Contracts make or break construction projects

Probably the most overlooked and underappreciated area is the necessity of contracts between the owner and general contractor and their subcontractors. The days of a verbal bid and a handshake are long gone.

All jobs should have written contracts between the owner and general contractor. In addition, the general contractor should have written contracts with all subcontractors. The contracts should address:

• Specific scope of work and performance standards

• Time for completion of the project

• Payment terms

• Risk of loss to ongoing work (typically covered under a builder’s risk policy)

• Indemnification and hold-harmless agreements

• Insurance requirements

Oral contracts can be valid and enforceable, but they are extremely difficult to prove if something goes wrong. In addition, they tend to focus on price and scope of work and often fail to address risk and the transfer of risk. The most commonly used methods of risk transfer include indemnification, hold-harmless agreements, insurance requirements and additional insured endorsements. The following chart is the normal “flow” of risk transfer:

Indemnification agreements transfer risk and responsibility to other parties. These agreements are a critical part of construction contracts. A property owner may require the general contractor on a project to sign an indemnification agreement, a hold-harmless agreement and name the owner as an additional insured on the liability policy. The general contractor then needs to require the same of its subcontractors.

Indemnification agreements

Many look at this process as excessive, but it reduces exposure from both higher- and lower-tier contractors (up and down the flow chart). There are several types of indemnification agreements:

Broad form agreement – The indemnitor assumes all risk described in the contract regardless of fault, even if the indemnitee is entirely at fault.

Intermediate form agreement – The indemnitor assumes all risk of loss described in the contract except when the loss is caused by the indemnitee’s sole negligence. Any fault will trigger the obligation of the indemnitor for all damages.

Limited form agreement – The indemnitor is obligated to reimburse for the extent of the damage described in the contract. It is typically calculated on a percentage basis and is sometimes referred to as a comparative fault agreement.

Often, construction contracts include hold-harmless agreements stipulating the party that assumes the risk agrees not to recover any portion of the damages from the other party.

As you can probably tell, the contractual process is complex, but critical. Also, not all risk transferred by an indemnification agreement is covered by insurance, and state statutes treat indemnity agreements differently.

Necessary coverage

Insurance requirements are another important part of construction contracts. There are two basic provisions that need to be addressed: the minimum limits of liability and coverages required and the additional insured provision.

Normally, minimum limits of liability and coverages required include:

• $1 million for each occurrence for bodily injury and property damage; $2 million aggregate;

• $1 million combined single limit for auto liability;

• $500,000/$500,000/$500,000 or statutory for workers’ compensation; and

• Written notice of 30 days if the policy is cancelled.

Additional insured status is normally addressed in the contract. Being named as a “primary” additional insured on a contractor’s policy obligates the policy to respond first in the event of a covered claim and protects the person listed as primary additional insured for covered damage.

In addition, language stipulating that completed operations are included is preferable to protect the higher tier on the flow chart.

Construction contracts are one of the most important documents to address on a building project. Make sure your insurance agent and attorney advise and approve every document you are required to sign. It will ultimately determine the outcome if something goes wrong.

Richard Ollis is CEO of Ollis and Company, an employee-owned, independent insurance agency. He can be reached at richardo@ollis

co.com.