Every commercial property owner, developer, general contractor, subcontractor, and vendor should understand the concept of contractual risk transfer and how it might affect its company and projects.
Contractual Risk Transfer Defined
With any kind of commercial property development, the parties involved face risk. Whether you’re the owner, general contractor, or some other entity involved in the project, there’s always the risk that accidents, injuries, damages, negligence, bad weather, or some other act of God could lead to increased costs and liability exposure. Often, insurance covers these risks. But contractual risk transfer serves as another useful tool that can protect you and the project.
Contractual risk transfer is the use of contractual obligations to pass on a potential risk to another party. The transfer can be done with indemnity and exculpatory agreements, waivers of subrogation, and contractual requirements to obtain insurance coverage for specific risks.
The objective is to transfer the risk of injury or property damage to the party that has the best ability to prevent the injury or damage. For example, a general contractor might be vicariously liable for any damage or injury caused by its subcontractors. Through contractual risk transfer, the general contractor transfers the risk to the entity with the ability to control the cause of the incident, the subcontractor.
Common Contractual Tools Used to Transfer Risk
There are specific contractual tools used to transfer risk. It’s good to understand these tools and have a general understanding of their purpose:
- Indemnification Agreement: These are more commonly referred to as “hold harmless agreements.” A hold harmless clause or agreement is where one party contractually assumes the liability of another. The indemnification can be broad or very specific depending upon what the parties require. For example, a subcontractor will agree to indemnify the general contractor and commercial property owner for any damages caused by the subcontractor’s actions.1
- Waiver of Subrogation: The right of subrogation is when an insurance company can step into the shoes of its insured after paying out damages on a claim and seek to recover what it paid from the third party that caused the loss. If you are, for example, a general contractor, it is to your advantage to require that your subcontractors’ insurance policies include waivers of subrogation in your favor so that the subcontractors’ insurers cannot later seek recovery from you for the insurance proceeds that they paid on the theory that you were the party that actually caused the loss.
- Additional Insured Endorsements: Owners are often contractually indemnified by the general contractor for any claims, and, pursuant to its contract with the owner, the general contractor is usually required to list the owner as an “additional insured” under the contractor's policies. General contractors also typically require their subcontractors to add them as an additional insured on the subcontractor’s insurance policies, on a primary and noncontributory basis,2 for all liability and expenses arising out of their work, including completed operations. Being named an “Additional Insured” gives these “upstream” parties rights provided to the “downstream” contractor or subcontractor in their insurance policies, including legal defense and indemnity.
- Safety Requirements: Contracts can require all of the parties to adhere to all federal, state, and local laws, regulations, and other legal requirements governing safety, health, sanitation, and the performance of the contract in general.
The Importance of Coverage Counsel
In order to successfully transfer risk, it is important for owners and general contractors to engage coverage counsel early in the development process. Having coverage counsel like SDV’s attorneys review and negotiate your insurance program before a project begins is the best and safest option. If coverage counsel is present from the very beginning, you may be able to avoid future litigation.
If you need help assessing the risks with a particular construction job, contact an experienced insurance coverage attorney to make sure you are adequately covered. The policyholder coverage attorneys at SDV are waiting for your call. Contact us today to schedule an evaluation.
1Most states have enacted “anti-indemnity statutes,” which limit or prohibit enforcing indemnification agreements in construction contracts. To the extent that an anti-indemnity statute applies to a particular contractual indemnity provision, such anti-indemnity statutes limit the scope of indemnity. You should work with competent coverage counsel to determine the particulars of the anti-indemnity statutes in your state.
2A primary and non-contributory endorsement ensures that the insurance policy to which it is added responds first in the payment of claims, regardless of other available insurance. These endorsements make the subject policy “primary” because the policy pays first and “non-contributory” because the policy must first exhaust before other available insurance begins to pay.