Have you ever signed a contract to start or consummate a business deal without really reviewing it first? It could be something as simple as a sales agreement, purchase order or repair. Maybe you’re building a home or remodeling an office. You could be a subcontractor hired for your first big project. The agreement – or contract – likely has language that might make you responsible for someone else’s acts or omissions. That’s right, you could be agreeing to take on someone else’s responsibility – financially and legally. Especially in construction, transferring risk and liability is becoming commonplace.
Construction agreements have changed dramatically in the past decade. Owners, developers, architects, general contractors and subcontractors are all changing their approach. This requires legal, insurance and financial expertise to secure a “deal.” The days of a handshake deal are over. Determining what the contract says after something goes wrong is too late; the damage already has been done.
Virtually every project, large or small, should have a written contract associated with it. The basics that should be covered include the scope of work, general conditions including indemnity, costs and payment provision, scheduling, time frames, insurance and bonding. This is not an all-inclusive list as many contracts can be far more elaborate with many special provisions.
In this article, our focus will be indemnity, risk transfer and insurance as it relates to risk transfer.
One of the more critical portions of a contract is understanding and negotiating the level of risk being assumed by each party, commonly referred to as indemnity. Owners, developers, architects, general contractors and subcontractors all should be keenly aware of the level of risk transfer in the contract. Essentially, it will determine if each party is responsible for only their own acts or omissions or if they are assuming others’ acts via contract. As you can imagine, assuming the risk of others is almost always problematic and creates financial, legal and insurance issues.
There are three basic levels of risk transfer or indemnity: broad, intermediate and narrow. The broad level transfers all of the risk from one party to another. This is also often referred to as indemnity for sole fault and transfers all risk to others who did not cause the damage. Many states and courts have deemed this invalid, even if both parties agree to this provision. Signing this type of agreement is extremely risky.
The intermediate level of risk transfer allows the transfer of risk caused by negligent acts or omission in whole, or in part, by the other party. It basically transfers some of the risk to another entity. This is often referred to as indemnity for partial fault and transfers part of the risk to whoever did not cause all the damage. As an example, the general contractor transfers, via contract, their share of the negligence to the subcontractor. In this example, a jury determines the general contractor was 60 percent responsible for the loss and the subcontractor 40 percent. In an intermediate indemnification contract, the court may have the subcontractor pay 100 percent of the damages.
Although many states may prohibit this broad or intermediate transfer of responsibility, many allow it to be transferred via insurance policy language and the additional insured provision. This essentially forces one person’s insurance company to pay for someone else’s negligence.
The narrow level of risk transfer limits damages of each party to their own negligence. In the previous example, the general contractor would be responsible for their own negligence of 60 percent and the subcontractor would be responsible for 40 percent negligence. This type of indemnity agreement places the risk and responsibility with the responsible party. As you can imagine, many feel the narrow level of risk transfer is the most desirable unless you want to transfer your risk to another party.
Since many states allow the transfer of risk – broad and intermediate – through an additional insured provision in the insurance coverage, many contractors and owners assume the risk of others inadvertently.
Regardless of whether you are an owner, developer, architect, general contractor or subcontractor, you need to be both educated and cautious of all contracts – sales, construction, maintenance, installation, etc. – and their provisions. Indemnity and insurance provisions can be critical if injury or damage occurs. Never sign anything without understanding the language and consequences.
Richard Ollis is CEO of Ollis/Akers/Arney, a certified employee-owned business consulting and insurance advisory firm. He also serves on Springfield City Council.
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