In the construction industry, contractual indemnity and additional insured
coverage are widely regarded as separate but parallel risk transfer paths—each
with their own nuances, advantages, and pitfalls. The two are ordinarily
intended to complement each other. Where one is unavailable, the other may yet
be.
Acknowledgment
The author would like to acknowledge and thank
coauthor Michael A. Barrese for his contributions to this commentary.
In many states, however, indemnity and insurance are being increasingly
pulled together. Upstream and downstream parties alike should recognize this
trend, appreciate the implications to their unique risk transfer goals, and
tailor their risk transfer plan accordingly.
Consider the History
Historically, contractual indemnity was the primary risk transfer tool,
governed by the common law and bound only by the clarity of the agreement
between the parties. A perceived imbalance in negotiating power between
contractors and subcontractors led to the advent of the anti-indemnity statute.
Anti-indemnity statutes became commonplace, and contractors diversified their
risk transfer efforts. Thus was born modern additional insured coverage, which,
much as with early indemnity, is largely governed only by common law contract
principles.
To date, 46 states have enacted anti-indemnity statutes that curtail
indemnity agreements.1 The remaining states
continue to rely on the common law to assess enforceability. In sum, all states
allow limited indemnity provisions under which the indemnitor promises to
indemnify the indemnitee for the indemnitor's negligence. The vast majority
of states prohibit an indemnitee from assigning its own sole negligence to an
indemnitor and only permit indemnification for vicarious liability. Only a
scant few permit broad form indemnity provisions in which the indemnitor
assumes the entire risk of loss regardless of whether it is the result of the
sole negligence of the indemnitee. Those states that permit broad form
indemnity agreements require that the agreement be "clearly and
unequivocally stated" in the contract.
Some of those statutes have evolved to specifically restrict the insurance
that can be provided to an upstream party. Anti-indemnity statutes in Arizona,
Colorado, Georgia, Kansas, Montana, and Oregon void as against public
policy additional insured coverage for sole negligence.2 Legislatures in those states generally equate the agreement to
provide insurance to the agreement to indemnify; thus, they reason, agreements
to provide insurance for an additional insured's own negligence should
likewise be void as against public policy.
The extension of anti-indemnity limitations to additional insured coverage
is not, however, always so obvious. Several anti-indemnity statutes have been
interpreted by courts as applying to insurance, even though the statute
otherwise appears silent on the issue or, worse, suggests that insurance
agreements are exempt.3 This diversity of outcome,
as illustrated by the case discussions that follow, reinforces the importance
for risk professionals not only in being conversant in the statutes themselves,
but also their application in case law.
NJ: Additional Insured Requirements Must Follow Anti-Indemnity Rules
In Shannon v. B.L. England Generating Station, 2013 U.S. Dist.
LEXIS 168715 (D.N.J. Nov. 27, 2013), where a federal district court examined
New Jersey law for which there was no direct precedent, B.L. England Generating
Station (BL) contracted with Industrial Process Solutions (IPS) to perform work
on an air drying compressor on BL's premises. In the contract, IPS agreed
to "defend, indemnify and hold harmless" BL from "all claims,
liabilities, and other potential losses arising out of or relating to ... any
act or omission of IPS or its employees, contractors, and agents in the
performance of the Services." In addition, IPS agreed to "procure and
maintain" sufficient insurance to protect IPS and BL from third-party
claims arising out of or connected with the performance of the work.
While IPS was performing its operations, one of its employees was injured.
The employee subsequently sued BL, alleging that BL, and BL alone, was
responsible for his injuries. BL tendered the suit to IPS and Travelers
Insurance (Travelers), IPS's general liability insurer, as an additional
insured. Both IPS4 and Travelers5 refused to defend or indemnify BL.
As a result of Travelers' denial, BL sued IPS for failure to procure
insurance. In response, IPS argued that BL was effectively seeking additional
insured coverage for its own negligence and that such a requirement would have
to comport with New Jersey's anti-indemnity statute, which required that
indemnity for sole negligence be clearly and unequivocally written to be
enforceable. Notably, New Jersey's anti-indemnity statute (N.J. Stat. Ann.
§ 2A:40A–1) specifically provides that it "shall not affect the validity
of any insurance contract." Nonetheless, the district court sided with IPS
and held that absent a clear contractual requirement that IPS purchase
insurance to cover BL's own negligence, no such obligation existed.
Therefore, IPS could not be in breach.
Importantly, in applying the anti-indemnity limitations to the trade
contract's insurance requirements, the court reasoned that to hold
otherwise would essentially allow "a back-door attempt at the statutorily
prohibited result of indemnification for [BL's] own negligence." As to
the statutory language that, facially, seemed to exempt insurance from the
statute, the court concluded such language merely meant that any insurance
policy purchased in compliance with the statute would otherwise be governed by
its own terms.
IL: Insurance Requirements Not Barred by Statute
In St. John v. Naperville, 508 N.E.2d 1128 (Ill. App. Ct. 1987),
recently reinforced in 2009 in Clarendon Am. Ins. Co. v. Prime Grp. Realty
Servs., 907 N.E.2d 6 (Ill. App. Ct. 2009), the Illinois Appellate Court
concluded that the Illinois anti-indemnity statute, which is similar in form to
New Jersey's, did not extend to insurance requirements.
In St. John, the city of Naperville contracted with Utility
Dynamics Corporation to construct an extension of the Naperville electrical
system. As part of the contract, Utility was required to provide certain
insurance coverage to Naperville, including insurance "equal to" that
described in the indemnity agreement.
While performing operations on site, a Utility employee was injured and
sought recovery for his injuries in a suit against Naperville. Naperville then
brought a third-party action against Utility for, among other things, failure
to procure insurance pursuant to the terms of the contract. Utility sought
summary judgment on the basis that the insurance requirements were void under
the Illinois anti-indemnity statute, which provides that every promise or
agreement to indemnify another for that person's own negligence is void and
wholly unenforceable.
Similar to New Jersey's anti-indemnity statute, the Illinois statute
(740 Ill. Comp. Stat. Ann. 35/3) includes a caveat regarding insurance
contracts, stating that "[t]he Act does not apply to construction bonds or
insurance contracts or agreements." The court held that the statute did
not apply to Utility's insurance obligations because a requirement to
procure insurance is different from an indemnity agreement in that an agreement
to procure insurance preserves a potential source of compensation for an
injured worker and limits the exposure to the downstream party to the price of
insurance premiums, whereas an indemnity agreement places potentially unlimited
liability on the downstream entity. Therefore, the court held that the contract
was not void under Illinois law.6
A Few Points To Consider
What is the solution to the potential for inconsistent results presented by
the diversity of statutes and case law? In true lawyer fashion, the answer is a
resounding "it depends." It depends on where you work, where you
bought the policy, your risk transfer goals, and so on. The only way to craft a
truly effective risk management plan is to think deeply and carefully about all
of these issues and more. In the meantime, there are several general strategies
to consider.
Know Which Law Applies
The first critical step in assessing the scope of anti-indemnity application
to insurance is to know which statute is likely to apply. For contractors with
a national footprint, this can often be a challenging assessment that requires
a careful examination of complex choice-of-law principles. Moreover, the
relevant contract is most often not the insurance policy, though the dispute is
ultimately about insurance, but rather the underlying contract that is the
original source of the insurance obligation.
Know the Law
By being familiar with anti-indemnity statutes, the additional insured can
tailor its insurance requirements to avoid having coverage invalidated on the
basis that the agreement to provide additional insured coverage runs afoul of
the anti-indemnity statute. For instance, in New Jersey, a contract can provide
for additional insured coverage for the additional insured's own negligence
if the contract explicitly states this intention.7
However, in Kansas, any contractual provision requiring a party to provide
insurance covering another's sole negligence is void.8 If the additional insured used the same contract in Kansas as
in New Jersey, the additional insured requirement would be deemed invalid, and
the additional insured's risk transfer solution may be nullified. However,
with knowledge of the jurisdiction's anti-indemnity statute, additional
insured requirements can be crafted to fit within the statutory scheme and
provide maximum risk transfer to the additional insured.
"Savings" provisions—language designed to preserve contractual
language to the extent permissible by statute where it would otherwise be
completely void—have become standard with indemnity provisions. Insurance
requirements should include the same language, if that is not done already.
Consider Wraps
In jurisdictions where indemnity and insurance face similar limitations,
upstream parties should consider additional alternative risk transfer
solutions, including consolidated insurance programs (commonly known as
"wrap-up" insurance). The Texas anti-indemnity statute (Tex. Ins.
Code Ann. § 151.104), which is among those that void certain additional insured
provisions, specifically does not apply to an owner-controlled or
contractor-controlled insurance program. These types of insurance programs are
purchased by upstream parties but are funded in part by each project
participant, including the downstream subcontractors. Wrap-up insurance
programs provide general liability coverage to all enrolled parties, thereby
avoiding the risk that downstream insurance requirements may run afoul of
expanded anti-indemnity laws.