October  20, 2000



Bulletin #41: What Is Indemnification?

Fred was the contract manager at ZZZ Sheet Metal. He knew his business from years of experience. Nobody in the industry had a better nose for an unusual clause, a one-sided retainage provision, or an unfair completion delay penalty formula. He had negotiated against the best on standard and proprietary contracts, and, more often than not, prevailed. He had been through a few arbitrations, but his negotiating skills (and some luck) had prevented most contract disputes for ZZZ. When an issue arose, the contract manager could usually point to language in the document that resolved the dispute. He was held in high regard in the industry and particularly by ZZZ management.

While he would not admit to it in public, there were still certain provisions of construction contracts that Fred found confusing and intimidating. Had he made a list of such provisions, indemnification clauses would be at the very top.

The typical indemnification language in the construction contracts was full of legalese, cross-references, and references to insurance coverages (which were also not one of Fred’s strong points). He was also not absolutely clear on the meaning of “negligence” (which usually appeared several times in the indemnification clauses), although he knew that the word was thrown around when the subcontractor’s workforce had screwed up. It was not clear to him whether “indemnify” and “hold harmless” meant the same thing or not. The use of the word “defend” in the clauses simply made it more confusing. Hoping never to have to deal with the concept of indemnification himself, Fred would simply cut the insurance section out of each proposed contract, fax it to his insurance agent, receive back a certificate of insurance, and hope for the best. This usually worked. Unfortunately, a day finally came when Fred was to learn the meaning of “indemnification.” Several ZZZ employees had been involved in hoisting a chiller onto the roof of a partially completed office building. Halfway up the building, the equipment being hoisted began to sway, and collided with the curtain wall of the building (which included marble, special glass, and other expensive materials). The exterior of the building was substantially damaged, as was the equipment. When the equipment finally reached the roof of the building, and was being set into place, it slipped causing damage to the roof and injury to several non-ZZZ employees. It was a fiasco of the highest order.

Not surprisingly, the phone calls began coming in immediately. After the shouting subsided, it became clear that numerous parties were looking to ZZZ for protection against the damages, and expenses that resulted from the mishandling of the equipment. Fred contacted the company’s insurance agent, and was informed that the company’s liability policy did not include a contractual liability endorsement, and that there may not be coverage for ZZZ’s indemnification obligations. When management learned of the situation, Fred’s job was very much in jeopardy. While the insurance company ultimately agreed to cover the actual claims, and losses asserted against ZZZ arising out of the accident, it denied any obligation to pay for costs of defense of the third parties. ZZZ was left with the obligation under its subcontract for very large legal bills for a number of other parties, including the general contractor and the owner. Fred was promptly sent to a remedial contract negotiation course, and forever lost his reserved parking space next to the building.

“Indemnification” is one of the most difficult and complex concepts that appear in a construction contract. It involves the interplay of multiple legal concepts, insurance issues, and matters of contract interpretation. Indemnification clauses also tend to be among the least clearly written sections of a construction contract. An entire semester in law school could be spent on the nuances of indemnification, and the typical contractor would prefer to spend that time building things (although he may want to send his son or daughter to law school, just in case). However, there are some general principles concerning indemnification in the context of a construction contract that every contractor should understand. The basic elements of an indemnification provision are:

1. Identification of whom is being protected. The typical construction subcontract extends protection to the owner, general contractor, architect, architect’s consultants, and their agents and employees.

2. Identification of what protection is being offered. The contract may provide either that the subcontractor shall “indemnify and hold harmless” or “indemnify, defend and hold harmless.” The difference is that, with an undertaking to defend, the subcontractor becomes responsible for actually pursuing the defense of claims on behalf of the indemnified parties, as opposed to simply paying the claims.

3. Identification of what type of situation triggers the indemnification obligation. Most often, indemnification clauses are triggered by a claim, damage, loss, or expense incurred by a protected party (which most typically involves bodily injury or property damage).

4. Identification of what level of subcontractor error triggers the indemnification obligation. Clauses can vary greatly as to this element. Some will say that the indemnification obligation arises only if the subcontractor or its employees have been negligent or committed willful misconduct. Others will trigger the obligation simply due to the fact the subcontractor or someone, for whom the subcontractor is responsible, was in any way involved in the events leading up to the claim or damage, whether or not any negligence was involved.

5. Identification of what the subcontractor must do if the indemnification obligation is triggered. Most often, the subcontractor is required to pay all claims, damages, losses or expenses, as well as attorneys’ fees incurred by the indemnified parties. The clause may or may not give the subcontractor the ability to settle a claim or give it any control over the process of defense.

There are a couple other matters concerning indemnification that bear comment. First, indemnification clauses are often used to circumvent the liability protection for an employer that would otherwise be in effect under workers’ compensation insurance. While a ZZZ employee could only recover workers’ compensation benefits from ZZZ for an injury received while in employ of that company, he could sue the general contractor (for example, based upon failure to maintain a safe work site). The general contractor could then use the indemnification provision of the subcontract to sue ZZZ, and make the subcontractor financially responsible to the injured employee for far more than just workers’ compensation benefits.

Second, and most important, the indemnification obligations of the subcontractor are typically insurable if the subcontractor is careful in its procuring of project insurance. Whether the protection comes through the basic terms of the liability policy for a particular project, through a blanket or umbrella policy, or through the obtaining of a specific contractual liability endorsement, the necessary coverage is usually available. However, it is up to the contractor to make certain that it has the coverage. Without insurance coverage, the indemnification obligations of a subcontractor can literally destroy its business in the event of a major casualty. 

 

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