Risk Management in the Construction Industry: 3 Concepts to Know

Risk Management in the Construction Industry

Photo Credit: Flinders University

Effective risk management in the construction industry requires businesses and non-lawyers to have a nuanced understanding of the legal framework related to loss shifting.  An understanding of the scope of indemnification obligations, the effectiveness of additional insured coverage, and the applicability of anti indemnity laws is vital to protect companies as they undertake new projects and as they transition away from existing projects.  Below are three concepts that, when understood well, can help companies draft better contracts, understand their risk better, and increase recoveries when claims are made. 

Indemnity Agreements in Construction Contracts

An indemnification provision is a risk-transfer tool that allows parties to a contract to allocate certain risks pertaining to losses on a project. Usually, indemnification provisions are one sided, and often, in practice, use terms like “upstream” and “downstream.” 

The “downstream” party is the party promising to indemnify the “indemnitee, the “upstream” party. In contrast, the “upstream” party is the party that should be protected from the loss based on the indemnity provided by the “downstream” party.  However, keep in mind, an indemnification agreement does not eliminate a party’s legal obligations as they relate to a loss, it only shifts the financial obligations related to the loss from the indemnitee to the indemnitor.

In construction agreements, the “upstream” party is usually the project owner or general contractor who hires a “downstream” party, usually a subcontractor. Risk managers must be aware of the presence of state law which at times negates indemnity agreements negotiated by the parties. 

Anti-indemnity Statutes

Anti-indemnity laws are creatures of state law and vary depending on jurisdiction. Generally, these statutes prohibit one party from absorbing the sole negligence of another. Anti-indemnity statutes are designed to limit the extent of indemnification that can be required by contract or agreement. Today, over 45 states have enacted anti-indemnity statutes 

Anti-indemnity statutes do not always ban the use of contractual indemnity agreements. Instead, some states mandate additional requirements for contracts in order to uphold contractual indemnity provisions. In these states, the contracts must include certain requirements, such as inclusion of the indemnity agreement within the bid documents, inclusion of a monetary limitation on the indemnity provision, or inclusion of a requirement to procure insurance to support the indemnity obligation.

Additional Insured Coverage  

Proper risk management requires a belt-and-suspenders approach. Contractual provisions alone are insufficient. Instead, additional contractual provisions requiring parties to procure additional insured coverage is standard practice today in the construction industry. Insurance coverage requirements assure that the other party to the contract has sufficient funds to fulfill its indemnification promises. Special care must be taken when writing the contract to ensure that the insurance provisions and indemnity provisions are not written such that the provisions could be interpreted to violated anti indemnity statutes or negate insurance coverage for a loss. Some courts refuse to enforce insurance provisions that are inextricably linked to the indemnity requirement because of applicable anti-indemnity statute.

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