Summary: The purchase of insurance is just one of many ways that an entity can transfer all or portions of its risk. Insurance policies have often been referred to as policies of indemnity, or indemnification contracts, as well as contracts of adhesion. An insurance policy meets the description of both an indemnity contract and a contract of adhesion. A contract of indemnity is a legal agreement between two parties in which one party agrees to pay another party for a loss or damage that meets certain criteria and conditions, barring certain specified circumstances. An insurance contract is just one type of a contract of indemnity. A contract offered intact to one party by another under circumstances requiring the second party to accept or reject the contract in total without having the opportunity to bargain over the wording is a contract of adhesion. Insurance policies are contracts of adhesion and, as such, are construed strictly against the party writing them (i.e., the insurer).
Both indemnity provisions and insurance agreements require one party to stand good for the loss of another. But there are some significant differences. Here, we will discuss the different types of indemnity, anti-indemnity statutes, insurance coverage for liability coverage, and additional insured endorsements.
What is Indemnity?
Indemnity provisions, also known as hold harmless agreements, are found in just about every construction or service provider agreement. Indemnity provisions contain a promise by one party to protect another party from claims for damages by a third-party. The intent of an indemnity provision is to transfer the risk of third-party claims to the party best-suited to bear the risk.
For example, owners have certain nondelegable duties to ensure that their property is safe. Therefore, if a person is injured on a construction site, the property owner is often named as a defendant in any litigation. An indemnity agreement operates to transfer the liability of the owner, the indemnitee, to the contractor, the indemnitor. As the contractor is in possession and control of the construction site, the contractor is in the best position to manage risk of injury on the site and, therefore, is the party best-suited to bear the risk.
What Are Anti-Indemnity Statutes?
The vast majority of states have enacted anti-indemnity statutes. These statutes set forth, or limit, the breadth and scope of indemnity provisions. If an indemnity clause is too broad, it may be declared void and unenforceable under a state’s anti-indemnity statute. When drafting an indemnity provision, a party must first know what is the permissible level of indemnity in the subject state. To assist in that regard, there are three classifications of indemnity provisions—broad form, intermediate form, and limited form. Each classification, or type of indemnity, shifts a different level of liability to the indemnitor.
Broad Form Indemnity
Under a broad form indemnity provision, the indemnitor assumes an unqualified obligation to hold harmless the indemnitee for all liability arising out of the contract, regardless of which party was actually at fault. Even if the indemnitee is solely at fault for the loss, the indemnitor has an obligation to indemnify. Often this is done by use of the term, ‘caused by…. in whole’ in the contract, meaning that regardless of who is at fault, the indemnitor will be held liable ‘in whole’ (100 percent) for the damage. Therefore, a broad form indemnity provision shifts the entire risk of loss arising out of the contract to the indemnitor.
By way of example, assume a pedestrian walking by the construction site slips and falls, resulting in $50,000 in bodily injury damages. Assume further that the owner, the indemnitee, had left crates stacked in the walkway area and was solely at fault for the loss. Under a broad form indemnity agreement, the contractor, the indemnitor, would be required to indemnify the owner for 100 percent of the damages, or $50,000.
Currently, less than 10 states permit broad form indemnity, and even in those states certain requirements must be met to enforce the provision.
Intermediate Form Indemnity
Under an intermediate form indemnity provision, the indemnitor assumes an obligation to hold harmless the indemnitee for all liability arising out of the contract, so long as the indemnitor is partially at fault—even one percent at fault. This is done by adding the term ‘in part’ (partially) in the contract language, so that the assumed liability in the contract reads, ‘caused by …. in whole or in part’.
Using the previous injured pedestrian example, assume that the owner was 95 percent at fault and the contractor was five percent at fault for the pedestrian’s damages. The percentage allocated to each party is irrelevant as long as the indemnitor has some level of fault. Under an intermediate form indemnity agreement, the contractor would be required to indemnify the owner for any liability allocated to the owner, 95 percent or $47,500, plus any liability allocated to the contractor, five percent indemnity; so the contractor would bear the full 100 percent liability of $50,000. Here, the contractor has agreed to indemnify the owner for the entire loss as long as the loss is caused ‘in part’ by the contractor.
It is not common; however, an intermediate form indemnity provision may be tied to the owner. For example, an intermediate form indemnity provision may read: “caused in whole or in part by the owner.” The words “in whole” must be removed or the provision reverts to broad form. Currently, 30+ states permit intermediate form indemnity provisions.
Limited Form Indemnity
Under a limited form indemnity provision, the indemnitor assumes an obligation to hold harmless the indemnitee only to the extent of the indemnitor’s fault. This is done by using the words, “but only to the extent caused by [the negligent acts or omissions of] the (indemnitor)” in the contract language. Again using the injured pedestrian example, assume that the owner was 75 percent at fault and the contractor was 25 percent at fault for the pedestrian’s damages. Under a limited form indemnity agreement, the contractor is required to indemnify the owner for the contractor’s percentage of fault, 25 percent or $12,500.
Limited form indemnity provisions are permitted in every state.
Does General Liability Insurance Cover Indemnity Obligations?
The standard ISO CGL policy provides coverage of the insured’s indemnity obligation. The coverage is afforded through an exception to the contractual liability exclusion. Under the contractual liability exclusion, coverage is eliminated for “assumption of liability” in a contract or agreement. This exclusion is intended to eliminate coverage for the insured’s contractual obligations, including liability arising out of indemnity or hold harmless agreements.
Through the exceptions to the exclusion, the exclusion is not applicable to “insured contracts”, as defined in the policy. The definition begins by listing five types of contracts, identified as a. through e:
- Lease of premises (but not for a promise to pay fire damage to a premises you rent or occupy)
- Sidetrack agreement
- Easement or license agreement (not for construction or demolition on or within 50 feet of a railroad)
- Indemnify a municipality (except for work for the municipality)
- Elevator maintenance agreement
In addition to the above five contracts, a blanket clause is included in subpart f. Of the definition of “insured contracts”, stated as follows:
That part of any other contract or agreement pertaining to your business (including an indemnification or a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for “bodily injury” or “property damage” to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.
This blanket contractual clause extends coverage to any contract pertaining to the named insured’s business under which they assume the tort liability of another, that is, an indemnity contract. (Note that a carrier may remove coverage for contractual liability using the Contractual Liability Limitation Endorsement, Form CG 21 39.)
Additional Insured Endorsements
An individual or organization can be covered under another party’s general liability policy as an additional insured by endorsement. Additional insured status gives the additional insured direct access to the other party’s insurance—they are treated as an insured under the policy. However, the coverage afforded to the additional insured differs depending on which endorsement form is used to add the party as an additional insured.
The main additional insured endorsements offered by ISO, identified by year, are as follows: the 1985, 2001, 2004 and the 2013 forms. Below is a summary of coverage provided under each form.
When it comes to being named as an additional insured, the broadest coverage afforded is under CG 20 10 11 85. Here, the additional insured is provided coverage for liability arising out of the insured’s work and coverage for claims arising out of the additional insured’s work. Coverage is afforded during ongoing operations and also for completed operations.
Most states have interpreted the 1985 form as providing coverage as long as the additional insured’s negligent act had a close and direct connection with the operations of the named insured. The coverage afforded to the additional insured is essentially identical to the named insured. Some carriers will no longer add this edition, as it arguably provides coverage for the additional insured’s own, or sole, negligence.
In 2001, ISO divided coverage for ongoing and completed operations into two separate endorsements, CG 20 10 10 01 (ongoing operations) and CG 20 37 10 01 (completed operations). In order to have similar coverage to the 1985 edition, which provided coverage for both ongoing operations and completed operations, both endorsements must be added to the policy.
ISO again divided coverage for ongoing and completed operations into two separate forms, CG 20 10 07 04 (ongoing operations) and CG 20 37 07 04 (completed operations). However, unlike the earlier versions, the 2004 endorsements remove coverage for the additional insured’s sole negligence by replacing the language “arising out of” with “caused in whole or in part by your work….” As a result, the 2004 form does not provide coverage for the additional insured’s sole negligence.
Following the earlier editions, ISO again divided coverage for ongoing and completed operations into two separate forms, CG 20 10 10 13 (ongoing operations) and CG 20 37 10 13 (completed operations).
The change in these endorsements from 2004, is that the 2013 endorsements do not automatically remove coverage for the additional insured’s sole negligence. Instead, the 2013 endorsements remove coverage for the additional insured’s sole negligence, “if not permitted by law”. The additional insured is not covered for the additional insured’s sole negligence, but only if the applicable law does not permit coverage. The intent of removing coverage for the additional insured’s sole negligence if not permitted by law is to address those states, for example Texas, that have enacted “anti-indemnity” statutes, where the statutes further declare as void the additional insured status of the indemnitee. This is commonly referred to as closing the additional insured loop.
In addition, the 2013 coverage is limited to what is required by the contract. If the contractor carries greater limits of insurance than what is required in the contract, the additional insured does not benefit from the additional coverage. Since the policy is tied to the contract, the contract arguably functions as part of the endorsement. This may cause underwriters to scrutinize the contract every time additional insured coverage is requested. What if insurance requirements change during construction? Would an increase in limits be binding? There are many issues related to tying the policy to the contract, and the carrier will look for the insurance requirements to be carefully defined; as if they are vague in any way, the carrier may construe the 2013 endorsements as limiting coverage.
A Closing Example
There can be significant differences between indemnity and additional insured obligations in the same contract. Using the previous injured pedestrian example, assume the owner and contractor used a limited form indemnity provision in the construction contract, and the owner was added as additional insured to the contractor’s CGL policy using a 1985 endorsement. Further, assume that the owner is 75 percent and the contractor is 25 percent at fault for the $50,000 in bodily injury damages.
Pursuant to the indemnity provision, the contractor is required to indemnify the owner only for its level of fault, 25 percent or $12,500. The contractor has insurance coverage under the exception to the contractual liability exclusion in the CGL. The contractor’s CGL carrier would then pay the owner $12,500 on behalf of the contractor.
However, as additional insured, the owner will submit the claim to the contractor’s CGL carrier. Since the 1985 additional insured endorsement was used, the carrier is required to defend and fully indemnify the owner for the claim, just the same as the carrier would for the named insured. The CGL carrier would then pay the third-party $50,000 on behalf of the owner. Even though the contract required only limited form indemnity, the owner is fully compensated for the third-party claim.
This inconsistent result is currently prevented by statute in only six states. In the remaining states, the indemnitor can receive full protection for a third-party claim with the use of a broad additional insured form, even if broad or intermediate indemnity is prohibited by statute.