Each year, the landscape for the construction industry becomes more complicated. Contractual requirements and litigation are challenges today’s contractors face with more regularity, making risk management a necessity.
Listed here are various terms, guidelines and definitions to promote discussions and development of a risk management program for your business.
General contractors often hire sub-contractors skilled in a particular trade, such as carpenters or electricians. However, general contractors may be held legally liable for any injury or damage caused by their sub-contractor’s work. Contractors are also responsible for the job-site safety of their own employees, their sub-contractors’ employees and visitors. For example, in most states an injured employee of a sub-contractor may sue the general contractor. To protect themselves, general contractors transfer risk.
Risk transfer entails shifting the risk of loss for injury or damage among the parties of a contract. A written contract is the best way to document risk transfer terms and agreements.
When it comes to transferring risk, contractors and other parties in a contract are referred to as either higher tier or lower tier. Example: When the owner hires a general contractor to construct a building, the owner is the higher tier and the general contractor is the lower tier.
Indemnification agreements transfer risk and responsibility to other parties. Under an indemnification agreement, the indemnitor (the party who contractually assumes risk) agrees to indemnify another contracting party for specified losses. The party that imposes the obligation (transfers the risk) is the indemnitee. Common Example: Contract between a general contractor and a sub-contractor.
Not all risk transferred by an indemnification agreement is covered by insurance. For instance, there is no coverage for warranty or breach of contract.
Types of Indemnification Agreements
The type of indemnification agreement determines who contractually bears the financial risk of loss. In the following examples, assume you are a higher tier transferring risk to a lower tier.
Broad Form: You transfer all risk of loss described in the contract regardless of who is at fault. The lower tier is responsible for all damages, even if you are entirely at fault.
Intermediate: You transfer all risk of loss described in the contract, except when the loss is entirely your fault. Even if the lower tier is just one percent at fault, it is responsible for all damages.
Limited Form: The lower tier is obligated to reimburse you for its share of liability for loss described in the contract.
State Laws Affect Indemnification Agreements
Be aware that most states have anti-indemnity statutes that limit the enforceability of some indemnification agreements. An invalid agreement means you could retain risk you meant to transfer to another party. Consult your attorney to help you draft indemnity and choice of law provisions that contemplate the variations in state laws.
Hold Harmless Agreement: The party assuming the risk agrees not to attempt to recover any portion of damages from the other contracting party.
Additional Insured Endorsements: As stated above, if a court rules that your indemnification agreement is invalid, you could end up retaining risk you thought was transferred. An additional insured endorsement helps to fill this potential gap in your risk management strategy.
An insurance policy is a contract between your business and an insurance company. When an insurance company issues a liability policy, it agrees to pay those sums that you are legally obligated to pay as damages because of bodily injury and/or property damage covered by your policy. If a covered claim occurs, the insurance company will defend you and any other insured, pay the amount of any settlement or judgment up to the policy limit.
When you hire a contractor you should request the lower-tier contractor to add your business to its liability policy as an additional insured. The lower-tier’s insurance company will do this by adding an additional insured endorsement to the lower-tier’s policy. As an additional insured, you are protected by the lower-tier’s policy against liability for injury or damage caused by the work the lower-tier contractor does for you. The lower-tier’s policy will defend all insureds and will pay the amount of any settlement or judgment, up to its policy limits.
Requesting coverage as an additional insured on a primary basis means the lower-tier’s policy must respond first in the event of a covered claim. Your liability policy will respond on an excess basis and will pay only the amount of any judgment or settlement that exceeds the lower tier’s policy limits.
If the additional insured coverage being provided to you is on an excess basis, your own policy pays covered claims first. The additional insured endorsement under the sub-contractor’s policy then responds only after your policy limits are exhausted.
Higher-tier contractors should require lower-tier contractors to maintain adequate limits of insurance such as:
|$1,000,000||Each Occurance – Bodily Injury & Property Damage|
|2,000,000||General Aggregate that applies on a per project basis|
|2,000,000||Products/Completed Operations Aggregate|
|1,000,000||Personal and Advertising Injury|
In construction contracts, higher tiers state the length of time for which additional insured status is required. Long after the job is completed, contractors may be held liable for injury or damage caused by lower tier who did work for them. As a result, many higher tiers require additional insured coverage under the sub-contractor’s policies for the entire time of the statute of limitations based on the laws of jurisdiction that applies. Your attorney can advise you what to require in your construction contracts.
The additional insured forms you should request are: CG2010 (07/04) and CG2037 (07/04) or their equivalent. These forms should include coverages, for both on-going and completed operations. You then need to request and maintain on file certificates of insurance from all of your sub-contractors. You will also need to carefully examine the certificates of insurance you receive from sub-contractors and ensure that you are named as an additional insured. You should receive the certificate of insurance before allowing any sub-contractors to enter the job site or start work.
You also need to set up a system to track certificates. This allows you to be notified when your sub-contractor’s policies come up for renewal. Due to the fact the sub-contractor’s policies may expire during the term of the job contract, it is necessary to make sure your certificates of insurance are updated.
The fact that a contractor has inadequate or no insurance is a danger signal. It puts you at Great Risk.