Removing the Mystery from Indemnity Agreements

Most, if not all, construction projects begin with a contract, which usually includes a critical provision—the indemnity provision (aka the hold harmless clause). The indemnity provision is a promise by the indemnifying party (the contractor) to cover the other party’s (owner’s) losses if the contractor’s actions cause harm or a lawsuit. 

In other words, the indemnity provision protects an owner or general contractor from exposure to liability if a loss occurs during construction. The provision is used in favor of one party to mitigate risks and shift potential costs to another party. It is triggered by breach of the contract, misconduct or negligence of the contractor or subcontractor (the “indemnitor”).

In many states, including New York, the law prohibits the indemnification of another party’s negligence in the context of a construction project. The General Obligations Law (GOL) states in part that “a construction contract that includes a provision where one party agrees to indemnify or hold harmless another party for its negligence, is against public policy and is void and unenforceable … ”  

Unenforceable Language

We often come across contracts that favor our client but are unenforceable, as the provisions violate the term of the GOL. Sometimes the unenforceable language is buried in the provision. One such contract included, “ … subcontractor shall indemnify and hold harmless the owner, general contractor, etc. … from and against claims, damages, losses to the extent caused by the negligent acts or omissions of the subcontractor and all acts other than the sole negligence or willful misconduct of the party to be indemnified.” 

A subcontractor cannot indemnify a party (whether it be the prime contractor or the owner) for the prime contractor’s or the owner’s own negligence. The GOL mandates that indemnity agreements, in which owners or contractors seek to pass along the risks for their own negligent actions to other contractors or subcontractors, are unenforceable. 

Magical Language

“To the fullest extent permitted by law, the contractor shall indemnify and hold harmless the owner … ” This language is also called the “savings clause,” given that if an indemnity provision contains unenforceable language, the words “to the fullest extent permitted by law” can save the contract. If a legal dispute arises over the contract terms, the court will not completely disregard the indemnity provision. Rather, it will assess the agreement to find its original intent and favor under the GOL.

Peculiar/Problematic Language 

A critical part of risk management for all parties involved in a construction project is practicing good “contract hygiene.” This consists of analyzing the proposed contract and evaluating the risks associated with the services to be performed and contractual risk transfer that can create or expand liability for contractors. If indemnification provisions are not properly worded, they can shift risk, exposing parties to large claims that may not be covered by their respective professional liability insurance policies.  

While owners may be justified in seeking indemnification, provisions that are unfair, poorly worded, ambiguous and/or uninsurable do more harm than good. Even a well-drafted indemnification provision cannot let a party avoid all disputes, but a clear and concise indemnification reduces the likelihood of litigation.

The following indemnification provision has problematic/inappropriate language that should be avoided: “Contractor shall indemnify, defend and hold harmless the owner, the owner’s employees, directors, officers’ agents, representatives, subsidiaries, affiliated companies and lenders from and against any and all liability, costs and expenses, including, but not limited to: attorney’s fees that occurred in whole or in part as a result of the contractor’s acts, errors or omissions.”

In analyzing the aforesaid provision, the problematic concerns are as follows:

1. Duty to defend—The term “defend” should be deleted because the duty to defend can be broader than the duty to indemnify. If the provision is not stricken, it could be argued that the contractor has the duty to defend and pay all associated costs immediately upon the filing a lawsuit, regardless of whether or not there is a claim of negligence. Without a claim of negligence, the contractor has acquiesced to liability that would not exist absent the contract and may not be insurable.

2. Agents, representatives, subsidiaries, affiliated companies and lenders—The agreement to indemnify the above parties is problematic on two fronts. First, this language could create an obligation to indemnify parties to whom the contractor otherwise may not have liability, thereby creating an uninsured exposure. Additionally, this language could be inferred as creating a privity with these parties, which again creates exposure where none previously existed. Thus, this language should be removed, and indemnity should only extend to the owner, its officers, directors and employees.

3. Any and all—This phrase is problematic, as it could extend the indemnity to claims beyond those relating to negligence.

4. Attorney’s fees—When indemnification extends to attorney’s fees, the phrase “attorney’s fees where recoverable under applicable law on account of negligence” should be used. In jurisdictions where attorney’s fees can be covered under a professional liability policy, they are likely based on a negligence claim, as opposed to a contractual obligation to reimburse.

5. In whole or in part—This language should be avoided. Instead, the phrase “to the extent caused by” should be used. If the “in whole or in part” language is utilized, it can create an uninsured exposure. Typically, professional liability insurance only extends coverage for the insured’s share of the liability.

Flow Down

When working with various construction contracts, including architectural or design contracts, engineering contracts or subcontracts, it is critical that indemnification provisions “flow down,” meaning that the indemnification terms of the prime contract between the owner and contractor are incorporated into the lower-tier agreements. 

In other words, flow-down provisions are clauses in a subcontract that incorporate the general contract by reference and bind the subcontractor to the general contractor in the same way the general contractor is bound to the owner. This is extremely important to ensure that the indemnification obligations on the project are consistent.

Overall, one of the best ways to mitigate risk and avoid disputes arising from a construction contract is to carefully analyze all relevant indemnification obligations or have legal counsel do it. By negotiating language that can potentially result in uninsured exposures and by removing provisions that are unfair and unenforceable, parties place themselves in the best possible position to avoid expensive and protracted litigation.