Indemnification can be a company’s best
protector, depending on how well it is
thought out and drafted. Here’s where an insurance specialist comes in as an advocate to both identify risk and keep liability
at bay through the tricky language of your
project’s contract.
“One of an account manager’s or agent’s
objectives should be to act as the client’s
outsourced risk manager when entering
into contract negotiations,” says Franz
Wagner, vice president of The Graham
Company in Philadelphia.
Smart Business asked Wagner about
gaining greater protection from your next
contractual venture.
What is indemnification?
Indemnification is a way to transfer the
risks associated with a particular project
from one party to another. For example, in
a construction contract the owner of the
project hires a general contractor to be
responsible for all of the construction to be
performed. In exchange for paying a general contractor agreed upon fees, the
owner will almost always require the general contractor to indemnify and hold the
owner harmless for accidents or many
other things that could go wrong during the
project. The general contractor then passes on this contractual liability exposure to
its prime contractors, and it then works its
way through the various subcontracts to
the lowest tier subcontractors.
It is very important to understand the
level of risk you are accepting when entering into a contract. A clear understanding
of this level of risk provides you the information needed to make appropriate decisions as to whether or not to move forward
on a particular job or to pass if the risks
aren’t worth the potential financial gain.
Who should think about indemnification?
It really crosses all industries. For construction and real estate clients, indemnification is probably more prevalent and we
spend more time dealing with it for these
classes of business. However, for any business, the indemnity language can have a
high financial impact in the event of a large
loss, so the principals of these businesses recognize the importance of understanding
the risk they are accepting (or passing on
to others) in each contract.
Are there different types of indemnification in
a contract?
There are really three forms of indemnification. There’s the limited form, where the
indemnifying party is only responsible for
their own negligence; then there’s the intermediate form, where the indemnifying
party finds themselves having to take on
the obligations of the owner for the
owner’s partial negligence; and then there’s
broad form, where the indemnification
obligation extends to include the owner’s
full and sole negligence. If we are working
with a subcontractor (indemnifying party),
we always try to avoid the broad form, and
while the intermediate form is not as harsh,
we would still suggest paring it down to the
limited form agreement, if possible. The
objective is to avoid taking on the negligence of another party if you can.
What does an agent look for in the contract
language?
When we look at a contract for a customer, we focus on two things — the
indemnification provisions and the insurance requirements.
When we look at an indemnification
clause, we would first advise on the form
of agreement and offer suggestions to
modify our client’s indemnity obligations
to the extent of their negligence only. In
addition to this, we also want to be sure
that the indemnification provision does not
extend beyond things that are insurable. To
simplify it, we normally look to recommend that the indemnification be limited to
bodily injury and property damage —
because those are the things that a customer’s general liability policy would typically respond to.
We also try to limit clients’ exposure to
direct losses only as opposed to consequential or indirect type losses. For example, suppose a contractor accidentally severs a power line in the course of his work.
Not only is he responsible for the damaged
line, but potentially the consequential damages of utility users downstream associated with plant shut downs, equipment damage and lost revenues. While a client may
have insurance coverage for this exposure,
we would try to limit any indemnity obligations for consequential damages, as this is
a difficult exposure to quantify.
And what about insurance requirements?
The other key component of reviewing
our client’s contracts is to make sure they
meet all the insurance requirements. We
negotiate broad terms and conditions so
that, in most cases, we have the appropriate coverage necessary for that owner.
Sometimes the contracts ask for additional
coverages that our client may not have,
such as professional liability or pollution
liability limits.
Any other advice?
Yes — make sure that you don’t allow
anyone to begin work until the contracts
are signed and accepted. Until the contract
is signed, the contractual provisions you’ve
set up to protect yourself cannot be triggered.
FRANZ WAGNER is vice president of The Graham Company.
Reach him at (215) 701-5278 or [email protected].
