by Carl Bloomfield, AAI, Vice President
In the last issue I set the stage to talk about the importance of Contractual Risk Transfer as an essential part of an effective risk management program, specifically indemnification and Additional Insured Status. Now, let’s continue the conversation on indemnification in greater detail and address pitfalls surrounding this risk transfer mechanism.To briefly recap, the word “indemnify” means to make compensation to another for hurt, loss or damage. There are three levels of indemnification – broad, intermediate and limited form:
Broad Form Indemnity: “… even for, and if caused in whole or in part by, any act, omission, or negligence of the indemnified parties.”
Broad Form Indemnity requires one party to assume the obligation to pay for another party’s liability even though that other party is solely at fault. One of the key indicators an indemnity agreement is Broad Form is the inclusion of the phrase “caused in whole or in part.”
One of the most common examples of a claim scenario where Broad Form Indemnity could come into play is when one of your injured employees sues the owner of the project to attempt to get an additional pay out beyond the workers’ compensation benefits they received from you. Injured employees are barred from suing their employer if workers’ compensation insurance has been provided, so they sue the owner of the job alleging that the owner was 100 percent negligent and caused their injury. The owner of the project is going to argue that they were not 100 percent at fault and they will tender the claim back to you. Since the employee’s allegation is that the owner is solely at fault, a Broad Form Indemnity would be required to respond to the owner’s tender of the claim to you.
Unfortunately, it takes many years and thousands of dollars of legal fees to ultimately determine liability in a case. Without coverage for Broad Form Indemnity, you may have to pay out of pocket until this determination is made by the court.
Intermediate Form Indemnity: “… even for, and if caused in part by, any act, omission, or negligence of the indemnified party.”
Intermediate Form indemnifies a party for its own negligence, except if that party is solely at fault. A key indicator an indemnity agreement is Intermediate Form is the inclusion of the phrase “caused in part.”
Notice the difference between this wording and that of Broad Form Indemnity. The omission of the word “whole” is what keeps this from being Broad Form, and what is left being covered is the partial negligence of the party seeking indemnity. Granted, partial negligence can be as much as 99 percent.
Limited Form Indemnity: “… but only to the extent caused by the negligent acts or omissions of the party providing the indemnification.”
Limited Form is not really indemnity at all since it does not indemnify a party for its own negligence. The key phrase to look out for with Limited Form is “only to the extent.”
Validity of Indemnity Provisions
There are many considerations that must be taken into account to ultimately determine the validity of an indemnity provision. Indemnity agreements are almost always much more complicated than the basic examples listed above because they detail all the various parties who are owed indemnity and what caused these parties to be owed indemnity. In my experience, most indemnity agreements provide such extreme detail and extemporaneous information, that the agreement becomes unclear and counterproductive to its intended purpose. Furthermore, some indemnity agreements will include variations of all three forms of indemnity listed above, further complicating the matter. Almost universally, the courts mandate that indemnification provisions must be “clear and unequivocal.” If the provision is not clear, it could be stricken altogether leaving you with no indemnity.
In most states, the courts require an affirmative assumption of the indemnitee’s negligence. In other words, the indemnity provision must plainly say what the indemnitee is being indemnified for. In other words, it should say something like “… for their own negligence.” Often times, the enforceability of an indemnity provision rests on the use or omission of a single word – the word “for.” Lastly, Anti-Indemnity Statutes limit the types of indemnity that are allowed in each state.
Most states do not allow Broad Form Indemnity for construction contracts. This is true for New York, in some situations, and always true in New Jersey, but it is not true in Pennsylvania. New York does not allow Broad Form Indemnification for construction contracts, but does permit enforcement of indemnification agreements where the indemnitee’s liability is based on the strict liability provisions of Labor Law 240(1). This caveat regarding indemnification of Labor Law 240(1) claims is a significant risk management protection for any company that utilizes subcontractors in New York. Most likely companies don’t have their indemnity agreements written appropriately for New York because generally Broad Form Indemnity is not permitted for construction contracts. It is important to note that Broad Form Indemnity is allowed for non-construction contracts in most states. Even though the majority of the contracts you enter into are related to construction, every business enters agreements with suppliers, banks, consultants, etc. that are not subject to the anti-indemnity statutes.
Operations in Multiple States
Many contractors operate in multiple states, yet they only have one standard subcontract agreement. With no uniformity between the states on what is permitted and what is not permitted with regard to indemnity, your company could be unnecessarily exposed to additional risk because of an inadequate or non-compliant subcontract agreement in that neighboring state.
For example, if a New Jersey-based contractor crosses into Pennsylvania, their subcontract agreement may not require Broad Form Indemnity from its subcontractors because New Jersey doesn’t permit it, or the indemnity provision may not meet Pennsylvania’s strict standards regarding a positive affirmation of the indemnitee’s negligence being assumed by the indemnitor.
A different scenario, but equally problematic, is if a New Jersey-based contractor’s Subcontractor Agreement requires Broad Form Indemnity for a contract within the state. If the indemnity was challenged in court, the provision would certainly get stricken and what is left would essentially be Limited Form Indemnity only. Therefore it is important to be aware of the state specific anti-indemnity statutes, as well as the different standards each state requires to have an enforceable indemnity provision so that you can properly craft your contracts with your subcontractors. Otherwise, you may be surprised with the level of indemnity your company is afforded at the exact time you need it.
You may recall from Part I of this article that I mentioned indemnification is not insurance. However, most insurance policies will back up the indemnity obligations that are placed on your company as long as the duty to provide that indemnity is rooted in an “insured contract.” The phrase “insured contract” is a defined term in most insurance policies and includes things such as a contract to lease a premises, an easement or license agreement, an obligation to indemnify a municipality, or any other contract which requires you to assume the tort liability of another party to pay for bodily injury or property damage.
Take note that the definition of an insured contract limits coverage to pay for bodily injury or property damage. The standard unendorsed commercial general liability insurance policy’s wording provides Broad Form Indemnification coverage. Even though the commercial general liability policy provides coverage for the broadest form of indemnity, not all indemnity obligations are covered by insurance.
For example, many indemnity agreements require you to indemnify another party for “any and all claims.” This is overly broad and would include things that are excluded from your liability policy such as property damage that is expected or intended from the standpoint of the insured. “Any and all claims” means things such as fines and penalties, employment disputes, copyright and patent infringement and breach of contract. It would also include things like personal injury, which is specifically excluded by the Contractual Liability Exclusion in Coverage B of the general liability policy.
In recent years, we have seen more and more insurance companies try to amend the definition of an “insured contract” in attempts to limit the scope of coverage their policies provide for indemnity agreements. Some carriers try to amend the policy to provide Intermediate Form Indemnity and some strive for Limited Form. Without insurance coverage to back up an indemnity agreement, your company’s balance sheet is exposed to a potential significant uninsured event.
The topic of indemnification is a difficult one to master. Get your insurance broker and attorney involved so that your company is properly protected and utilizing this risk transfer mechanism to the fullest extent possible.
Carl M. Bloomfield,
AAI, Managing Director, Enterprise Risk and Advisory Services