DTCI: Importance of Perfectly Worded Risk Transfer Provisions

Raman

By Barath S. Raman

For Construction Contracts, It’s as Easy as 1-2-3

As with any contractual agreement, the importance of shifting or transferring risk in the unfortunate event of either bodily injury or property damage loss is imperative. The importance of transferring risk in construction cases cannot be overstated since the damages are often significant and catastrophic.

Generally, in construction contracts, there are two main ways for a contractor to appropriately transfer risk; namely, through (1) an indemnification provision and/or (2) an additional insured clause. Although this is common knowledge, many construction contracts are so poorly or inadequately written in this regard that a contractor is ultimately subject to significant liability exposure.

Indemnity

“An indemnity agreement involves a promise by one party (the indemnitor) to reimburse another party (the indemnitee) for the indemnitee’s loss, damage, or liability.” Henthorne v. Legacy Healthcare, Inc., 764 N.E.2d 751, 756 (Ind. Ct. App. 2002) (citations omitted). In a construction contract, the indemnity clause may require the subcontractor to reimburse the general contractor for liability arising out of the subcontractor’s work. This type of risk transfer is common because the subcontractor is in the best position to take precautions to prevent accidents arising out of its work. A right of indemnification may arise in either of two situations: (1) common-law indemnity or (2) contractual indemnity.

As a practical matter, there are several issues with a contractor relying upon common-law indemnity as an avenue to transfer risk in construction cases. Specifically, the right to indemnity may be implied at common law only in favor of one whose liability to another is solely derivative or constructive and only against one whose wrongful act has caused such liability to be imposed. Id. Ultimately, Indiana adheres to the general rule that common-law indemnity is available only to a party who is without fault. Id. More simply, if a contractor is only 1 percent at fault for a loss, then it is not entitled to common-law indemnity from any entity.

That is why construction entities should go to great lengths to ensure that a construction contract contains a written indemnification provision that is clear and complies with applicable statutes. In the context of an owner, a principal, or a general contractor, many construction contracts contain indemnity provisions such that the owner, the principal, and the general contractor will be indemnified by an independent contractor for the independent contractor’s own liability or wrongdoing. However, an indemnification provision, without more, is generally worthless to the owner or the principal since a plaintiff will typically allege independent claims of negligence (or other theories of liability) directly against the owner and the principal.

As a result and despite the above-mentioned indemnity provision, a general contractor will still be responsible for paying legal fees and any damages that are assessed against it. The question then becomes, what was the point of the indemnification provision in the contractual agreement?

A general contractor should always attempt to negotiate and include in the construction agreement stronger indemnification terms and conditions such that a subcontractor owes a duty to indemnify the general contractor for the general contractor’s own liability. While this is common sense, a defense attorney would be astonished to learn of the number of construction contracts that contain inadequate indemnification provisions that ultimately fail to properly protect and/or limit a general contractor’s liability exposure.

Indiana courts are clear that an owner and a principal may require an independent contractor to indemnify them for their own negligence or other wrongdoing. GKN, Co. v. Starnes Trucking, Inc., 798 N.E.2d 548, 552 (Ind. Ct. App. 2003). However, given the harsh reality of such a provision, this can be done only if the independent contractor knowingly and willfully agrees to such an indemnification provision. Id. Such indemnification provisions are strictly construed and will be deemed unenforceable unless the terms and conditions are unequivocally clear. Id.

Indiana courts have established a two-step analysis to determine whether a party has knowingly and willingly accepted this burden. Id. To satisfy the first step, courts will determine whether the indemnification clause clearly and unequivocally states that negligence (or the plaintiff’s theory of liability) is an area of application under the indemnification clause. GKN Co. v. Starnes Trucking, Inc., 798 N.E.2d 548, 552 (Ind. Ct. App. 2003). GKN provides an example of the exact language necessary to satisfy this first step, namely,

[Subcontractor] shall indemnify and hold harmless … [the general contractor] from and against all claims, damages, causes of actions, losses and expenses, including attorney’s fees, arising out of or resulting from the performance of work, provided that such claim, damage, loss or expense (1) is attributable to bodily injury, sickness, disease, or death, or to injury to or destruction of tangible property … .

GKN, 798 N.E.2d at 550. While the plaintiff’s claim in GKN was rooted in negligence, it can be argued that the above-mentioned indemnification clause would cover not only negligence claims but also other typical claims that would arise out of a construction project, including breach of contract and breach of warranty claims.

The second step of this analysis is to ensure that the indemnification provision “in clear and unequivocal terms” states that “it applies to indemnification of the indemnitee by the indemnitor for the indemnitee’s own negligence.” GKN, 798 N.E.2d at 552. Again, clear contractual language evidencing this burden is prudent and often is determinative if a court will enforce an indemnification provision that obligates an independent contractor to indemnify an owner or a principal for their own liability. As it relates to the second step of this analysis, the Indiana Court of Appeals in GKN established the “magic language” required to enforce such indemnity provisions. Specifically, in GKN, the construction contract at issue expressly stated that the independent contractor will indemnify the general contractor for damages resulting from bodily injury where the claim

is caused in whole or in part by any negligent act or omission of [the independent contractor] or any of [its subcontractors], anyone directly or indirectly employed by any of them or for anyone for whose acts any of them may be liable, regardless of whether it is caused in part by a party indemnified hereunder.

GKN, 798 N.E.2d at 553-55. In completing the two-step analysis, the Indiana Court of Appeals in GKN placed great emphasis on the phrase “regardless of whether it is caused in part by a party indemnified hereunder” in its holding that the indemnification provision clearly established that the independent contractor had agreed to indemnify the general contractor for the general contractor’s own negligence when the plaintiff’s injury was caused, at least in part, by the negligence of the independent contractor.

Indiana’s Anti-Indemnity Statute

In drafting an indemnity provision in construction contracts, it is important to keep in mind Indiana’s Anti-Indemnity Statute. Specifically, Indiana’s Anti-Indemnity Statute expressly states that all

provisions, clauses, covenants, or agreements contained in, collateral to, or affecting any construction or design contract except those pertaining to highway contracts, which purport to indemnify the [indemnitee] against liability for: (1) death or bodily injury to persons; (2) injury to property; (3) design defects; or (4) any other loss, damage, or expense … from the sole negligence or willful misconduct of the [indemnitee] or the [indemnitee’s] agents servants or independent contractors who are directly responsible to the [indemnitee] are against public policy and are void and unenforceable.

See Indiana Code § 26-2-5-1. As such, in most construction contracts, the statute prohibits requiring a party to indemnify an owner or a principal to the extent that the owner or the principal is solely liable for a plaintiff’s injuries and damages.

In GKN, the indemnity clause did not violate the Anti-Indemnity Statute because the clause applied only if the damages were “caused in whole or in part” by the indemnitor, meaning the indemnitee would not be indemnified for its sole negligence. GKN, 798 N.E.2d at 553-55. Likewise, in Moore, the indemnity clause did not violate the Anti-Indemnity Statute because the clause stated that it did not obligate the indemnitor to indemnify the indemnitee for the indemnitee’s “sole negligence or willful misconduct where such indemnification is contrary to law.” Moore Heating & Plumbing, Inc. v. Huber & Nichols, 583 N.E.2d 142, 144 (Ind. Ct. App. 1991). In both GKN and Moore, the express language requiring that a subcontractor was not obligated to indemnify the general contractor for the general contractor’s sole negligence was critical in order for the indemnification provision to satisfy the Anti-Indemnity Statute.

Wilhelm Construction v. Secura Insurance

An unpublished Indiana Court of Appeals opinion expanded Indiana’s Anti-Indemnity Statute such that a general contractor is not entitled to indemnity from an independent contractor where the general contractor owes a nondelegable duty. See Wilhelm Construction, Inc. v. Secura Insurance, 86 N.E.3d 234 (Ind. Ct. App. 2017). In Wilhelm, the contractual agreement between the general contractor and its independent contractor contained what appeared to be a strong and adequate indemnity provision that satisfied the above-mentioned two-step requirement. Id. As such, the general contractor argued that it was entitled to indemnification by its independent contractor even for its own negligence. Id. On its face, the indemnification provision appeared to comply with Indiana’s Anti-Indemnity Statute. However, because the general contractor had assumed a nondelegable duty to provide a safe work environment for its independent contractors, the general contractor was then vicariously liable for the negligence of its independent contractor. Id. As a result, the general contractor was effectively solely responsible for the negligence of its independent contractors. Id. Therefore, the Indiana Court of Appeals, relying on the fourth provision of the Anti-Indemnity Statute, held that the general contractor was not entitled to indemnification from its independent contractor since the provision was void and unenforceable. Id.

In reaching its decision, the Indiana Court of Appeals in Wilhelm cited to the purpose of the Anti-Indemnity Statute, which was “to increase safety at construction sites.” Id. However, the holding in Wilhelm may have the opposite effect. Ordinarily, the longstanding rule in Indiana is that a “principal will not be held liable for the negligence of an independent contractor.” Bagley v. Insight Commc’ns Co., L.P., 658 N.E.2d 584 (Ind. 1995). Therefore, a general contractor owes no outright duty of care to a subcontractor’s employees. Id. This means that when a subcontractor fails to provide a reasonably safe workplace, the general contractor will incur no liability for the employee’s injury, even when such injury is proximately caused by the subcontractor’s negligence. Id. However, if a general contractor takes affirmative steps to gratuitously provide a safe workplace, then courts usually will find that the general contractor assumed a duty of care. In addition to already having an incentive to forgo affirmative steps regarding safety of a job site (i.e., the establishment of a duty when one ordinarily would not exist), the Wilhelm opinion now further discourages a general contractor from assuming a duty to “increase safety at [the] construction site.” If it were to assume that duty, it would not be entitled to indemnification from its subcontractors.

Additional insured language

It is also imperative that every owner or principal require that they be listed as an additional insured on their independent contractor’s general insurance liability policy. This is another way to transfer risk and liability exposure in any construction case. As with any insurance policy, the nature and extent of any available coverage is dependent on the terms and conditions of the actual insurance policy. Although many construction contracts require an owner or a principal to be listed as an additional insured, contracts are generally silent on when the additional insured coverage is applicable. Often, the availability of additional insured coverage is different from the requirements set forth by the contractual indemnification/defense provisions.

Although some states have extended their anti-indemnity statutes to apply to additional insured coverage, Indiana has not. Thus, while the Anti-Indemnity Statute prohibits an owner and a principal in most construction contracts from seeking indemnity from a subcontractor for the owner’s and principal’s sole negligence, there is nothing in the statute that prohibits an owner and a principal from demanding additional insured coverage for their sole negligence. There appear to be no Indiana cases that have directly addressed this issue. In Wilhelm, the additional insured coverage effectively mirrored the indemnification provision such that the owner and principal were afforded coverage only in the event they were not solely liable for the plaintiff’s injuries. Disregarding the nondelegable issues in Wilhelm, it is unclear whether the Court of Appeals would have enforced a contractual provision that sought to provide an owner and a principal insurance coverage as an additional insured even if the general contractor were solely negligent.

At a minimum, like an indemnification provision, every construction contract should also expressly provide that any additional insured coverage will be available to a general contractor regardless of the owner’s or principal’s wrongdoing. Moreover, an additional insured provision that requires coverage for all liability “arising out of the subcontractors’s operations” may provide coverage broad enough to cover even the general contractor’s sole negligence.

Ultimately, given the harsh reality of risk transferring indemnification provisions that purport to have one party indemnify another for their own wrongdoing, as the Court noted in GKN, such provisions are to be strictly construed. That is why careful consideration must be given when drafting risk transferring provisions in construction contracts given the high potential for significant or catastrophic injuries and damages.•

Barath S. Raman is an associate with the Indianapolis firm of Lewis Wagner and chairs the Construction Law Section of DTCI. The opinions expressed in this article are those of the author.