Bare the Risk

This article originally appeared in the Spring 2017 issue of CLM sister publication, Construction Claims magazine. All rights reserved.

Construction litigation often carries the potential for significant damages exposure whether the case involves defect, delay or personal injury damages. As result, one of the most significant and important elements and considerations for construction contracts, whether in the drafting on the front end or in the analysis on the back end after litigation has ensued, is the possible shifting of liability and risk. Two of the most significant contract provisions used to attempt to shift liability and risk are indemnity and limitation of liability.

Indemnity Provisions
One of the primary risk-shifting devices in any construction contract can be indemnification provisions. These provisions attempt to allocate possible risks to those who should more appropriately bear responsibility based on the duties set forth under the parties’ respective contracts. Usually, indemnification clauses attempt to require one party to pay the damages and costs (including legal costs and expenses) incurred by another party. However, the common law (case law) of most states imposes limitations on the enforceability of certain risk transfers, like indemnity agreements. Courts will generally enforce these agreements only if they are convinced it will achieve the result intended by the parties. Because of the significance of these agreements in the construction context, most states have also enacted statutes that limit or prohibit the enforceability of certain indemnification agreements, especially for the construction industry. As a result, it is essential to understand the specific type of indemnification clause at issue and what your jurisdiction has to say about the enforceability of that type of provision.

Indemnity provisions can take on many different forms, but they typically fall into one of three categories, generally described as: broad, intermediate or limited form.

Broad Form Under this form, the indemnitor agrees to hold harmless the indemnitee for all liability, regardless of fault. Even if the indemnitee is solely at fault, the indemnitor still has the obligation to indemnify. The obligation to indemnify the other party is triggered if the indemnitor is at all responsible for a claim or damages, and it includes the obligation to indemnify even if the indemnitee is solely negligent. These clauses effectively shift the entire risk of loss from one party to the other. This form typically uses this type of language: “Shall indemnify for claims arising out of [an event]…whether caused in whole or in part by the negligence of the Indemnitee. … It is specifically understood that this indemnity shall be interpreted as indemnifying the Indemnitee from its own sole and/or partial negligence.”

These types of indemnity provisions are generally prohibited by statute in most states. For example, in Michigan, Mich. Comp. Laws §691.991, titled “Building Industry; certain contracts for indemnification void,” provides: "A covenant, promise, agreement or understanding in, or in connection with or collateral to, a contract or agreement relative to the construction, alteration, repair or maintenance of a building, structure…purporting to indemnify the promisee against liability for damages arising out of bodily injury to persons or damage to property caused by or resulting from the sole negligence of the promisee or indemnitee, his agents or employees, is against public policy and is void and unenforceable."

Intermediate Form Under this form, the indemnitor agrees to hold harmless the indemnitee for all liability, unless the indemnitee is 100% at fault. Any amount of fault on the part of the indemnitor obligates it to cover the entire loss. The obligation to indemnify the other party is triggered if the indemnitor is at all responsible for a claim or damages; however, this includes the exception that the obligation to indemnify does not apply if the indemnitee is solely negligent. This form typically uses this type of language: “Shall indemnify…whether caused in part by the negligence of the Indemnitee. … This clause is not intended to indemnify the Indemnitee for claims, damages, losses and expenses caused by the sole negligence of the Indemnitee.” The language of the AIA A201 form follows this form of indemnity provision. “To the fullest extent permitted by law the Contractor shall indemnify and hold harmless the Owner…from and against claims, damages…arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor…, regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder.”

About 50% of states have legislation that prohibits these types of indemnity provisions and have enacted statutes that prohibit indemnity for sole or partial negligence. North Carolina N.C.G.S. §22B-1, titled “Construction Indemnity Agreements Invalid,” is a good example and provides: "Any promise or agreement in, or in connection with, a contract or agreement relative to the design, planning, construction, alteration, repair or maintenance of a building, structure…, purporting to indemnify or hold harmless the promisee, the promisee’s independent contractors, agents, employees, or indemnitees against liability for damages arising out of bodily injury to persons or damage to property proximately caused by or resulting from the negligence, in whole or in part, of the promisee, its independent contractors, agents, employees, or indemnitees, is against public policy and is void and unenforceable."

Limited Form Under this form, parties to the agreement are responsible for indemnity only to the extent of their own liability on a comparative basis of fault. The obligation to indemnify the other party extends only to the extent of the indemnitor’s negligence. This form typically uses this type of language: “Shall indemnify…but only to the extent caused in whole or in part by the negligent acts or omissions of Indemnitor…under a comparative basis of fault.” The ConsensusDOCS 200 language below follows this form of agreement. Most states allow this form of indemnity agreement.

10.1 INDEMNITY
10.1.1 To the fullest extent permitted by law, the Constructor shall indemnify and hold harmless the Owner…from all claims for bodily injury and property damage, other than to the Work itself and other property insured, including reasonable attorneys fees, costs and expenses, that may arise from the performance of the work, but only to the extent caused by the negligent acts or omissions of the Constructor.

While most states have “anti-indemnity” statutes that prohibit enforcement of broad or intermediate form indemnity clauses in construction contracts, the great majority of states allow parties to require insurance coverage which ultimately serves the same purpose of the very indemnity clauses it strikes down. This phenomenon is referred to as the “Additional Insured Loophole,” a gap in the anti-indemnity statutes that essentially allows broad and intermediate form indemnity if it results from the contract’s insurance provisions instead of an express indemnity provision.

However, through efforts of organizations like the American Subcontractors Association, a few states have started to close this loophole and now prohibit a party from requiring another party to name it as an additional insured under a policy of insurance that would provide broad form indemnity coverage. One such state is Oregon, which enacted a statute, Oregon Revised Statutes Section 30.140 (2009), upheld as constitutional by the Oregon Supreme Court in Walsh Construction Co. v. Mutual of Enumclaw, which reads:

Except to the extent provided under subsection (2) of this section, any provision in a construction agreement that requires a person or that person’s surety or insurer to indemnify another against liability for damage arising out of death or bodily injury to persons or damage to property caused in whole or in part by the negligence of the indemnitee is void.

Limitation of Liability Clauses
One of the more potentially significant risk-limiting provisions seen primarily in design professionals’ professional services agreements is the limitation of liability clause. Limitation of liability clauses generally establish the maximum liability or exposure of one party if there is a claim. The purpose of these clauses is to recognize the proportional role of the professional service provider in the project and limit its liability according to the level of compensation received under the agreement. If enforceable, the clause will serve to cap a party’s liability for damages to an amount certain. However, there some jurisdictions in which these types of clauses are either disfavored or even unenforceable. As a result, it is important to understand at the outset of a claim if one of these clauses exists and has a potential effect on the liability issues, as well as which jurisdiction is involved and what that jurisdiction’s case law and/or statutory law has to say about the enforceability of these clauses.

While there is no standard AIA or industry form document that contains limitation of liability provision language, most of them are proposed as a custom term added to these documents by design professionals. Most read along the lines of the following: "In recognition of the relative risks and benefits of the Project to both the Client and the Design Professional, the risks have been allocated such that the Client agrees, to the fullest extent permitted by law, to limit the liability of the Design Professional and Design Professional’s officers, directors, partners, employees, shareholders, owners and subconsultants for any and all claims, losses, costs, damages of any nature whatsoever whether arising from breach of contract, negligence, or other common law or statutory theory of recovery, or claims expenses from any cause or causes, including attorneys fees and costs and expert witness fees and costs, so that the total aggregate liability of the Design Professional and Design Professional’s officers, directors, partners, employees, shareholders, owners and subconsultants shall not exceed $__________, or the Design Professional’s total fee for services rendered on the Project, whichever amount is greater."

As far as enforceability of these provisions, most states will enforce them where the parties to a contract are sophisticated business entities dealing at arm’s length, the limitation is reasonable in relation to the design professional’s fee, and the damages are purely economic. In the minority of states, these provisions are unenforceable unless properly worded and are subject to careful scrutiny, and others find them totally unenforceable for reasons ranging from violation of that state’s anti-indemnity statutes to public policy reasons.

A limitation of liability clause simply places a fixed cap on the amount of damages that may be recovered against a contracting party in the event of a claim. Generally, courts hold that such clauses are not, per se, against public policy, but several states are more protective, and some have enacted legislation by way of anti-indemnity statutes that hold such clauses void and unenforceable.

Generally speaking, in order to contractually limit damages for a party’s future negligence, the contractual language at issue must be: (1) clear, (2) unambiguous, (3) unmistakable and (4) conspicuous.

There are several principles that emerge from states that find limitation of liability clauses enforceable. As a rule, most states that enforce them strictly construe them against the beneficiary of the clause. The clause must still meet the above four language requirements. However, a theme from these cases is that the courts are not in a position to rewrite sophisticated parties’ business agreements and will generally enforce them as written.

For the jurisdictions that have taken a very restrictive view of these clauses, they will uphold them but heavily scrutinize them, requiring such things as separate negotiation or bargaining for the clause at issue, evidence of separate consideration for the limitation of liability clause, or that it be very conspicuous—in a different typeface, highlighted and not merely set out along with several other numbered paragraphs.

Jurisdictions that refuse to enforce the clauses do so for a number of reasons, including finding the clauses violative of the specific state’s anti-indemnity statute or holding that they are against public policy.