• Developing Trends in Shifting Contractual Risk: States Restrict Indemnification Provisions
  • March 31, 2008 | Authors: Jessica L. Anders; Raymond L. DeLuca
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • Contractual indemnity clauses that release a party from liability and push the risk to another are widespread as contractors are willing to accept the burden to land a job. While it has become the norm for those in the construction industry to encounter indemnity provisions in their contracts, several state legislatures have taken on the task of limiting a party’s ability to transfer the risks inherent in construction projects to another party.

    In indemnity provisions, one party, the indemnitor, agrees to protect and hold harmless the other party, the indemnitee, from liability arising from personal injury, property damage on the job or other risks associated with the project. Essentially, these provisions shift the risk of liability from a negligent party, the indemnitee, to an innocent party, the indemnitor. Accordingly, indemnity clauses have been criticized as being inequitable. Are these risk-shifting clauses becoming a thing of the past?

    A party’s ability to enter into an indemnification or hold harmless agreement on a construction project has been severely reduced or altogether eliminated due to anti-indemnification statutes. Additionally, legislatures are examining the effect that additional insured provisions may have on a party’s contractual indemnity obligations. Many states, reacting to lobbying pressure from contractors and subcontractors, have enacted statutes that restrict, modify or even invalidate standard indemnification agreements contained in construction contracts.

    Generally, three types of express contractual indemnity provisions are found in contracts – broad, intermediate and narrow or limited forms. In the broad form agreements, a party would indemnify another against the other party’s sole negligence. Intermediate clauses are a compromise where the indemnitee is usually only indemnified for acts of passive, as opposed to active negligence. Often in these situations, the indemnitee’s own negligence is not addressed. Narrow contractual provisions are essentially comparative fault schemes. In these narrow clauses, the indemnitor agrees to indemnify the indemnitee only to the extent of the indemnitor’s own negligence.

    The majority of states that have passed anti-indemnity statutes have focused on prohibiting and invalidating broad clauses – those that purport to indemnify the indemnitee for losses resulting from the indemnitee’s sole negligence or willful misconduct. The trend for state legislatures is to have a fair and equitable distribution of risks on a construction project rather than force a smaller contractor or subcontractor to be responsible for the sole negligence of another party with more bargaining power on a large project.

    While the majority of states have at least minimally addressed limiting contractual indemnification, most recently Oklahoma, Colorado and Georgia have shown legislative movement tracking the recent trend to limit contractual ability to shift construction risk. The statutes passed in these three states speak to the larger national trend.

    Oklahoma – Following the National Trend to Bar Sole Negligence Indemnification

    Until November 1, 2006, Oklahoma law did not address the issue of contractual indemnification in construction contracts. Following the most popular legislative trend in anti-indemnity law, the government passed Senate Bill 324 that prohibits sole negligence indemnity and additional insured requirements in construction contracts from indemnifying parties against damages arising out of their own negligence or fault. See 15 Okl. St. § 221.

    The new Oklahoma statute, which is typical of many state statutes barring indemnification for a party’s sole negligence, states in part that:

    “Any provision in a construction agreement that requires an entity or that entity’s surety or insurer to indemnify, insure, defend or hold harmless another entity against liability for damage arising out of death or bodily injury to persons, or damage to property, which arises out of the negligence or fault of the indemnitee, its agents, representatives, subcontractors, or suppliers, is void and unenforceable as against public policy.”

    This drastic change in Oklahoma indemnity law means that those working on construction projects are not held liable for the mistakes of others due to insurance requirements or contractual clauses.

    Colorado – A Focus on Public Policy in New Anti-Indemnity Laws

    Following the trend of passing legislation that prevents a party from contractually indemnifying another for damage or injury caused by its own negligence, sweeping changes have recently occurred in Colorado. On July 1, 2007, an indemnity reform bill, C.R.S. § 13-21-111, went into effect that invalidates broad and intermediate forms of indemnity agreements.

    Focusing on the equitable aspects of anti-indemnity provisions, the Colorado General Assembly states in the bill, “It is in the best interests of this state and its citizens and consumers to ensure that every construction business in the state is financially responsible under the tort liability system for losses that a business has caused.” C.R.S. § 13-21-111.5(6)(a)(1). The equitable considerations behind the Colorado anti-indemnity law embody the general movement by legislatures to attempt to properly apportion risk to those who actually cause the harm.

    Georgia – Modifying the Law to Close Additional Insured Loopholes

    The standard for risk transfer and the interaction with additional insured provisions in Georgia was far from clear before the enactment of House Bill 136. The new legislation, effective July 1, 2007, amends Georgia Code §13-8-2 by expanding state restrictions against broad form indemnification clauses to now include additional insured requirements. This new law closes a judicially created loophole in Georgia’s indemnity statutes.

    Georgia’s indemnification statute invalidates broad form indemnity clauses that require one party to indemnify another for all claims arising out of a party’s sole negligence. However, Georgia appellate courts created an exception that permitted parties to circumvent the anti-indemnity laws through contractual requirements. The courts found that when a broad form indemnity statute was coupled with a contractual obligation for an indemnitor to provide insurance coverage that the indemnification statute did not apply, making the clause enforceable. The newly drafted law closes this loophole so that the statute is in line with public policy – to make broad form indemnity clauses void and unenforceable despite any additional insurance coverage provisions.

    These three states are among the most recent to modify a party’s ability to contractually allocate construction risk in a project. However, owners, architects and contractors alike should be aware that no uniform standard exists among state indemnity statutes.

    While the legislative trend is to create a more equitable landscape in the distribution of risks by eliminating both indemnification clauses that permit sole negligence indemnification and by closing additional insured loopholes, the law is in flux. While a contractor or subcontractor may be willing to accept a harsh indemnity provision to secure a job, increasingly those clauses are not legally enforceable due to anti-indemnity statutes. Accordingly, it is important to stay informed of legislative developments and trends that change a party’s ability to contractually allocate construction risk as what is permissible changes almost every year.