Don’t Overlook the Indemnity Provision

Don’t Overlook the Indemnity Provision

By: Barry R. Geisler

As a result of the ongoing economic downturn, General Contractors (GC), Construction Managers, trade contractors, remediation contractors and all others who face daily environmental risks are facing unprecedented challenges in their efforts to remain competitive. With stiff competition on each project, it is easy to overlook a very important aspect of most construction contracts: The indemnity provision.

An indemnity or “hold harmless” provision requires one party (the indemnitor) to reimburse and, in some cases, defend the other party (the indemnitee) against certain claims brought against the indemnitee by a third party. The purpose of the provision is to transfer the costs associated with such claims from the indemnitee to the indemnitor. It is important to understand that an enforceable indemnity clause does not relieve the indemnitee of its liability. Rather, such a provision transfers the obligation to pay the costs associated with that liability to the indemnitor.

Contractors are business persons in addition to being highly skilled craftsmen. As such, the concept of indemnity is not new. However, ever increasing environmental exposures coupled with a contractor’s willingness to assume the owner’s or an “upstream” contractor’s liability to win the job can have dire consequences, especially with profit margins that continue to be razor thin. While each state has its own statutes and case law that may restrict the enforceability of indemnity provisions, they remain enforceable in most jurisdictions. Fortunately, there are insurance options available to the savvy contractor to help mitigate these risks.

While performing soil removal activities at a Brownfield project, XYZ Remediation Co. accidentally broke an underground petroleum pipeline that the general contractor had failed to properly mark. Product was released, causing extensive contamination. Prior to beginning work, XYZ had signed a contract with the GC promising to indemnify the GC for any claims made against the GC because of any pollution was caused, in whole or in part, by XYZ’s contracted services.

The owner of the project, a local developer, was required by the state Department of Environmental Protection to clean up the spill. As you would expect, the owner sued the GC and XYZ to recover the substantial investigation expenses, cleanup costs and monitoring fees.

The GC made a cross claim against XYZ contending it was entitled to full indemnity. After several years in court, the whole matter was resolved, with both XYZ and the GC being found 50% at fault and the court determining that XYZ’s indemnity obligation was fully enforceable. As a result of it indemnity obligation, XYZ was ultimately responsible to pay all the damages, although it was only 50% at fault. Fortunately for XYZ, it had purchased Contractors Pollution Liability (CPL) coverage that included contractual liability protection.

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Generally, CPL forms exclude coverage for the liability of another assumed in a contract or agreement. That is, there is a general exclusion for the types of indemnity exposures discussed above. Had XYZ not obtained contractual liability coverage, its insurance would likely have only paid 50% of the damages on behalf of XYZ. The carrier would not have paid the portion of the award that was based upon XYZ’s indemnity obligation due to the contractual liability exclusion in the policy.

There is an exception to the contractual liability exclusion that some companies, like Great American, offer which provides coverage for certain pollution-related liabilities assumed in a contract signed by a contractor and its client prior to the date the pollution commenced. It is important to understand that the available coverage is only for liability assumed in a contract; that is, liability incurred when one promises to indemnify another, and does not refer to liability that results from breach of contract.

Because XYZ obtained this coverage, its indemnity exposure to the GC was covered. What if XYZ didn’t have the coverage? In all likelihood, it would not have had sufficient assets to pay the remaining 50% and face bankruptcy or close its operations. Even if XYZ survived, the damage to its reputation would have been irreparable because it was not able to meet its financial obligations. The GC would still have to make the owner whole (remember the indemnity does not relieve it of its liability to the owner) and, as a result, would have likely taken a big loss on the project. Careful insurance planning by XYZ substantially mitigated these risks.

In the absence of obtaining contractual liability coverage, other options are available. XYZ could have made a request to the carrier to add the GC as an insured on its policy, solely with regard to the work performed on this project. While there certainly would have been some additional premium associated with the addition, the amount of the premium, in hindsight, would have been well worth it.

Another option would have been to purchase an Owner Controlled Insurance Policy (OCIP) or Contractor Controlled Insurance Policy (CCIP) for the project. An OCIP provides coverage for the owner, GC and all subcontractors, and a CCIP provides coverage for the GC and all subcontractors. These types of forms provide coverage for all work being done on the project and can greatly reduce the need for costly and time-consuming contractual indemnity litigation.

The hypothetical outlined above is just one of a multitude of scenarios involving environmental exposures that may happen at any time. Regardless of your risk management practices, your business is more likely than not to be impacted by an environmental claim at some point. With a little up-front planning, insurance can be there to protect your most important asset – your reputation – and support your ongoing success.

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