INSURANCE AND INDEMNIFICATION WHAT YOU DON T KNOW CAN COST YOU

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1 STRUCTURAL ENGINEERS ASSOCIATION OF OKLAHOMA INSURANCE AND INDEMNIFICATION WHAT YOU DON T KNOW CAN COST YOU Gail S. Kelley, P.E., Esq., LEED AP October 27, 2017 The Design Agreement Establishes each party s obligations: the scope and schedule for the services the standard that the services must meet the amount of compensation /when and how it is to be made Establishes each party's rights if the other party does not comply with its contractual obligations Allocates the risk of loss, including loss that is beyond either party's control 2 The Two Most Common Means of Allocating Risk: Contractual Indemnification Clauses Insurance Other Contract Terms for Risk Allocation: Warranties Limitations of Liability Waiver of Consequential Damages Liquidated Damages Assumption of Risk Termination for Convenience Right to Suspend Services Pay if Paid / Pay when Paid 3 1

2 Contract law (the law that courts use to interpret contracts) is almost exclusively state law. The courts of one state may interpret the wording of a particular provision completely different from another state. While there are both state and federal laws (statutes) that apply to contracts, contract interpretation is primarily common law. Common law means the law that has developed from previous judicial decisions (case law) as opposed to laws passed by the legislature. Because disputes related to design agreements are often either arbitrated or settled before they go to trial, there may be no case law on a particular issue. The court may look to decisions involving similar types of contracts or decisions of other states. However the decisions of other states are not controlling. 4 Most design agreements include a Governing Law provision. When the Client has properties or projects in several states, it will typically want all of its design agreements to be governed by the law of the state in which it has its headquarters. For example: This Agreement shall be governed by the laws of New Jersey, without reference to its choice of laws provision. However, twenty two states, including Oklahoma, have laws that override the choice of law specified in a contract related to a construction project. Most of these laws also specify that provisions which require litigation or arbitration to be conducted in another state are void as against public policy Unenforceable contract provisions. A. This act shall not apply to any contract relating to a single-, two-, three-, or four-family dwelling. B. The following are against this state s public policy and are void and unenforceable: 1. A provision, covenant, clause or understanding in, collateral to or affecting a construction contract that makes the contract subject to the laws of another state or that requires any litigation, arbitration or other dispute resolution proceeding arising from the contract to be conducted in another state; and 2. A provision, covenant, clause or understanding in, collateral to or affecting a construction contract that disallows or alters the rights of any contractor or subcontractor to receive and enforce any and all rights under this act. 6 2

3 State Statute Arizona Ariz. Rev. Stat Colorado Colo. Rev. Stat (6)(g) Connecticut Conn. Gen. Stat. Ann m Illinois 815 ILCS 665/10 Indiana Ind. Code Kansas Kan. Stat. Ann (e) Louisiana La. Rev. Stat. 9:2779 Minnesota Minn. Stat Montana Mont. Code (1) Nebraska Neb. Rev. Stat Nevada Nev. Rev. Stat. Ann (2) New Mexico N. M. Stat. Ann A-1 N.Y. Gen. Bus. Law, Chapter 35-E, New York 757 North Carolina N.C. Gen. Stat. 22B-2 Ohio Ohio Rev. Code (D) Oklahoma Ok. Stat. Ann. tit. 15, Oregon Or. Rev. Stat Pa. Stat Ann. 514 (only applies to Pennsylvania payment disputes) Rhode Island R.I. Gen. Laws (a) Tennessee Tenn. Code (a) Texas Tex. Bus. & Com. Code Ann Wisconsin Wis. Stat (2) 7 8 To indemnify someone means to agree to financially protect them if they are held vicariously liable for claims that you are responsible for either by directly paying costs they are liable for, or by reimbursing them for the costs they have incurred. Under a typical indemnification clause, one party (the Indemnitor) agrees to financially protect the other party or parties (the Indemnitee or Indemnitees) if the Indemnitee(s) are held vicariously liable for claims that are caused by the Indemnitor's negligence. 9 3

4 Even without a contractual indemnification clause, there is a common law (implied) right of indemnification if one party is held vicariously liable for damage caused by another party. For example, an employer can be held vicariously liable for the wrongdoing of his employee, a principal can be held responsible for the actions of its agent, and the owner of a vehicle can be held liable for damage caused by a driver. The party held liable would have the right to seek indemnification from the party that actually caused the damage. Under the common law, the party that caused the damage would only be liable to the extent they caused the damage. 10 A party seeking common law indemnification must prove entitlement however. Some states require the party seeking indemnification to be completely blameless or only be passively negligent. As a result, most design agreements explicitly require that the Engineer indemnify the Owner for claims arising from the Engineer s negligence. The requirement for indemnification is not unreasonable the Owner is likely to be held vicariously liable for injuries or damage caused the Engineer s negligence. 11 While it is not unreasonable for the Owner to require indemnification from the Engineer if the Engineer is negligent, owners sometimes try to obtain the protection they are seeking with language that is completely inappropriate. In other cases, the Owner may try to shift risk that is beyond the control of the Engineer or that extends beyond negligence based liability. In such cases, the Owner may be requiring an indemnification obligation that will not be covered by insurance. 12 4

5 13 Most design agreements include an insurance article that lists the policies the Engineer is required to carry and the required policy limits. The policies typically required are: Commercial General Liability (CGL) Commercial Automobile Liability Workers Compensation / Employers Liability Professional Liability Insurance (PLI) 14 In many design agreements, the insurance and indemnification obligations are in the same article, which can create confusion. The agreement may further confuse the issue by requiring that the Indemnitees (the parties being indemnified) be listed as "additional insureds" on some of the Engineer's insurance policies. Alternatively, the indemnification clause may require the Engineer to indemnify everyone who is listed in the Insurance section as an Additional Insured. BUT THE INDEMNIFICATION AND INSURANCE OBLIGATIONS ARE COMPLETELY UNRELATED While both insurance and indemnification provide financial protection to the covered individuals, it is important to understand the difference between the obligations. 15 5

6 The indemnification obligation is between the Engineer and its Client: If the Engineer agrees to indemnify the Client for claims that are not covered by insurance, the Engineer will be responsible for the claims itself. As an example, PLI only covers claims to the extent they are caused by the Engineer's negligence. If the Engineer agrees to indemnify the Client for any and all claims arising from its services," and the claim was partly caused by the Client, the Contractor or a third party, the Engineer could nevertheless be held liable for the entire claim. The portion of the claim that was not caused by the Engineer's negligence would not be covered by PLI. 16 One reason that indemnification clauses in design agreements are inappropriately worded is that many design contracts are based on the AIA agreements. Historically, the AIA agreements have not included an obligation for the designer to indemnify the owner. As a result, owners who want to require indemnification from the design professional often just copy the indemnification provision from the construction contract. There are significant differences between what is covered by a contractor s insurance and what is covered by a design professional s insurance, however. Thus the indemnification requirement in a typical construction contract is not appropriate for a design agreement. 17 The standard Insurance Services Office (ISO) form that is used for CGL does not exclude professional services. But virtually all (probably all) GCL policies are written with an endorsement (amendment) that explicitly excludes coverage for claims arising from professional services. If the Engineer is doing work on site for example a condition assessment and there is an allegation of injury or property damage due to the Engineer s negligence, the Client will likely file a claim under both the Engineer s CGL and its PLI and let the insurance carriers work out the coverage. However, unless the Client is working on site, claims are likely to be PLI claims. 18 6

7 Professional liability insurance: Coverage is only granted to the extent the claim was caused by the insured's negligent acts, errors or omissions in the rendering or failing to render professional services. Contractual assumption of liability is excluded, except for liability that would have attached in the absence of the contract. (in other words, the common law indemnification requirement) In the absence of a contract stating otherwise, the Engineer would only be liable for a claim to the extent the claim was caused by its negligence. Defense of an indemnified party is not covered. 19 The liabilities that a Contractor is required to provide indemnification for are generally covered under its Commercial General Liability (CGL) policy. CGL policies provide much broader coverage than professional liability policies for liabilities assumed under a contract such as warranties. The CGL policy will generally cover the entire claim even if the contractor is only partially responsible. The Contractor's CGL policy will include defense of claims against those it has agreed to indemnify. Defense of indemnified parties is not covered under a professional liability policy 20 Even beyond the issue that the indemnification clause may be based on language written for contractors is the reality that some Owners simply want to transfer as much risk as they can to other parties, rather than allocating the risk fairly. The following is an example of a clause that allocates the risk unfairly and creates uninsurable risk for the Engineer: The Engineer shall indemnify, defend and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, that occurred in whole or in part, as a result of the Engineer s acts, errors or omissions. 21 7

8 The Engineer shall indemnify, defend and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, that occurred in whole or in part, as a result of the Engineer s acts, errors or omissions. Delete the word "defend". This is the most significant issue with this clause. While professional liability insurance covers defense when a claim is filed against the insured, it does not cover defense of an indemnified party. An agreement to defend an indemnitee means the Engineer will be paying the costs of defense from the moment a claim is made, even if it is ultimately determined that the Engineer was not negligent. There is no common law duty to defend. Thus, the Engineer will be agreeing to liability that goes beyond liability that would have attached in the absence of the contract. 22 Engineer shall indemnify and hold harmless the Client, the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, that occurred in whole or in part, as a result of the Engineer s negligent acts, errors or omissions. Insert negligent before acts, errors or omissions. The indemnification obligation is only insurable to the extent the claim is based on the Engineer s negligence. 23 Engineer shall indemnify and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, that occurred, in whole or in part, as a result of to the extent caused by the Engineer s negligent acts, errors or omissions. Replace that occurred in whole or in part, as a result of with to the extent caused by. The words "in whole or in part" can make the Engineer liable for the entire amount of the claim, even if it was only partly responsible. Professional liability insurance policy only covers the insured for its share of the liability. 24 8

9 Engineer shall indemnify and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, to the extent caused by the Engineer s negligent acts, errors or omissions. Delete any and all. The wording any and all implies indemnification of claims that may not relate to negligence. 25 Engineer shall indemnify and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against liability and expenses including, but not limited to, reasonable attorney s fees where recoverable under state law, to the extent caused by the Engineer s negligent acts, errors or omissions. Insert "reasonable" in front of attorneys' fees Insert "where recoverable under state law after attorney s fees. Not all states allow a plaintiff to recover its legal costs in a negligence claim as a matter of law. Attorney's fees will generally not be covered under a professional liability policy unless entitlement is provided by state law. 26 Engineer shall indemnify and hold harmless the Client, the Client s employees, directors, officers, agents, representatives, and lenders from and against liability and expenses including, but not limited to, reasonable attorney s fees where recoverable under state law, to the extent caused by the Engineer s negligent acts, errors or omissions. Delete "agents, representatives". The terms "agents" and "representatives" are extremely broad. The Client should identify the specific entities it wants indemnified by either name or function. Do not agree to indemnify the Client s consultants or contractors they cannot be held vicariously liable for your negligence so they do not need to be indemnified 27 9

10 Engineer shall indemnify and hold harmless the Client, and the Client s employees, directors, officers, and lenders from and against liability and expenses arising from third party claims including, but not limited to, reasonable attorney s fees where recoverable under state law, to the extent caused by the Engineer s negligent acts, errors or omissions. Insert the words arising from third party claims after expenses. This is to clarify that the indemnification obligation only applies to claims brought against the Client; it does not apply to contract claims. 28 Original wording: Engineer shall indemnify, defend and hold harmless the Client, and the Client s employees, directors, officers, agents, representatives, and lenders from and against any and all liability and expenses including, but not limited to, attorney s fees, that occurred in whole or in part, as a result of the Engineer s acts, errors or omissions. Suggested wording: Engineer shall indemnify and hold harmless the Client, and the Client s employees, officers, directors and lenders from and against liabilities and expenses arising from third party claims, including but not limited to reasonable attorney s fees where recoverable under state law, but only to the extent caused by Engineer s negligent acts, errors or omissions or willful misconduct

11 In most design agreements, the indemnification is one sided, providing protection only to the Client: Engineer shall indemnify and hold harmless the Client, and the Client s employees, directors, officers, and lenders... Some of the industry standard design agreements, particularly subcontract agreements, contain a mutual indemnification clause. The clauses may be worded identically such that each party assumes the same obligation to the other party. The clauses may also be worded differently to reflect the parties' relationship. Often the Client or Prime Consultant will assume a more limited indemnification obligation. Examples of agreements with mutual indemnification clauses: AIA C401, ConsensusDocs 240 and ConsensusDocs 420, EJCDC Mutual indemnification clauses tend to be rare, however, particularly in contracts that have been drafted by the client. Engineers usually need to negotiate for indemnification. While a general indemnification against claims arising from the client's negligence may not be necessary, an Engineer should require indemnification against certain risks. These can include: Misuse of the Instruments of Service Hazardous Materials Existing Conditions Liability that must be assumed under an Access Agreement 32 Some design agreements are written such that the engineer grants the Owner a non exclusive license to use the work product. Other design agreements are written such that the Owner obtains the copyright to the work product upon payment for the Engineer s services. In either case, the Owner will often want to be able to use the plans and specifications for maintaining, altering, or adding on to the Project. Some Owners want to be able to use the documents on other projects. It is a good idea to require the Owner to indemnify and defend the Engineer against claims arising from use of the drawings on other projects or changes made to the drawings by others

12 The wording of such clauses may depend on the scope of work, but commonly used clauses include: The Owner agrees to indemnify, defend, and hold Engineer harmless from any claims arising from changes made to the documents by others or from Owner s use of the Instruments of Service on any other project without engagement of the Engineer. The Owner agrees to indemnify, defend, and hold Engineer harmless from any claims arising from Owner s use of the Instruments of Service for any purpose other than the purpose they were prepared for under this agreement. The Owner agrees to indemnify, defend, and hold Engineer harmless from any claims arising from changes made to the Instruments of Service by others. 34 Many contracts make the Engineer liable for claims arising from hazardous materials brought onto the site by the Engineer unless the Engineer was acting under the specific direction of the Owner. However, the Engineer should not be liable for claims arising from hazardous materials already existing on the site or brought onto the site by others, unless the Engineer has exacerbated the situation through its negligence. When hazardous materials are a concern, the Engineer may want to require that the contract includes a clause similar to the following: The Owner agrees to indemnify, defend, and hold Engineer harmless from any claims arising from hazardous materials existing on the site or brought onto the site by others, except to the extent the Engineer has exacerbate the situation by its negligent acts, errors, or omissions. 35 When the project involves renovation of an existing structure or the subsurface conditions are unknown, it may be advisable to require the Owner to provide a general indemnification against claims arising from existing site conditions, except to the extent the Engineer has exacerbated the situation through its negligence. The Engineer s liability should be limited to its negligence; the Owner should bear the risk of existing site conditions

13 Engineers who do site investigations will sometimes need to enter onto a third party's property; this is particularly true of engineers who do geotechnical investigations. Often, the property owner will want the Engineer to sign an Access Agreement that requires the Engineer to indemnify the property owner from any claims arising from the investigation as well as assume the risk of any damage to the property, regardless of whether the Engineer is negligent. This is not unreasonable, as the property owner should not be expected to bear these costs, however, the Engineer's liability for this work should not be greater than its liability under its contract with its Client. 37 But to be covered by professional liability insurance, the Engineer's indemnification obligations should be limited to the extent caused by the Engineer's negligence; when an Engineer anticipates having to enter onto another party's property in order to perform the work required by the design agreement, it should consider including a clause such as the following in the design agreement. If the Engineer is required to sign an Access Agreement to enter onto the property of a third party, Client shall indemnify, defend, and hold the Engineer harmless from any claims arising from its work on the third party's property, except to the extent caused by the Engineer's negligent acts, errors or omissions. 38 Under California law, an agreement to indemnify a claim arising from a design or construction project includes a duty to defend, unless there is an explicit disclaimer. If the parties have agreed that the design agreement will be governed by California law, indemnification clauses should be qualified by the addition of a sentence such as: "The obligation to indemnify shall not extend to the defense of professional liability claims. While California SB 496 (which will take effect on Jan 1, 2018) has made some changes related to an Engineer s indemnification obligations under California Civil Code , engineers may still responsible for an upfront duty to defend unless expressly disclaimed

14 Disclaimer: This information in this presentation is not legal advice and cannot be relied upon as such. Any suggested changes in wording of contract clauses, and any other information provided herein is for general educational purposes to assist in identifying potential issues concerning the insurability of certain identified risks that may result from the allocation of risks under the contractual agreement and to identify potential contract language that could minimize overall risk. Advice from legal counsel familiar with the laws of the state applicable to the contract should be sought for drafting final contract language. This presentation is not intended to provide an exhaustive review of risk and insurance issues