Contractual Indemnity Clauses In Construction Contracts

By K&L Gates attorneys Timothy L. Pierce and R. Michael Viayra, Jr.

Express indemnity clauses are a common component in virtually all construction contracts, yet they are routinely included in such contracts without a full understanding of the risk transfer objectives of the parties or whether the indemnity clause fulfills those objectives.  Indemnity clauses are risk transfer provisions whereby one party seeks to shift the risks of claims on a construction project down the line to the entity closer to the actual work.  Typically such clauses transfer risk from the owner to the general contractor and subsequently to the subcontractors.  This article examines the forms of indemnity clauses, issues often not specifically addressed in such clauses, jurisdictional limitations on indemnity provisions and the influence such clauses may have on additional insured coverage.  Finally guidance is provided on ways to negotiate more effective indemnity clauses.

I.          General Definitions. 

The following definitions are useful to understand indemnity clauses:

• Indemnitor – the party who assumes the risk and agrees to pay for/reimburse another if a specified accident/loss occurs.

• Indemnitee – the party who will be paid/reimbursed if a specified accident/loss occurs.

• Active negligence – affirmative negligent action(s) by a party which contributes to an accident/loss.

• Passive negligence – failure to act by a party with the ability to potentially prevent an accident/loss from occurring.  For example, an owner is typically alleged to be passively negligent simply because the owner, even if not present or directly contributing to the accident/loss, could potentially have taken preventive measures to ensure the circumstances surrounding the accident/loss never occurred in the first place.

II.        Types of Indemnity Clauses

Indemnity clauses are typically classified into the following three types:[1] 

• Type I – This type “expressly and unequivocally” states that the indemnitor will indemnify the indemnitee, even if the indemnitee is solely or concurrently negligent with the indemnitor.  Thus, under this type of clause, even if the indemnitee is 100 percent at fault, the indemnitor must fully indemnify the indemnitee.[2]

• Type II – This type provides that the indemnitor will indemnify the indemnitee for the indemnitor’s negligence and the indemnitee’s concurrent passive negligence.  Therefore, the indemnitor must indemnify the indemnitee for the percentage of active and passive negligence of the indemnitor plus any concurrent passive negligence by the indemnitee; but the indemnitor does not cover the percentage of active negligence by the indemnitee.

• Type III – This type is the most limited indemnity and provides that the indemnitor will only indemnify the indemnitee for that portion of liability caused by the indemnitor’s negligence.  Thus, negligence of the indemnitee could bar or reduce the indemnification benefits provided by the indemnitor.

Although courts have established the three “types” of clauses, such descriptions are not always conclusive as to how the clauses will be interpreted and enforced.  Likewise, the active/passive negligence distinction will not always be determinative.  Rather, courts often look at the express language of the clause and attempt to enforce the intent of the parties, as exemplified by the following statement from the California Supreme Court: “…the question whether an indemnity agreement covers a given case turns primarily on contractual interpretation, and it is the intent of the parties expressed in the agreement that should control.”  Rossmoor Sanitation, Inc. v. Pylon, Inc., 13 Cal.3d 622, 633 (1975). 

While courts in California and other states continue to classify indemnity clauses according to their “type,” courts typically apply rules of contract interpretation in an effort to divine the intent of the parties.  For example, the court in Morton Thiokol found that although the indemnity clause was a Type II, the court found that the indemnitor was required to indemnity the indemnitee because the injuries were a) the result of the indemnitor’s breach of the contract and b) the type of damage contemplated by the parties when they entered into the agreement.  Morton Thiokol, Inc. v. Metal Bldg. Alteration Co, 193 Cal.App.3d 1025 (1987).  Therefore, courts in a majority of jurisdictions typically look past the “type” of indemnity clause and attempt, instead, to determine the intent of the parties as expressed in the specific language of the clause.

In addition, the language and scope of the indemnity clause can have an unanticipated effect on insurance coverage issues.  Courts have looked to indemnity clauses when interpreting the scope of additional insured coverage under the indemnitor’s general liability policy.  In a typical arrangement, an owner will require a contractor to indemnify the owner and to obtain general liability insurance with the owner named as an additional insured under the policy.  While the owner will likely have its own general liability policy, the owner anticipates that any claims or disputes arising out of the contractor’s work will be covered by the contractor’s general liability insurance.  Thus, the owner anticipates that the contractor’s general liability insurance will act as “primary” insurance responding before its own general liability insurance.  When the indemnity clause covers the indemnitee/owner, this is precisely the case; however, if the indemnity clause does not cover the indemnitee/owner (e.g. the owner is actively negligent but the indemnity clause does not cover the owner’s active negligence), the owner’s insurer may be liable for contribution for any such claims.

For example, in the Rossmoor case, the owner and its insurer sought indemnification from the contractor’s insurer pursuant to an additional insured endorsement and the express indemnity agreement.  Rossmoor Sanitation, Inc. v. Pylon, Inc., 13 Cal.3d 622, 633 (1975).  The contractor’s insurer in turn sought apportionment from the owner’s insurer based on an “other insurance” clause which purportedly made the owner’s policy also liable.  Id.  The California Supreme Court held that apportionment amongst the owner’s insurer and the contractor’s insurer would effectively negate the indemnity agreement and avoid the indemnification of the owner for which the owner had expressly bargained.  Id.  Therefore, since the indemnity agreement covered the loss, the contractor’s insurer would be primary and could not seek apportionment from the owner’s insurer.  Id.

In a more recent case, the court could not determine whether a claim was covered by an indemnity agreement, and thus the court allowed a claim for contribution between the insurance companies.  Travelers Cas. & Surety Co. v. Am. Equity Ins. Co., 93, Cal.App.4th 1142 (2001).  This linkage between indemnity and insurance was again applied when a court examined the express language and intent of an indemnity provision to determine whether an indemnitee’s insurer should be deemed a de facto “excess” carrier or whether a contribution action by the indemnitor’s insurer would be allowed.  California Capital Ins. Co. v. Farmers Ins. Group, ____ Cal.App.4^th ___ (2007).  Thus, it is important to carefully craft indemnity provisions to be consistent with the respective insurance obligations of each party.

III.       Statutory and Judicial Limitations on Contractual Indemnification

Not all forms of indemnity clauses are valid or enforceable in every jurisdiction.  Some states apparently have concluded that absent legislative intervention, indemnitees will routinely impose stringent indemnity obligations on contractors with less bargaining power.  This can be particularly problematic in the context of public works projects where the low bidder must accept the terms of the contract as written.  These concerns have lead many states to enact legislation to limit the enforcement of certain indemnity clauses.  For example, while a standard Type I indemnity clause allows for indemnification of the indemnitee even for its sole fault, a number of states have statutes barring such indemnification.  California, Maryland, and Washington bar indemnification for the sole negligence or willful misconduct by the indemnitee.  [3]   Thus, Type I indemnity clauses in these states must have an exception for sole negligence or willful misconduct to be enforceable.

Other state statutes go further and limit indemnification for any active negligence by the indemnitee.[4]  For example, California and Florida bar indemnification of a public agency for the agency’s active negligence.  Therefore, California public works contracts may contain at most a Type II indemnity clause.  Other states such as Illinois, New York, and Washington bar indemnification for an indemnitor’s negligence on both private and public construction projects.  Thus parties seeking indemnification must be mindful of such legislative restrictions and assure their indemnification provisions do not exceed such limitations.

IV.       Does the Indemnitor have to be at Fault?

If an indemnity clause is sufficiently detailed, courts will likely enforce such clauses even where the indemnitor is not actively at fault.  For example, in Florida, an owner was entitled to indemnity from a contractor for injuries suffered by the contractor’s employee even though the contractor was not at fault.  Nonetheless, the indemnity clause was broad enough to include liability arising from the mere presence of contractor’s employees on the site even though the contractor was not at fault.  Winn Dixie Stores v. D & J Constr., 633 So. 2d 65 (Fla. 4th DCA 1994).  In California, where the indemnity clause is sufficiently clear and explicit, courts have required indemnification of the indemnitee even without a showing of fault or negligence by the indemnitor.  Centex Golden Const. Co. v. Dale Tile Co., 78 Cal.App.4^th 992 (2000).  Therefore, parties should clarify their desire to transfer the risk even if the indemnitor is not negligent.

V.        Is the Indemnitee entitled to a Defense?

Another issue not always fully addressed is the indemnitor’s defense obligation.  It is common that an indemnitor at fault will also be required to provide for the defense of the indemnitee.  In California, an indemnitor at fault must defend an indemnitee (or reimburse the costs and fees incurred as a result of the indemnitor’s failure to indemnify the indemnitee) even if the contract does not expressly cover defense costs and fees.  Cal. Civ. Code § 2778(4).  However, if the indemnitor is not at fault, the indemnitor may not be required to defend the indemnitee based on the express language of the indemnity clause.  Thus, careful examination and crafting of the language defining the duty to defend is necessary to address the defense obligation of an indemnitor that is ultimately adjudicated not to be at fault.

VI.       Preparation of Indemnity Provision

Parties to construction contracts regularly negotiate construction contracts with form indemnity clauses without fully understanding (1) the indemnity agreement between the parties (because it is not specifically discussed) and (2) whether the clause they ultimately adopt accurately reflects the level of risk transfer both (or either) party desires. 

A common practice by parties seeking to finalize a written contract so that the work can begin is to propose modifications to the agreement without first actually discussing what risks the parties are agreeing to transfer.  Thus, the beginning step for drafting an indemnity clause (assuming it is subject to negotiations) is for the parties to reach an agreement on what liability will be transferred.  In addition, the parties should address issues such as the scope of the defense to be provided and whether fault on the part of the indemnitor is required to trigger the indemnity obligations.  Next, the parties must assure that the level of indemnity to which they have agreed is not limited by any statutes in the applicable jurisdiction.  Finally, the parties should assure that the indemnity clause, as drafted, accurately memorializes the agreement of the parties.  Indemnitees should also review whether an indemnity clause may unexpectedly limit their additional insured coverage under the indemnitor’s liability policy.

No doubt, indemnitees negotiating a construction contract will seek the greatest coverage while the corresponding indemnitor will seek to limit the indemnification as much as possible.  But despite these diametrically opposed objectives, owners and contractors of every tier must understand the precise nature of the risks they have transferred to avoid surprises and to assure that their respective insurance programs will mesh with the level of risk each party has assumed or retained.