Developers rushing to get projects off the ground can face significant risks without developing clearly defined indemnity clauses at the outset.
Indemnity clauses, included in virtually all construction contracts, are part of the risk allocation scheme between owners, contractors and design professionals, and are a critical component of any construction project.
At their most basic, an indemnitor agrees to pay for or reimburse an indemnitee in the event that a specific accident or loss occurs. But this "basic" agreement doesn’t match the complexities that most projects require.
The degree of project risk, and the relative willingness of the involved parties to share it, means that indemnity clauses need to be tailored individually.
But despite their importance, contracting parties often attempting to close the deal prior to the start of work "negotiate" an indemnity clause without first agreeing on specific terms. As a result, parties often agree on boilerplate contract language without fully understanding either the agreement in general or the clause in particular. By understanding three frequently used types of indemnity clauses, builders, owners, and design professionals can draft more precise contracts to protect themselves from unwanted risk.
The Purpose of an Indemnity Clause
Should a contract dispute move towards legal action, "intent" becomes the key word in indemnity agreements and should be addressed early. The California Supreme Court stated in a 1975 case that "… 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" (emphasis added). Thus, starting the process by tweaking an existing boilerplate indemnity clause without ever defining the full indemnity terms will often result in contract language that does not express the parties’ intent and may result in unexpected or unintended consequences.
A useful starting point for defining the intent of an indemnity agreement is to review the following "types" of indemnity clauses, which were created by the California judiciary and since adopted by many other jurisdictions. These three different types of clauses allow the involved parties to take on varying degrees of risk.
Three Types of Indemnity Clauses
- The first type states that the indemnitor, even if they are in no way negligent for the accident or loss, will be fully responsible to reimburse the indemnitee. However, many states, including California, Maryland, and Washington bar indemnification for the sole negligence or willful misconduct of the indemnitee.
- The second states that the indemnitor will be responsible for reimbursing the other party for their own negligence and for any passive negligence by the indemnitee. The indemnitor is not responsible for active negligence by the indemnitee.
- Finally, the third states that the indemnitor will only reimburse the indemnitee for the portion of liability caused by the indemnitor’s own negligence.
Selecting a clause for a particular project depends on the relative bargaining position of the parties, the level of risks on a project, the financial strength of the parties, statutory restrictions, and a potential indemnitor’s ability to control risks.
For example, the first form of indemnity is more likely when the indemnitee is in the better bargaining position and a party may be willing to accept the first type of clause if it can control the risk through safe operations and adequate insurance. When the parties bargaining power is more equal, they are likely to use the second or third type of clause.
Crafting an Indemnity Clause that Conforms to the Parties’ Intent
Once parties reach an agreement on the intent of an indemnity agreement, it is important to ensure that the language of the agreement conforms to that intent. Failing to do so can lead a court to divine its own intent from the clause and other circumstances.
The best method of ensuring that the indemnity clause conforms to the parties’ intent is to discuss any specific areas of concern and then draft a clause that specifically addresses each aspect of the parties’ agreement.
When drafting indemnity clauses, the biggest mistake a contracting party can make is failing to document the parameters of a comprehensive agreement with clear intent.
At the very least, parties should determine the "type" of indemnity clause that best suits their needs; decide if the agreement should allow indemnity in the absence of fault; decide if the indemnitee is entitled to a defense and the requirements of such a defense; and ensure that the express language of the indemnity clause fully reflects the parties’ intent. Doing so early will minimize problems later.
(Tim Pierce is a partner in the Los Angeles office of K&L Gates LLP where his practice focuses on legal matters in the construction industry. He can be reached at Timothy.Pierce@klgates.com.)