Owners, contractors, subcontractors, and suppliers routinely require downstream parties to indemnify and add them as additional insureds; and downstream subcontractors then similarly require their downstream subcontractors and suppliers to grant them the same status. Though it is routinely required, many of these owners, contractors, and suppliers often do not know why they are doing it.
Indemnity agreements operate as risk-transfer devices where one party (the indemnitor) promises to assume the liability of another (the indemnitee). In the standard American Institute of Architects AIA A201 agreement, the contractor serves as the indemnitor and the owner as the indemnitee—with the contractor promising to assume the owner's liability resulting from the contractor's work.1
This risk transfer device often utilizes one of three types of indemnity clause: broad, intermediate, or limited.
Broad form indemnity agreements indemnify the owner for any loss arising from the project even if the loss is caused by the owner's own negligence.
Intermediate form indemnity agreements indemnify the owner for the entire loss arising from the project if responsibility for some of the loss can be placed on the contractor.
Limited form indemnity agreements indemnify the owner only for the amount of the loss directly attributable to the contractor's negligence.2
In the construction setting, indemnity issues often arise in conjunction with injuries on the job. Property owners generally have a nondelegable duty to ensure that their property remains safe—meaning an injured person can sue an owner even if the owner does not have any control over the day-to-day operations at the job site. The indemnity agreement operates to transfer liability from the owner to the contractor for injuries caused at the construction site.
Indemnity Agreements Provide Assurance—Not Insurance
It is critical to note that indemnity agreements are not insurance agreements. Indemnity agreements operate merely as risk transfer devices transferring liability from one party to another. With that said, indemnity and insurance agreements often go hand-in-hand. Because an indemnity agreement is only as good as the indemnitor's financial ability to pay for a loss, a financially defunct indemnitor provides no meaningful protection to the indemnitee.
For this reason, owners often require contractors to obtain insurance to ensure that the indemnitor has the financial ability to pay for the indemnified loss. In this way, commercial general liability (CGL) insurance often serves as the financial backing for indemnity agreements. There are two complementary and non-mutually exclusive policy mechanisms by which coverage is accomplished: contractual liability insurance and additional insured coverage.
Contractual Liability Insurance
CGL policies provide financial assurance in the contractual liability clause of a policy. Interestingly, CGL policies provide this coverage by way of an exception to an exclusion. The standard CGL policy excludes bodily injury and property damage that the insured is obligated to pay "by reason of the assumption of liability in a contract or agreement." However, the standard CGL policy contains an important exception to the exclusion for "insured contracts." In the commercial construction context, indemnity clauses provide the most relevant type of "insured contract."3
This exception to the exclusion covers both the contractor (directly) and the owner (indirectly). It insures the contractor directly by specifically stating that insurance applies, and it "insures" the owner indirectly by giving the owner assurance that there is a larger pot of money available to the contractor in the event the owner is sued for the contractor's negligence.
While contractual liability insurance in CGL policies has its benefits, two specific problems with the coverage often arise. Coverage may not be available (1) when the indemnity agreement is void and (2) when the policy is endorsed to exclude indemnity agreements.
Legislatures across the United States have become increasingly hostile to indemnity clauses in construction agreements. More and more, legislatures are prohibiting broad form and intermediate form indemnity agreements.4 When a contract includes an indemnity clause that is prohibited or void by statute, the indemnity clause no longer falls within the definition of "insured contract." This means that insurance coverage is no longer directly available for the indemnity agreement.
The second problem arises in the CG 21 39 endorsement often attached to contractors' CGL policies. The CG 21 39 endorsement removes coverage for indemnity agreements by deleting indemnity agreements from its list of "insured contracts." A policy endorsed with a CG 21 39 endorsement simply does not insure the contractor's indemnity agreement.
The CG 24 26 endorsement also warrants discussion here, though its impact is significantly less than the CG 21 39 endorsement. The CG 24 26 endorsement essentially removes coverage for broad form indemnity agreements. This does not mean that the endorsement makes broad form indemnity agreements void in states that otherwise allow such endorsements; it simply means that the insured will be covered only for losses caused in whole or in part by the subcontractor. The CG 24 26 endorsement was also recently revised in the Insurance Services Office, Inc. (ISO), 2013 CGL revisions to clarify that indemnity agreements are only "insured contracts" to the extent the indemnity agreement is permitted by law.
Additional Insured Status
Because of these two problems (among others) with contractual liability insurance, owners often require contractors to name them as additional insureds. Similarly, contractors require their subcontractors to name them as additional insureds on the subcontractors' CGL policies.
As an additional insured on the policy, the owner has direct access to the contractor's CGL policy. This means that the owner can look to the contractor's CGL policy for a defense of a claim that potentially could be covered by the policy. The history of ISO's additional insured endorsements will be discussed in a future article, but standard additional insured clauses cover the owner's liability for bodily injury or property damage caused by the contractor's acts or omissions.
In addition to avoiding the problems associated with contractual liability coverage alone, additional insured status also has several other benefits to the insured concerning defense costs and subrogation.
CGL policies provide unlimited, or uncapped, defense costs. When an owner is included as an additional insured under the policy, there is no limit to the defense costs to which the owner is entitled, and the defense costs do not "waste" the limits of the policy. When the owner is not named as an additional insured but relies only on coverage under the contractual liability portion of the policy, the owner's defense costs are paid under the policy limits, meaning that the defense costs and indemnity paid by the insurer are capped at the policy's coverage limits.
Additional insured status also helps in preventing subrogation. As a general rule, "[t]he insurer's basic right to pursue subrogation does not extend to its own insured, including any party covered as an additional insured under the policy."5
Recent Case on Contractual Liability Insurance and Additional Insureds
The Minnesota Supreme Court recently addressed these issues in Engineering & Constr. Innovations, Inc. v. L.H. Bolduc Co., Inc., 825 N.W.2d 695 (Minn. 2013). There, ECI was a subcontractor for a sewer pipeline and Bolduc was a sub-subcontractor to ECI. Bolduc had a CGL policy with Travelers Insurance, and ECI was included as an additional insured. The contract between ECI and Bolduc also required Bolduc to indemnify ECI for any losses ECI incurred.
During construction, Bolduc damaged a sewer pipe, and ECI paid to have the damage repaired. ECI sued Bolduc and Travelers. ECI and Bolduc went to trial first. The jury ultimately decided that Bolduc damaged the sewer pipe but that it was not negligent in doing so. ECI then proceeded to its breach of contract claim with Travelers, arguing that Travelers owed a defense under the contractual liability clause and because ECI was an additional insured under the policy.
The Minnesota Supreme Court ultimately held that the indemnity clause between ECI and Bolduc was unenforceable. By statute, Minnesota allows only limited form indemnity agreements. The court held that requiring Bolduc to indemnify ECI when Bolduc was not negligent would violate the statute. Thus, there could be no coverage under the contractual liability section of the policy.
The court also discussed Bolduc's status as an additional insured at great length. The additional insured endorsement was not on an ISO form but still only included ECI as an additional insured "if, and only to the extent that, the injury or damage is caused by acts or omission of [Bolduc] or [Bolduc's] subcontractor in the performance of 'your work.'" ECI argued that the plain language of the additional insured endorsement should grant coverage: ECI was an additional insured and the losses occurred because of Bolduc's acts. Travelers disagreed, arguing that the language "acts or omissions" indicates that there must be some fault by Bolduc before coverage can apply.
The court agreed with Travelers. The court explained that the liability could appear in the contractor/subcontractor relationship in three ways:
Direct liability when the contractor is liable through its own acts of negligence
Vicarious liability when the contractor is liable solely because of its relationship with the subcontractor that was ultimately responsible
Assumption of liability when one party assumes liability for another's actions by contract
The court ultimately found that the additional insured endorsement applied only to situations involving vicarious liability. The court held that, because Bolduc was not liable for the damages, ECI could not be vicariously liable for the damages, and therefore, the additional insured endorsement did not grant coverage.
The availability of insurance coverage often depends on the contractual relationship between and among the owner, contractor, subcontractor, and insurer. Indemnity agreements and additional insured endorsements play a key role in providing coverage. Insureds, however, need to understand what relationship they are seeking and why they are seeking it to ensure that they are adequately covered.
1 For clarity, throughout this article, the terms "contractor" and "owner" will be used in place of "indemnitor" and "indemnitee," respectively. It should be noted, however, that the indemnitor/indemnitee relationship also arises in contractor/subcontractor and subcontractor/supplier relationships.
2 For a state-by-state breakdown of the types of indemnity clauses authorized in each state, see Patrick J. Wielinksi, W. Jeffrey Woodward, and Jack P. Gibson, Contractual Risk Transfer (2013), IV.L.
4 The State of Texas, for example, was one of the more recent and notable states to move to prohibiting all indemnity agreements except limited-form indemnity agreements. See Texas Ins. Code 151.101–105 (2013).
5 New Appleman on Insurance Law Library Edition § 41.05, 5–41.
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