Indemnities Demystified

Indemnity. In the panoply of contract terms, no other word strikes as much terror into the hearts of contract administrators, project managers and other business types. This fear is often born of the failure to understand the essential elements and parameters that are typically hidden in a thicket of enormous run-on sentences.

Simply, the indemnitor, a/k/a party on the hot seat, must protect the indemnitee, a/k/a party on the catbird seat, from certain categories of claims that are caused by certain types of circumstances. The key to understanding the indemnity is to parse the categories of claims identified in the indemnity, and the scope of causative circumstances. And the key to evaluating the indemnity is to recognize whether the causative circumstances can be managed (more on that below), or the claims can be insured.

Don’t get bogged down in the lists of synonyms, “claims, costs, loss, damages” and the like. Those arise from the predilection of counsel to never use one word when five will do. (There are, in fact, subtle differences in many of those terms, but they are not critical to evaluate the indemnity.) Focus instead on categories of claims covered, and the causation standard.

First, categories of claims that may be in a construction contract indemnity:

• Personal injury and property damage claims – almost always included. • Payment claims by lower-tier subs or vendors – often included. • OSHA citations or other safety or regulatory sanctions – sometimes included. • Patent infringement or violation of intellectual property right – often included in a stand-alone paragraph addressing only IP issues. • Other categories sometimes included: breach of contract, or broad all-encompassing “kitchen sink” language.

Second, causative circumstances that may be expressed:

• Arising from the indemnitor’s actions – very common, and also unlikely to run afoul of any anti-indemnity statute. • Arising to the extent caused by the indemnitor’s actions – common as a “pure comparative” indemnity, and the indemnity is co-extensive with the indemnitor’s actions. • Arising in whole or in part from the indemnitor’s actions – also common, and could require the indemnitor to protect the indemnitee even for claims arising from what the indemnitee did (most common with insurable risks, and in conjunction with insurance risk allocation). But this causative standard may be narrowed or even voided by an anti-indemnity statute to cut off any portion of the damages not caused by the indemnitor. • No causative circumstance identified - very rare, and probably only in settings where the category of claims is closely tied to the indemnitor’s work, such that there realistically would not be any other cause.

Thus, an indemnity can be broadened either by expanding the categories of claims covered by the indemnity, or by broadening the causative circumstances – or both. Conversely, the indemnity can be narrowed by reducing the categories or by limiting the scope of the causative language – or both.

Assessing whether an indemnity is problematic requires analysis as to what risks covered by the indemnity are not insurable (see the next paragraph on this issue). For uninsurable risks, can they be managed, either directly by the indemnitor’s project controls or by passing the risk along to another party via contract? Any risk that is not insured, and is also not passed along to someone else, must be managed by the indemnitor. For instance, the risk of an OSHA sanction arising from the indemnitor’s work must be managed by the indemnitor’s project management and/or safety managers, and through training of the workforce.

Insurance in the construction setting will likely cover only personal injury and property damage claims. Even here, there are limits. One obvious limit is in the amount of coverage. A catastrophic event on a project may result in either personal injury or property damage claims, or both, that overwhelm the amount of insurance coverage available. In that setting, the indemnitor may have insured the risk, up to a point, but then be exposed to a greater risk than insurance is available to cover. As well, contractors have found themselves in situations where coverage was restricted or even denied. For example, the general liability carrier for an erection sub whose tower crane collapsed in New York City denied coverage altogether, when it came to light that the sub had misrepresented the nature of its operations on the insurance application, in order to reduce premiums. Thus, there was no insurance to back up the sub’s indemnity obligations in that case.

About 40 states have some sort of anti-indemnity law on the books. Those laws vary, but a common element is some sort of restriction on the causative circumstances allowed. For instance, a subcontractor indemnity that, on paper, requires the sub to indemnify the prime or the owner for a claim not caused by the sub may not be enforceable against the sub in a number of states. Courts in many states applying the particular state’s anti-indemnity law have construed the phrase “to the fullest extent permitted by law” to narrow the indemnity language so as to comply with the particular state law. Thus, that phrase is a common predicate to an indemnity clause.

Keeping these different elements in mind will help one to understand and evaluate a proposed indemnity. After that, it is just a matter of negotiation. And making sure your project team has been trained to properly manage the risks that remain and aren’t insured.