by Lee Brumitt, Esq., Dysart Taylor Cotter McMonigle & Montemore, P.C.
There is no more prevalent or dangerous clause in a subcontract than the one transferring the responsibility for claims “arising out of” a project to the subcontractor. This provision routinely makes the “Killer Contract Clauses” list. Risk-shifting provisions by which subcontractors indemnify, hold harmless, and/or defend those upstream should be the subject of much more attention by the subcontractor community.
Perhaps one reason why these commonly found provisions are often glossed over by subcontractors is that they employ terms like “indemnify” and “hold harmless,” terms which are not taught in an estimating or construction course. “Indemnity” is the shifting of responsibility from one person to another. “Hold harmless” is frequently understood to mean the same thing as “indemnity.” However, the phrase “hold harmless” really means “release.” Therefore, one who agrees to hold someone else harmless for claims covered by the provision is agreeing to release them from any such claims. Lastly, the subcontractor which agrees to “defend” another is agreeing to hire an attorney and pay the legal fees and expenses generated.
When subcontractors purchase insurance, they do so to protect assets in the event they make a mistake and cause an accident. One of the most publicly-debated issues in the construction industry is the practice of contractually shifting the damages caused by one’s own mistake to another, i.e., the practice of a general contractor shifting the damage for its mistake to a subcontractor. Most states now make such “broad form indemnity” clauses in construction contracts void, unenforceable and against public policy.
Some states have gone even further. For instance, Kansas went a step further and made construction contract provisions which waive or extinguish insurance subrogation rights void and unenforceable. Therefore, in Kansas, insurance carriers which pay a claim may seek reimbursement for paid claims from the party or parties whose negligence caused the damages. Most states have not adopted this right and still allow parties to contractually waive such insurance subrogation rights.
Despite efforts to limit contractual “broad form” risk shifting so that all parties are responsible for their own mistakes, it is still common practice to require subs to name general contractors as “additional insureds” on subs’ insurance coverages. The practical effect is to undermine the prohibitions against transferring risk to another for one’s own mistake. Under this practice, if the general contractor makes a mistake, and it causes personal injury, death or property damage, the general contractor can make a claim on the subcontractor’s insurance policy. If the liability insurer pays that claim, the limits of the subcontractor’s coverage is reduced by the same amount. Very few states have closed this loophole by voiding provisions in construction contracts in which a party is required to provide liability coverage as an “additional insured” for another.
Put this in perspective. You are a subcontractor and you have 10 separate projects. On each of those projects, you are asked to name the owner, architect, and general contractor as “additional insureds” on your liability insurance. A mistake by one of the additional insureds causes a catastrophe in which a person is killed and substantial property is damaged. When claims are inevitably made against one or all of the additional insureds, the additional insureds seek coverage from your liability coverage. If your policy has a limit of $2 million and claims are paid in the amount of $1,750,000, your limit is now $250,000, even though you were not at fault. Such a small limit leaves your assets exposed in the event of other claims. Needless to say, if you are able to renew that insurance, your premium will be substantially higher. If you need bigger limits to accommodate the increased claims potential, you will pay more in premium.
Subcontractors can take steps to lessen the financial impact of risk transfer provisions.
Understand coverage afforded by general liability policies, as well as common coverage gaps. General liability carriers agree to cover claims for “bodily injury or property damage” resulting from an “occurrence.” An “occurrence” is “an accident … which is neither expected nor intended from the standpoint of an insured.” General liability policies exclude coverage for (a) damage “expected … from the standpoint of the insured” or damage which is simply not considered an “occurrence” because it is a contractual liability, not a tort liability; (b) “your work”; (c) damage to property which cannot be used or is less useful, i.e., “impaired property,” arising out of a defect in “your work”; and (d) mold-related claims.
Limit your indemnity and hold harmless obligations to the extent of your own negligence and only for “occurrences” covered by a general liability policy. In no case should a subcontractor agree to indemnify or hold any other person harmless for that person’s own mistakes contractually or through “additional insured” status. Additionally, because general liability policies only cover “bodily injury or property damage” caused by “occurrences,” i.e., “accidents,” any indemnification or hold harmless obligation should extend only to claims arising from “bodily injury and property damage” and then only to that part caused by the fault of the subcontractor or those under its control. Also, consider adding reciprocal provisions whereby the general contractor agrees to indemnify and hold the subcontractor harmless for claims caused by the general contractor’s fault.
Understand the risk you are being asked to assume and modify the subcontract accordingly. Contractual terms defining the risks transferred affect the timing as to when a subcontractor’s obligation to indemnify is triggered. For instance, courts have held that indemnity for “damages,” “costs,” “losses,” or “obligations” is not actually payable until the person indemnified sustains a loss by being compelled to pay something. On the other hand, indemnity for “liabilities” is considered broader and requires payment when the liability has become fixed and established. An indemnity for “demands,” “claims,” “actions,” “causes of action,” or “suits” triggers an immediate obligation when the third party asserts a complaint against the person indemnified. Temporally then, it is more beneficial for subcontractors to limit indemnity to “damages,” “costs,” “losses,” or “obligations” rather than assuming a contractual obligation to indemnify for “demands,” “claims,” “actions,” “causes of action,” or “suits.”
Do not agree to “defend” a general contractor, owner, or other participant. The duty to defend is universally considered independent of and broader than the duty to indemnify. A sub which has agreed to provide a defense for a claim asserted against a general contractor must immediately and actively defend against that claim by hiring counsel and incurring attorney fees often leading to a strong desire to settle the claim before incurring the full brunt of the costs of a lawsuit and determining the fault attributable to the general contractor. Alternatively, an agreement by which the subcontractor agrees to pay its percentage portion of fault related to the defense costs is fair. There is no reason why a subcontractor which by contract or state law pays only that portion of a claim caused by its fault should pay 100 percent of the costs of defense.
Omit language requiring a subcontractor to name a general contractor as an “additional insured.” This is one of the most entrenched practices in the construction industry and, therefore, one of the hardest to break. If you are in a state such as Kansas that prohibits insuring general contractors as “additional insureds” for their own fault, you should insist on incorporating the state law into the contract language. If you are located in a state that allows a general contractor to be added an “additional insured” and insured for its own fault, you might consider offering an Owners and Contractors Protective policy as a substitute. An OCP policy is a stand-alone policy that covers the named insured’s liability for bodily injury and property damage caused, in whole or in part, by an independent contractor’s work for the named insured. The cost is easily identifiable and should be easily quantified in the subcontractor’s bid.
Remove language waiving subrogation for claims covered by workers’ compensation or general liability policies. Like the “additional insured” requirement, waiver of subrogation is commonplace. Again, if you are in a state like Kansas that prohibits waiver of subrogation, you should insist on marrying the contract language to the state law. If you are not in such a state, advise the general contractor with whom you are negotiating that you have no problem waiving subrogation claims against the owner, but all other parties with an active presence on the jobsite must be responsible for their own mistakes and fault.
Lee Brumitt is a director and shareholder with the Kansas City law firm of Dysart Taylor Cotter McMonigle & Montemore, P.C. He has more than 30 years of experience in construction law and litigation. He represents subcontractor trades and specialty contractors on public, commercial and residential projects. He currently serves as the attorney for ASA–Greater Kansas City. Brumitt can be reached at (816) 714-3027 or lbrumitt@dysarttaylor.com.
