The lack of knowledge and understanding regarding indemnification provisions is astounding considering their power. Often, contractors and suppliers do not understand the ramifications until they are on the wrong side of a claim. These provisions can be absolutely devastating. It is critically important for subcontractors and suppliers to be able to understand and negotiate these provisions on projects.
What is an indemnification provision?
Indemnification provisions appear in most substantial construction contracts. The standard AIA subcontract (AIA Document A401-207 Standard Form of Agreement Between Contractor and Subcontractor) provides a relatively fair provision:
To the fullest extent permitted by law, the Subcontractor shall indemnify and hold harmless the Owner, Contractor, Architect, Architect’s consultants, and agents and employees of any of them from and against all claims, damages, losses, or expenses, including but not limited to attorney’s fees, arising out of or resulting from performance of the Subcontractor’s Work under this Subcontract, provided that any such claim, damage, loss, or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent act or omissions of the Subcontractor, the Subcontractor’s Sub-subcontractors, anyone directly or indirectly employed by them, or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss, or expense is caused in part by a party indemnified hereunder.
This essentially means that is someone brings a claim against an indemnified party (owner or GC) arising out of subcontractor or supplier’s work, the at fault party has to reimburse those losses. For example, if a framing contractor’s work fails and the owner brings a claim against the general contractor, the general contractor will use this provision to bring a claim against the subcontractor.
The AIA subcontract’s indemnification provision accomplishes this goal relatively reasonably. Not every contract is as equitable.
The Largest Risk: the Duty to “Defend.”
Not included in the standard AIA subcontract is the duty to defend. However, many larger developers and contractors require indemnification provisions that add one seemingly innocuous word: “To the fullest extent permitted by law, the Subcontractors shall defend, indemnify, and hold harmless…” The inclusion of this one word is a complete game changer. It requires the indemnitor (subcontractor) to provide an attorney to defend the claim. Practically speaking, the indemnified party (owner/GC) will engage their very expensive attorney and simply demand that those fees be paid by the subcontractor or supplier on an ongoing basis.
This can create huge problems. Imagine a dispute between an owner and a general contractor. The owner is complaining about several issues, one of which is within your scope of work. The general contractor is complaining about the owner’s failure to provide payment. They go to war, and in the complaint alleges that everything is wrong with the project, including your scope of work. The general contractor engages an attorney. There is a large amount at issue. There are a lot of issues involved. You are one very small piece. But the general contractor sends you a letter demanding that you pay for their hand-picked attorney to contemporaneously defend at least part of the claim. A year goes by. You have spent thousands of dollars on the general contractor’s attorney. The case settles and your scope of work was barely even mentioned. You have effectively subsidized the general contractor’s legal fees. At an absolute minimum, you financed those costs, interest free.
Contractors and suppliers should refuse to agree to the duty to defend. Ensure that the word “defend” is removed. This term will usually be included in the first sentence of the indemnification provision, but can be located again in the body of the provision and other provisions in the contract.
This essentially brings the provision back to the AIA subcontract’s indemnification provision. If it is good for the AIA, why is it not good enough for the owner or the general contractor? Fundamentally, the people with whom you are negotiating do not even understand the ramifications of this provision in their contract. Explain it to them. Show them this article. Invite them to have a conversation with your lawyer. Once they understand how harmful this could be, the representative will agree to the modifications. If they do not – if they simply say: “This is the contract, no changes, sign it or we will find someone else!” – you have to think long and hard about whether you want to work with that company. It is a strong signal that if something goes wrong, their goal will be to push all loss to you.
How to Defend a Claim.
What do you do if your contract contains the most onerous indemnification provision possible and a claim has been submitting relating to your work? The indemnified party (owner or general contractor) sent you a letter invoking the provision and demanding that you provide a defense. Now what? Mitigate as much as possible.
First, contact your insurer. Indemnification claims typically arise out of some sort of negligence, for which there is often insurance coverage. Immediately notify your carrier. Delayed notification can jeopardize coverage. More on that here.
If there is no insurance, try to resolve the claim. If you have to pay for the owner/GC’s attorney fees, you are essentially paying two attorneys. This can get out of hand real fast. Even if the claim is weak, you should explore the business case for throwing some money at it to make it quickly go away. Lick your wounds. Lesson learned. Remove this provision from all future contracts.
If resolution of the claim is not possible, try to negotiate a release of the owner or general contractor. Consider posting a bond or placing funds in escrow to ensure collection of any liability in exchange for a dismissal of the indemnified party. At that point the claimant should have no solvency concerns. However, many claimants will not agree to this, fully cognizant of the financial pressure the indemnification provision creates.
In that situation, take control of the litigation. Hire counsel and push as hard as you can for the indemnified party to take a back seat. They will still want to hire their attorney. But because larger companies have more expensive lawyers and they are not paying the bill, you want to bench that lawyer. Your lawyer, who is likely going to be considerably less expensive, should take the lead in the case in all aspects. The owner/GC should agree to this. In the end, if there is a judgment, it will come out of your pocket. Offer to provide constant updates and get input as necessary, but insist as much as possible that your attorney take the lead on all substantive work.
Finally, consider the possibility of coming back over the top. If the claim lacks substantial justification and is simply intended to squeeze a settlement, immediately assert a claim for attorney fees as damages. In your answer, initial disclosures, proposed case management order, discovery responses – everywhere. Provide copies of the monthly attorney fee invoices you receive from the indemnified party. Warn that you are going to take this defense the distance and the downside risk to the claimant is enormous.
The bottom line is this: you must defend these claims extremely aggressively. Plodding along through litigation while paying two attorneys is simply not an option.