JVs Offer Advantages, But Create Added Risk. Here’s How to Partner Smart
by Carl Bloomfield, AAI, Producer, Jim Marquet, Producer
You’ve made it through the Great Recession; but now that the economy is rebounding, contractors need to evaluate how they can better avoid or spread the risk on any given project. Projects that are large, complicated, have onerous contract language and liquidated damages should not be chased unless the contractor has identified a way to limit or spread the project’s risk. If you’re working outside your geography or expertise, a joint venture may be the smartest way to insulate your balance sheet from some of the project’s risk.
But, while forming a Joint Venture offers many advantages, it also creates additional risks. One of the keys to a successful Joint Venture is having a risk management approach that addresses these additional risks. There are two main approaches to insuring Joint Ventures:
- The Joint Venture Self-Performs the work, and the liabilities of the Joint Venture partners are shifted to the Joint Venture
- Joint Venture holds the contract for the job, but subcontracts work to Joint Venture partners, and the liabilities of the Joint Venture are shifted to the Joint Venture partners
Approach 1: Joint Venture Self-Performs the Work
In the first option where the Joint Venture self-performs the work, the primary insurance for the activities will be provided by the Joint Venture’s policies. The partners of the Joint Venture should obtain indemnification protection in the Joint Venture Agreement and be added as “Additional Insured” on the Joint Venture’s General Liability and Umbrella Liability policies. This will transfer the exposure away from the insurance policies of the individual partners. In addition, the Joint Venture’s Workers Compensation policy should include an “Alternate Employer Endorsement” naming the partners to ensure that any injury to a Joint Venture employee is insured under the Joint Venture’s Workers Compensation policy and not the individual partners’ Workers Compensation policy.
Experience Mod for Joint Venture
When the Joint Venture is self-performing the work, there will be a Workers Compensation Experience Mod created for the Joint Venture. In simple terms, a Workers Compensation Experience Mod is a factor calculated by the Workers Compensation Bureau based on a company’s prior loss experience. If ABC Company has lower loss experience than the average company for its class of business, ABC receives a credit Mod (such as .750). This credit Mod correlates into a 25 percent discount off of the standard Workers Compensation insurance rates. Conversely, if ABC Company has loss experience that is higher than the average company for its class of business, ABC receives a debit Mod (such as 1.400). This debit Mod correlates to a 40 percent surcharge to the standard Workers Compensation insurance rates.
In most situations when a new entity is formed, the entity will get a 1.00 Experience Mod. This is not always the case with Joint Ventures. With a new Joint Venture, there is no prior Loss Experience, so how do the Workers Compensation Bureaus address new Joint Ventures? Even though a Joint Venture is a new entity, the majority of states will create a “blended” Mod based on the Experience Mod of the Joint Venture Partners. For example, if a new Joint Venture is a 50/50 partnership formed between XYZ Contractor (who has a .90 Mod) and ABC Contractor (who has a 1.30 Mod), the Joint Venture would have a 1.10 Mod in most States. However, Pennsylvania and Delaware are two states that do not have a “blended” arithmetic average rule and would use a 1.00 Mod for the new Joint Venture.
An additional issue when the Joint Venture is self-performing the work is the need for rented equipment. Typically the Joint Venture will rent vehicles or equipment from the individual partners since the Joint Venture does not have any of its own equipment. To properly transfer this risk to the Joint Venture, there should be a formal Rental Agreement between the Partner and the Joint Venture, and the Joint Venture should purchase its own Auto Liability policy.
Approach 2: Shell Joint Venture
The second option for setting up a Joint Venture is where the Joint Venture only holds the contract for the job and subcontracts the work to the Joint Venture partners. This is typically referred to as a “Shell Joint Venture.” In this approach, the goal is to transfer liabilities away from the Joint Venture’s insurance policies to the Practice insurance policies maintained by the individual partners; this is the opposite of what is done when work is self-performed in Approach 1.
The Joint Venture should obtain indemnification protection from the individual partners in the Joint Venture Agreement and be added as “Additional Insured” on the Joint Venture partners’ General Liability and Umbrella Liability policies. In addition, the Joint Venture partners’ Workers Compensation policies should include an “Alternate Employer Endorsement” naming the Joint Venture to ensure that any injury to a Joint Venture partner employee is insured under the Joint Venture partners’ Workers Compensation policy and not the Joint Venture’s Workers Compensation policy.
Certificates of Insurance for the Owner
One of the challenges with a “shell” approach is the Joint Venture holds the contract with the Owner, and some Owners will require that the Joint Venture provide a Certificate of Insurance that evidences the Joint Venture as a Named Insured for the limits of insurance required for the job. Most “shell” Joint Ventures will purchase a General Liability and Workers Compensation policy in the name of the Joint Venture. However, if the Owner requires the Joint Venture to also have its own Umbrella and Excess Liability coverage (which may be a $25 million limit required in the contract), the additional cost of these Joint Venture limits can be a challenge. Some Owners will accept a Certificate of Insurance from the Joint Venture Partners evidencing their Umbrella/Excess Liability coverage, which adds the Joint Venture as an Additional Insured.
Completed Operations Exposure
One of the exposures that is often forgotten with a Joint Venture is the liability for injuries that occur after the work is complete. Most states have a Statute of Repose that defines how long a contractor has liability for a project. These statutes can create liability for a Joint Venture for up to 12 years (which is long after everyone has left the site and any profits have been divided). In addition, the Partners in a Joint Venture may be liable for the acts of the other Partners and the Joint Venture. For example, if the one Joint Venture Partner goes out of business and no longer maintains insurance, the other Partner that owns only 50% of the Joint Venture may be held liable to pay 100% of the liabilities created by the Joint Venture. Therefore, it is critical that the Partners properly insure the exposures created by the Joint Venture. One way to do this when the Joint Venture is self-performing the work is to purchase “Joint Venture Completed Operations coverage” for the full Statute of Repose based on the applicable state. This ensures that the Joint Venture would have full liability protection so the Partner’s own insurance won’t be impacted.
Joint Ventures have many advantages, but they also create additional liability pitfalls. Prior to forming a Joint Venture, consult with your insurance broker for recommended insurance requirements and indemnification wording to include in the Joint Venture Agreement. These risk management steps can help you avoid the potential surprise of additional costs and liabilities that develop later after the project has been finalized.
Carl M. Bloomfield,
AAI, Managing Director, Enterprise Risk and Advisory Services