Generally, no one ever calls me on a good day for their business. As a result, I find myself frequently advising business owners on how to create indemnification clauses to avoid ever needing to be in the same room with me.
Not a month goes by where I don’t find myself reviewing a newly filed lawsuit or demand and lamenting the absence of some simple measures a client might have taken to ensure they were protected from the time and expense associated with litigation. I’ll review their contracts and often I’ll find good language requiring their subcontractor to defend and indemnify them and to ensure they have insurance requiring they be added as an additional insured.
Unfortunately — and equally as frequently — I’ll find that the subcontractor did not add them as an additional insured or did so improperly. Then comes the unfortunate phone call with the client to inform them that their indemnification and defense clause, while well written, likely won’t get them out of the lawsuit.
Luckily, the remedy to this problem isn’t difficult and simply requires the installation and observation of a few common-sense best practices. Indemnification and defense clauses aren’t “set it and forget it” — and taking a few extra steps can mean the difference between intrusive and costly litigation and a simple tender process and assumption of defense by your subcontractor’s insurance company.
Simply put, an indemnification and defense clause serve the same purpose as any contract clause: to provide certainty to the signing parties as to the duties and responsibilities for each. More specifically, the purpose of an indemnification and defense clause is to ensure that if a subcontractor exposes the general contractor or property owner to liability due to their negligence, that contractor will defend the other party in a suit, indemnify them for any financial losses and hold them harmless — not seeking remuneration for any of the preceding payments.
Now, in practice, many contractors, if not most, are not sufficiently capitalized to bear the expense of multiyear, multiparty litigation out of their own pocket. As a result, the agreement to such a clause is only as good as the contractor’s ability to pay. Therefore, most well-written clauses contain requirements for the contractor to obtain sufficient insurance and to ensure the other party is added as an additional insured to their policy. But these clauses are only worth their writing if they are actually followed.
Why Indemnification Clauses Often Fail
One of my favorite legal quotations comes from the classic film, “A Few Good Men”: “It’s the difference between paper law and trial law.” On paper, the indemnification clause may be well written, but if the requirements of the clause are not followed, then practically, they have little value.
Consider the following example. Acme Propane contracts with Delta Construction to service some of its propane lines. As a result of Delta’s negligence, an accident occurs and a home fire starts, resulting in property damage and bodily injury. The homeowner’s insurance and the injured family sue both Delta and Acme. Acme, relying on its indemnification clause, tenders the defense of the action to Delta and its insurance carrier. They come to find that Delta never added Acme as an additional insured and the carrier denies the tender. Acme’s lawyer calls Delta’s and maintains that despite the lack of insurance, Delta still has an independent requirement to indemnify Acme. Delta’s lawyer acknowledges this, but notes that Delta is a small business, a single-member LLC with three employees and no appreciable assets. Acme can assert its contract rights all it wants, but Delta doesn’t have the meaningful ability to pay a lawyer out of its own pocket to defend Acme, much less the cost of experts or the costs of any judgment. Acme, practically, now has no choice but to incur these expenses itself.
Another legal aphorism I find helpful when explaining the law to nonlawyers is that in the world of contract law, there isn’t right and wrong — there’s performance and the cost of breach. Most of the time indemnification clauses contain no specific penalties for the contractor if it fails to procure the required insurance. But again, even if it did, we return to the difference between paper law and trial law.
Consider, again, the previous example between Delta and Acme. Imagine the contract between the two contained a clause noting that if Delta failed to procure the required insurance, adding Acme as an additional insured, and litigation resulted, Delta would owe Acme $50,000 as a penalty. Practically, Delta has no ability to pay this penalty, and it would likely simply result in the dissolution of the LLC. Moreover, it does nothing for Acme in the litigation it faces as a result of Delta’s negligence.
While there are certainly other significant reasons such clauses fail (e.g. poor draftsmanship or jurisdictional requirements) to result in a successful acceptance of a tender of defense, common sense practices can ensure businesses get the most out of their well drafted contractual defense and indemnification provisions.
Best Practices for Compliance
Given the preceding, breach penalties are not particularly helpful as a remedy. In my experience, as well, most of the time when indemnification clauses fail, it is the result of honest oversight by the contractor. Thus, the remedy to such problems is not more severe breach penalties, but the installation of best practices and proper workflow tasks to ensure the provisions are followed.
Now, in many cases where I am hired to pursue a tender to a hired contractor, I am provided a certificate of insurance from the contractor. However, this certificate almost always notes that it is not a controlling insurance document and frequently, even in cases where a certificate of insurance (COI) is on file, the actual policy itself fails to provide coverage. Prudent hiring companies ought to include in their workflow (and contract language) the requirement for the indemnifying contractor to provide them with an actual copy of the policy showing the addition of the hiring party as an additional insured before work begins. From this document, the hiring party can verify it has been added and that all required coverages (e.g., errors and omissions, completed operations, etc.) are present.
An additional, and unfortunately frequent, cause of tender denials is the lapse of coverage. This can occur due to a payment oversight, or often as a result of a project that takes longer than the stated policy period on the COI. There are many cases where a COI was obtained prior to the project beginning, but the project lasts longer than the policy period on the COI, and the policy was not renewed or was transferred to a new insurer by an agent who did not add the hiring contractor as an additional insured. Prudent hiring contractors ought to verify the payment schedule of premiums by their contractor and should consistently verify during the project (or projects) that the premiums are being paid and the policy has not lapsed. Moreover, they should ensure their contractor informs them if insurance changes and make sure they obtain a copy of any new policies. These practices, taken together, can eliminate the sources of many tender denials.
The Value of Proactive Measures
While the above remedies may seem tedious, in practice they amount to a few extra minutes of phone calls and emails for a given project. When the alternative is expensive and time-consuming litigation, they are the definition of an ounce of prevention being worth a pound of cure. While there are certainly many additional considerations for such clauses (e.g., quality of draftsmanship, limits and coverages required, and jurisdictional considerations), simple steps can make such clauses effective and valuable. Working with your legal team, prudent businesses should establish workflows to:
- Ensure contractors provide up-to-date copies of certificates of insurance and policies containing the required limits and provisions
- Verify coverage details for all contract requirements
- Monitor premium payments and ensure the policy remains active
- Require and follow up on notifications of insurance company changes, policy amendments or cancellations
A single avoided lawsuit will pay for such measures a hundred-fold. In conclusion, indemnification and defense clauses are not “set it and forget it.” They are as valuable as almost any clause in a contract when it comes to party expectations and avoiding increased costs. With a few simple steps, they can give the parties the peace of mind they expect at the time of signing — and beyond
