Anatomy of an Indemnity Clause

Operation

Indemnity clauses are one of the most negotiated (and litigated) provisions in a construction contract.

They’re also one of the least understood.

But we’re here to dissect it for you, so to speak.

What is an indemnity clause?

An indemnity clause is simply a risk transfer provision that seeks to transfer risk from one party to another party.

Here’s an example of an indemnity provision from one of the more popular construction form contracts, the AIA A201 General Conditions:

To the fullest extent permitted by law the Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder. Such obligation shall not be construed to negate, abridge, or reduce other rights or obligations of indemnity that would otherwise exist as to a party or person described in this Section 3.18.

What does an indemnity provision do?

As discussed, an indemnity provision transfers risk from one party (called the “indemnitee”) to another party (called the “indemnitor”). Under an indemnity provision, the indemnitor agrees to reimburse the indemnitee for losses resulting from a claim or claims brought by a third-party.

An example would be someone (i.e., a third-party) tripping and falling on a set of stairs and suing the owner of the building (i.e., the indemnitee) for their injuries on the ground that the stairs were not built according to building code. The owner, if he had an indemnity provision in his construction contract with the general contractor (i.e., the indemnitor), would look to the general contractor to reimburse the owner for any amounts the owner has to pay the third-party.

What are the components of an indemnity clause?

To understand how an indemnity clause works it is helpful to understand what the language used in an indemnity provision means.

So, let’s take a look at the indemnity clause from the AIA A201 General Conditions we mentioned above and use it as an example:

To the fullest extent permitted by law the Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder. Such obligation shall not be construed to negate, abridge, or reduce other rights or obligations of indemnity that would otherwise exist as to a party or person described in this Section 3.18.

  • “To the fullest extent permitted by law . . .” – Many states, including California, have anti-indemnity statutes which limit the extent to which a party can require another party to indemnify them. The language, “[t]o the fullest extent permitted by law,” is intended to protect the indemnity clause from being disregarded by a court or arbitrator in the event that the clause is found to be more protective than what is permitted under the law.
  • “Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them . . .” – This language identifies who the indemnitor and indemnities are. In this case, the Contractor is the indemnitor and the Owner, Architect, Architect’s consultants and their agents and employees are the indemnitees. There are also the words “indemnify” and “hold harmless.” We’ve discussed indemnity, which is where an indemnitor agrees to reimburse an indemnitee for losses resulting from a claim or claims brought by a third-party. Unlike indemnity, which involves reimbursement by one party to another, a hold harmless provision is an agreement that one party will not make claims against another party. So, taken together, under the indemnity and hold harmless language, an indemnitor agrees to reimburse the indemnitee for losses resulting from a claim or claims brought by a third-party and the indemnitor further agrees not to bring claims against the indemnitee.
  • “From and against claims, damages, losses and expenses, including but not limited to attorney’s fees, arising out of or resulting from performance of the Work . . .” – This language identifies what will be reimbursed. Although every contract is subject to interpretation, it is fairly clear that “claims” includes claims which have not been litigated, “damages” includes damages alleged but not proven, “losses” includes amounts awarded or paid following judgment or otherwise, and “expenses” includes attorney’s fees and other expenses incurred by the indemnitee.
  • “Provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself) . . .” – This language limits the situations in which the indemnitor is required to reimburse the indemnitee. In this case, reimbursement is limited to claims, damages, losses or expenses attributable to the physical injury or death of a third-party or to damage or destruction of property of a third-party. It does not, however, include damage or destruction to the project itself. The limitation to physical injury or death of a third-party or damage or destruction of property of a third-party is intended to parallel the limits of insurance coverage available to indemnitees as additional insureds under the commercial general liability policy of the indemnitor. More on that later.
  • “But only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable . . .” – This language limits the liability of the indemnitor to situations in which the Indemnitor, one of its subcontractors, or one of their employees caused a loss. And even then, only to the extent the loss was caused by the indemntor, one of its subcontractors, or one of their employees.
  • “Regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder . . .” – This language is intended to restrict an indemnitor from arguing that the indemnity provision is unenforceable because the loss was caused in part by one of the indemnitees.
  • “Such obligation shall not be construed to negate, abridge, or reduce other rights or obligations of indemnity that would otherwise exist as to a party or person described in this Section 3.18” – This is a safety net provision. In addition to express indemnity (i.e., a written indemnity provision between parties, as here) courts can construe the existence of an indemnity obligation under one of several theories including equitable indemnity. This provision is intended to preserve the ability of an indemnitee to argue, in the event that the indemnity provision in the contract is found be unenforceable or limited in some way, that the indemnitee should nevertheless be indemnified by the indemnitor.

Are there anti-indemnity statutes in California that limit indemnity provisions?

Indeed there are. As discussed in an earlier post, California has anti-indemnity statutes which limit the breadth of indemnity provisions in construction contracts:

  • No Indemnity for Sole Negligence or Willful Misconduct – Civil Code section 2782(a) provides that indemnity provisions in construction contracts in which an indemnitor is required to indemnify an indemnitee for their sole negligence or willful misconduct are void and unenforceable.
  • No Indemnity by Public Agencies for Active Negligence – Civil Code section 2782(b) provides that indemnity provisions in construction contracts in which a general contractor is required to indemnify a public agency for their active negligence are void and unenforceable.
  • Limitations on Indemnity in Residential Construction Contracts – Civil Code section 2782(d) provides that indemnity provisions in residential construction contracts entered into after January 1, 2009 in which an indemnitor is required to indemnify and/or defend a builder or general contractor are unenforceable to the extent that the builder or general contractor is negligent, for defects in design furnished by the builder or general contractor, or if a claim does not arise out of the work of the indemnitor.
  • Limitations on Indemnity by Public Agencies Against Design Professionals – Civil Code section 2782.8 provides that indemnification provisions in design professional contracts entered into with a public agency after January 1, 2007 in which a design professional is required to indemnify and/or defend a public agency are unenforceable except for claims that arise out of negligence, recklessness, or willful misconduct of the design professional.
  • Limitations on Indemnity in Wrap-Up Insurance Policies – Civil Code sections 2782.9 through 2782.96 provide that indemnity provisions in residential construction contracts with a wrap-insurance policy, also known as Owner Controlled Insurance Policies (“OCIP”), entered into after January 1, 2009 in which an  enrolled and participating subcontractor or other participant in the OCIP program is required to indemnify and/or defend another party for any claim covered by the wrap-insurance program are unenforceable.
  • No Indemnity for Active Negligence or Willful Misconduct – Civil Code section 2782.05 which provides that indemnity provisions in construction contracts entered into on or after January 1, 2013 in which a subcontractor is required to indemnify and/or defend a general contractor, construction manager, or other subcontractor for their active negligence or willful misconduct, for defects in design furnished by such persons, or for claims that do not arise out of the scope of work of the subcontractor are void and unenforceable.
  • No Indemnity by Public Agencies for Active Negligence – Civil Code section 2782(b)(2) which provides that indemnity provisions contained in construction contracts with public agencies entered into on or after  January 1, 2013 in which  a general contractor, subcontractor or supplier of good or services is required to indemnify a public agency for their active negligence are void and unenforceable.
  • No Indemnity by Private Builder Not Acting as Contractor – Civil Code section 2782(c) which provides that indemnity provisions contained in construction contracts entered into on or after January 1, 2013 with the owner of  privately owned real property (in which the owner is not acting as a contractor or supplier of materials or equipment) in which a general contractor, subcontractor or supplier of goods or services is required to indemnify the owner for their active negligence are void and unenforceable.  However, Section 2782(c) does not apply to homeowners performing home improvement projects on their own single-family dwellings.

What should indemnitors and indemnitees be thinking about when negotiating an indemnity clause?

Owners vis-a-vis general contractors, general contractors vis-a-vis subcontractors, and higher tier subcontractors vis-a-vis lower tier subcontractors want the broadest possible indemnity clauses they can negotiate. Conversely, general contractors vis-a-vis owners, subcontractors vis-a-vis general contractors and lower tiered subcontractors vis-a-vis higher tiered subcontractors want to avoid indemnification clauses all together or, at the very least, limit them. So, here’s what you should be thinking about whether you’re an indemnitor or indemnitee:

  • “To the fullest extent permitted by law” – Indemnity provisions are only as good as they are enforceable and only as effective as they are applicable. As such, indemnitees will want to ensure that their indemnity clauses aren’t found to be unenforceable because they are more protective than what is permitted under the law or, conversely, that their indemnity provisions are less protective than what is permitted under the law. As such, indemnitees will want to include language that the indemnity clause that it is to be construed “to the fullest extent permitted by law.” Indemnitees, of course, would rather not have such language.
  • The duty to defend – While indemnity provisions benefit an indemnitee, they only apply to the extent an indemnitee is required to pay for a loss, which often won’t occur until after a case goes to trial. In the meantime, the indemnitee will likely have spent tens if not hundreds of thousands of dollars in attorney’s fees. Thus, for indemnitees, they will want to have an express provision requiring the indemnitor to  “defend, indemnify and hold harmless” the indemnitee. They may also want to reserve the right to select defense counsel of their choosing.  Indemnitors, on the other hand, would rather have an indemnity clause remain silent on the issue of the duty to defend or, even safer, expressly disclaim an obligation by the indemnitor to defend the indemnitee.
  • Expert costs – Expert testimony is often required in construction cases. And, experts can be expensive. Expert costs might be construed as an “expense,” but if you’re an indemnitee, why take the chance. This is particular so because “costs” is a term of art in litigation and does not include expert costs unless an expert was ordered by the court, which is rare. As such, if you’re an indemnitee, you would want to make clear that an indemnitor is required to reimburse you not only for attorney’s fees but for expert costs as well. An indemnitee might also want to add “claims, damages, losses, or expenses of any kind or character,” just to be safe. An indemnitor, as you might guess, would not want to include such language.
  • Bodily injury or death and property damage or destruction (other than to the Work itself) – Indemnitors will want to limit indemnity provisions to those claims that would be covered by their commercial general liability insurance policies. Commercial general liability insurance will generally cover bodily injury or death of a third-party and damage or destruction to property of a third-party. Thus, indemnitors would will want to limit indemnity clauses to bodily injury or death and damage or destruction to property of a third-party. Indemnitees, on the other hand, will want broader more open-ended indemnity provisions and will want to avoid such limiting language.
  • “To the extent caused by” vs “arising out of” – Words have meaning. Indemnitors desiring to limit their indemnity obligations will want to limit indemnity provisions “to the extent caused by” their acts or omissions, whereas indemnitees desiring to have their indemnity provisions construed as broadly as possible will want to require their indemnitees to indemnify them for losses “arising out of” the indemnitees work or “arising out of” the indemnities acts or omissions.

What are some examples of a broad and narrowly written indemnity provisions?

Because there are anti-indemnity statutes in California you need to be careful when drafting indemnity provisions for projects in California to make sure that they comply with California’s anti-indemnity laws.

Here’s an example of a broad (i.e., more protective of an indemnitee) indemnity clause for in a commercial construction contract between an owner and general contractor for a project in California:

To the fullest extent permitted by law, Contractor shall defend, indemnify and hold harmless Owner, Owner’s design professional and other consultants, and their officers, directors, shareholders, members, managers, partners, employees, agents and representatives (“Indemnified Parties”), from and against any claims, allegations, damages, awards, judgments, and expenses of every kind or character, including, but not limited to, attorney’s fees and expert costs, which may arise out of or result from in whole or in part Contractor, Contractor’s subcontractors and material suppliers, or their employees, agents, or representative’s performance of the Work, except to extent caused by the sole negligence or willful misconduct of Indemnified Parties. Contractor’s obligation to defend Indemnified Parties shall be immediate upon written notice by Owner to Contractor and Contractor shall, if requested by Owner, defend Indemnified Parties using counsel approved by Owner in its sole discretion.

And, here’s an example of a narrow (i.e., less protective of an indemnitee) indemnity clause, again for a commercial construction contract between an owner and general contractor for a project in California:

Contractor shall indemnify Owner from and against any losses incurred by Owner, but only to the extent such loss was incurred as a result of Contractor’s acts or omissions with respect to the Work and not due in whole or in part to the breach, negligence or misconduct of Owner.  

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