Construction / 3 min read
A standard feature of contracts, and particularly construction contracts, is what is called an Indemnification Clause. These are usually in all upper-case letters, bolded text, and often underlined. Despite their attention-drawing appearance and regular use, it seems to be the case that many players in the construction industry don’t know what they have agreed to with these clauses. The purpose of this article is to define a few of the terms and shed some light on this dense tangle of legalese.
Indemnify:
A shareholder recently said he tells clients to read this word as “pay money.” Anytime you are indemnifying another party you are agreeing to reimburse them for a loss suffered because of a third party’s act or default. We often see this arise in the context of a construction defect claim by an owner against a general contractor. The general contractor then asserts an indemnification claim against the subcontractor for the cost of the repairs of the construction defect. But it is not just judgments in a lawsuit that you are agreeing to pay for. This is a broad provision: INCLUDING BUT NOT LIMITED TO ALL EXPENSES OF LITIGATION, COURT COSTS, AND ATTORNEY’S FEES (COLLECTIVELY “CLAIMS”), FOR BODILY OR PERSONAL INJURIES, INCLUDING DEATH, TO ANY PERSON OR DAMAGES TO OR DESTRUCTION OF PROPERTY, INCLUDING THE LOSS OF USE THEREOF, OR DAMAGES OF ANY KIND, INCLUDING ECONOMIC LOSS. This includes court costs, attorney fees, loss of use, and could include fines, late fees, and penalties.
Defend:
It means what it says. You are agreeing to defend the other party against claims arising under the scope of the work. And not just lawsuits: as stated above the provision is very broad: CLAIMS, LOSSES, DAMAGES, DEMANDS, INJURIES, JUDGEMENTS, CAUSES OF ACTION, SUITS. This would apply to a wide range of actions and might include tickets, fines, and/or late charges, related to the scope of work. Some clauses specify that you pay the cost of counsel while some grant the defended party the right to select counsel. You could be on the hook for their attorney fees.
Hold harmless:
This is a promise to not hold the other party responsible if the other party caused damage to the promising party.
WHY SIGN CONTRACTS WITH THESE CLAUSES?
A central component of construction contracts is risk shifting and risk management. It makes sense to shift the risk of damage and litigation to the party with the most control over the work: the party actually doing the work. Subcontractors often bear the brunt of this risk but are in the best position to control the performance of the work.
Many states have anti-indemnity clauses which limit the scope of indemnification clauses. As a general rule, indemnification clauses which require indemnification and defense for the sole negligence of the indemnified party are void as a matter of public policy. For example, if a general contractor is solely responsible for the damage or injury, they cannot seek indemnification or defense from the subcontractor. Additionally, professional liability insurance generally limits or excludes defense for the negligence of others performing their scope of work. As a result, there is no defense coverage available under these policies. The architect may have agreed to defend something without coverage.
A few takeaways:
- Indemnification clauses are a standard part of contracts which allow the parties to customize who bears the risk of damages and lawsuits.
- While statute limits the scope of indemnification, it is likely not all or nothing. The court will limit using “to the extent” language.
- Limit the parties you indemnify to the proper parties. Does an electrical subcontractor really want to indemnify the architect for design defects?
- Design professionals should expressly disclaim their duty to defend which is not covered by the standard. Agreeing to defend regardless of design professional fault. Professional liability policies do not generally cover claims by third parties where the insured did not violate the standard of care, therefore there would be no coverage for this duty and the architect would have to pay out of pocket.
- Careful review of indemnification clauses for all tiers of contractors is advisable as this is often the most litigated portion of contracts and can affect both insurance coverage and result in the assumption of risk.