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The Interaction Between Indemnity Provisions and Liability Insurance Is an Important Aspect of Risk Management in the Construction Industry
May 3, 1996
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Thelen Reid Brown Raysman & Steiner LLP
Indemnity
agreements are used today on virtually all construction
projects as a means of risk management. In fact, with
few exceptions all parties involved in a construction project
have indemnity obligations (an indemnitor) or are the beneficiary
of an indemnity agreement (an indemnitee). Risk management
through indemnity agreements must, however, be properly
augmented with liability insurance policies since those
policies will frequently determine whether a party is able
to honor its contractual indemnity obligations or receive
the indemnity benefits for which it contracted. Consequently,
it is important for both indemnitees and indemnitors to
understand the interaction between indemnity provisions
and liability insurance to maximize the risk management
benefits that can be achieved through the proper combination
of both.
For an indemnitee, a primary concern should be whether the
indemnitor has adequate financial or insurance resources
to honor its indemnity obligations. A common practice
by indemnitees to alleviate this concern is to be added
as an additional insured on an indemnitor's liability policy.
When properly managed, the benefits as an additional insured
may actually exceed those available as an indemnitee.
This is because the insurer's obligation to defend a claim
may be broader than an indemnitee's defense obligation.
Such a difference can be important because an indemnitor
may not have to reimburse an indemnitee's cost of defending
false claims while an insurer on a standard form liability
policy would be obligated to defend claims that ultimately
were proven untrue. The key to maximizing additional
insured benefits lies in obtaining broad additional insured
endorsements which, at a minimum, provide coverage beyond
completion of the project.
A recent decision by the California Court of Appeals highlights
another manner in which a liability policy can protect an
indemnitee. In Insurance Co. of North America v.
National American Ins. Co. (1995) 37 Cal.App.4th 195,
the court addressed the coverage provided by a standard
form liability policy for a subcontractor's indemnity obligation
to a general contractor. In that case, the subcontractor
was obligated under a "Type I" indemnity agreement
to indemnify the general contractor for all liability arising
from not only the subcontractor's negligence, but also the
general contractor's joint negligence with the subcontractor.
The court ultimately determined that the subcontractor's
policy covered the derivative liability the subcontractor
had assumed under its indemnity agreement with the general
contractor.
The court's finding in Insurance Co. of North America
hinged on a broad form property damage endorsement in the
subcontractor's policy that narrowed the work-performed
exclusion such that it did not exclude damage to the subcontractor's
work caused by "others." The court then reasoned
that derivative liability assumed under an indemnity agreement
had to be caused by the negligence "of others"
(here the general contractor) and therefore was not precluded
by the exclusion for damage to the insured's work.
To take advantage of the rule announced in the Insurance
Co. of North America decision, indemnitees must assure
that the work-performed exclusion in the indemnitor's policy
excepts work performed "on behalf of" the insured.
This modification is incorporated in many standard general
liability forms today, but indemnitees should always verify
that the indemnitor's policy contains the newer language
or is properly modified by the broad form property endorsement.
The precautions to be taken by indemnitors to assure that
their indemnity obligations do not become an uninsured financial
liability, not surprisingly, closely mirror the recommendations
for indemnitees. First and foremost, an indemnitor
needs to have insurance that is commensurate with its indemnity
obligations. For example, it is important to understand
when an agreement requires the indemnitor to assume responsibility
for all jointly caused damages even if the indemnitor's
responsibility is significantly less than that of the indemnitee.
An indemnitor assuming such an obligation should assure
that it has adequate policy limits to cover its indemnity
exposure.
Indemnitors should also consider naming the indemnitee as
an additional named insured. This common requirement
in construction contracts can actually benefit the indemnitor
by shifting the burden of an indemnity agreement to the
indemnitor's liability carrier. Here again, it is
critical to assure that the additional insured coverage
corresponds to the indemnitor's obligations to the indemnitee.
Consequently, the indemnitor's policies should not terminate
the additional insured coverage when the project is completed.
Indemnitees should also consider whether subsequent policies
adequately cover contractual indemnity obligations that
continue after completion of the subcontract work.
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For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-369-7229 or at pwberning@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©1996 Thelen Reid Brown Raysman & Steiner LLP
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