Construction projects are inherently risky endeavors. A myriad of things that can go wrong range from damaging a tree on neighboring property, to the structural failure of a completed building, and the loss of limb or life. One of the most important reasons one enters into a contract while participating in a construction project is to transfer those types of risks to one or both of the contracting parties. There are a number of contractual mechanisms parties can use to transfer the responsibility of paying for damages caused by the occurrence of such events.
Two of the most important contractual risk-allocation methods involve using indemnification and insurance provisions. These two provisions typically overlap in that contracting parties often agree that one party must insure the indemnification obligations it has towards the other party. This is distinguished from including the other party as an additional insured on one’s insurance policy. Contracts with indemnification provisions that have been insured are known as the “insured contract.” This article briefly explores the differences between insuring those two very different types of risks, as well as the potential impact on those obligations of increasingly popular, and often varied, state anti-indemnification statutes.
An indemnification provision states that one party agrees to be responsible for another party’s damage to a third party. Thus, the true force of that provision is contingent upon the indemnifying party’s (the indemnitor) financial condition. In other words, indemnification provisions provide assurance, not insurance. Parties often work around this limitation by requiring that the indemnitor insure its indemnification obligations towards the other party (the indemnitee). However, there are downsides to using this approach because it can give rise to complex questions regarding whether the risk transfer actually transferred the risk to the insuring party. Parties need to understand both the benefits and limitations of taking the insure-the-contract approach versus including contractual provisions that require the indemnitor to instead add the indemnitee to its insurance policy as an additional insured.
The Insurer’s Duty To Defend The Indemnitee
When one insures an indemnification obligation, that party’s responsibilities are defined by two things: the language in both the insurance policy and the relevant indemnification provision that is in the insured contract. The insurer’s duty to the indemnitee is indirect and derivative of the insured-contract’s indemnification provision.
One way the derivative nature of this duty manifests itself in the contracting relationship is when the indemnification provision does not require that the indemnitor defend the indemnitee. Insurers agreeing to insure an indemnification risk will not then have a duty to defend the indemnitee. The difference between the two can often be boiled down to whether or not the relevant indemnification provision includes one word. For example, an indemnification provision that requires the insurer to defend the indemnitee is typically structured as follows:
“The Contractor shall defend, indemnify and hold the Owner, its officers, officials, employees and volunteers harmless from any and all claims, injuries, damages, losses or suits including attorney fees, arising out of or in connection with the performance of this Agreement, except for injuries and damages caused by the sole negligence of the Owner.”
If the provision does not contain a reference to “defending” the indemnitee, the insurer is not required to provide a defense.
In a number of different ways, this stands in stark contrast to insuring a party as an additional insured. Unless expressly excluded or limited in the additional insured endorsement to the primary insured’s insurance policy, the insurer has the duty to defend the additional insured. Also, the insurer’s cost of defending does not count against the policy limits because it is a separate duty. In contrast, the insurer’s cost of defense of the indemnitee counts directly towards the insurance policy’s limits thereby decreasing the funds available to cover any eventual liability.
Another significant difference between insurance coverage as an additional insured and an indemnitee arises when there is a conflict of interest between the insuring party and the insured party. Typically, when there is a conflict between an additional insured and the insured party, the insurer will simply assign different counsel for each insured party. This may not be the case when there is a conflict between the indemnitee and the indemnitor. In those cases, the insurance company can include a provision in the coverage that states there is no duty to insure the indemnitee. For these reasons, it is very important that the contracting parties carefully review the language in the insured contract to determine its impact on the indemnitor’s insurer’s duties and vice versa.
The Role of Anti-Indemnification Statutes
Insure-the-indemnity clauses have taken on a special significance in the wake of most states enacting some variation of what are called “anti-indemnification statutes.” States’ anti-indemnification statutes differ dramatically in how they limit the degree to which parties can transfer risk amongst themselves using indemnification clauses. They do that in a number of different ways depending on which state’s law governs the insured contract.
Some states, such as Alaska, California and Georgia, have anti-indemnification statutes that prohibit “broad” indemnification when the indemnitor must indemnify the indemnitee even when they are solely at fault. Other states, such as Connecticut, Illinois and New York, prohibit broad indemnification, as well as “limited” indemnification which occurs when the indemnitee is partially or concurrently at fault.
One must carefully review the relevant state’s antiindemnification statute to ensure that the indemnification provision in an insured contract does not conflict with that statute. If the insured’s indemnification provision is prohibited by that state’s anti-indemnification statute, that statute effectively bars coverage because the provision is void. This is what occurred in Transcontinental Insurance Company v. National Union Fire Insurance Company of Pittsburgh, 662 N.E.2d 500 (1996). In that case, the court found that a contractor was not obligated to indemnify its subcontractor whose employee was injured when some scaffolding collapsed because the indemnification provision required the subcontractor to indemnify the contractor for its own negligence which is prohibited by Illinois law.
The importance of factoring in a state’s anti-indemnification statute into how one decides whether to use an insure-the-indemnity versus an additional insured approach is most obvious in those states that prohibit broad indemnification. In those states, one cannot be obligated to indemnify the other party for their sole fault but can be obligated to insure them as an additional insured.
Texas, for example, bars indemnification when the indemnitee’s negligence causes the harm but recognizes additional insured coverage for additional insureds in such cases if the insured contract requires both sides to secure equal amounts of liability coverage for the other. See, e.g., Mid-Continental Casualty Company v. Swift Energy Company, 206 F.3d 487 (5th Cir. 2000). The court in Mid-Continental found that an insurer who had no indemnification obligation was obligated to insure a contractor hired by an oil driller when one of the contractor’s employees was injured even though the contractor was negligent. This is but one example demonstrating why choosing an additional-insured approach over insure-the-contract can have a huge impact on whether the relevant risk has been successfully transferred to the other party.
It is impossible in this short article to touch upon, much less discuss, the wide ranging issues related to insuring indemnification duties, additional insureds and the impact of anti-indemnification clauses on those two types of insured risks. Some of those issues are straightforward but there are many others whose complexity can only be understood through in-depth study. In short, when writing, entering into, and/or interpreting insured contracts that have insured indemnification and additional insured provisions, it is imperative that one seek counsel from a risk management expert regarding one’s rights and duties.
Risk management experts such as insurance professionals and attorneys have the experience and knowledge needed to ensure that the contractual relationship is structured in a manner that best addresses all of the relevant risk management needs. There are too many pitfalls to ignore seeking advice. Even a short consultation can make a world of difference down the road should you need to enforce an indemnification provision or call upon your coverage as an additional insured.