourse against their subcontractors.

The Supreme Court held that, while this might be true for Hensel in this case, going forward, general contractors that enter into contracts with the Commonwealth can draft or amend their subcontracts to comply with the Uniwest holding.

Regardless of the role of the construction professional at issue, contracts should be written and negotiated such that the construction professionals are protected from lawsuits arising from the construction project. Challenges abound with regards to indemnity provisions given the changing treatment of indemnity across the country via case law and legislatively created anti-indemnification statutes. Indemnification provisions, the use of additional insured provisions and the various duties to defend and indemnify all must be carefully considered when entering into contracts with other parties. As this area is rapidly changing, it is advisable to always consult the current status of your jurisdiction’s laws and treatment of the laws.

by Miles M. Masog
Miles Masog's practice serves clients in the construction and insurance industries. He has experience litigating matters ranging from construction defects to insurance defense.

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