The Nuts and Bolts of Indemnity Clauses in Construction

The construction process is, by its nature, an inherently risky venture. As a result, construction contracts are generally drafted to allocate such risks among the various parties to the project. These risks may include claims for personal injuries, property damage, project delays, lost profits and a myriad of other financial harms.

Indemnity may be defined as an obligation of one party to make good a loss or damage another party has incurred. An indemnity obligation may take the form of either express indemnity, which is a contractual provision by which one party (the indemnitor) agrees to protect another (the indemnitee) from the legal consequences of the conduct of one of the parties or other third party, or it may take the form of equitable indemnity, which can be implied from a contractual relationship or may arise from the equities of a particular circumstance.

An indemnity agreement is not the same as an insurance contract, but its effect is to place the burden on the indemnitor of insuring against any loss within its scope. The specific contract clauses that seek to allocate the responsibility for various types of risk on a construction project are called contractual indemnities.

Typically, the project owner will seek to place the risk of project related losses on the general contractor and the architect. In turn, these parties will seek to shift the responsibility for such losses to their respective lower tier subcontractors and design consultants. And sometimes, the contractors and subcontractors that procure materials, supplies, equipment and related goods for a project will attempt to further shift liability for projected related losses to distributors of those goods. This method of risk allocation is often justified under the theory that the party with the greatest ability to prevent a loss should be the party responsible for such losses should they occur.

In many states, there are certain limitations as to the types of risks that can be shifted among the parties to a construction project. For example, state law often prohibits indemnification for intentional torts (e.g., fraud or willful misconduct). In addition, some statutes prohibit contract clauses that purports to indemnify against liability arising from the sole or active negligence of the indemnitee.

Regardless, it is imperative for risk managers to determine the appropriateness of indemnity provisions in construction contracts, purchase orders or other agreements that establish the terms and conditions between the parties. For subcontractors and material suppliers, it is also particularly important to scour any agreement or purchase order for "incorporation by reference" language that may attempt to incorporate other agreements that may contain contractual indemnities. At a minimum, the existence of a contractual indemnity should trigger a review and evaluation process to ensure the risks posed by such an express indemnity agreement is acceptable, or whether the contractual indemnity should be limited, narrowed and/or allocated to another party (e.g., a product manufacturer).

-Christopher Ng, managing partner, Gibbs Giden Locher Turner Senet & Wittbrodt LLP

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