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@example.com.