Date: February 29th, 2012
Categories: Contracts, Indemnity

Indemnity provisions are one of the primary and most easily recognized tools used in allocating risks in a construction contract. There are others, of course, like provisions addressing delay, unforeseen conditions, or consequential damages. But none of those provisions allocates the breadth of risks that are typically channeled through a construction contract’s indemnification clause.

When used properly, these clauses improve efficiency by allocating risks to the parties best able to control or bear them. A practical illustration of this efficiency is insurance policies: with an understanding of what risks are born by whom, each party purchases only the amount of insurance required to insure against the losses allocated to that party. But when an indemnity clause shifts the costs of a risk from the party who causes a loss onto a party largely (or entirely) free of fault, the result can mean a financial windfall to one party, and an unexpected liability to someone else.

Fortunately for public and private construction projects in Washington, for years now Washington has had legislation that seeks to avoid inefficient risk allocation. Under the state’s anti-indemnification statute (RCW 4.24.115), a party to a construction contract cannot be required to indemnify the other party for the other party’s own negligence. The law declares that any contract provision requiring otherwise is against public policy and void.

But a decision from our state supreme court last week raises a caution flag for the construction industry. In that case[1. Snohomish County Pub. Trans. Benefit Area Corp. v. Firstgroup America, Inc., No. 83795-3 (Wash. Feb. 23, 2012) (en banc.)], a chain-reaction accident on I-5 involving Community Transit buses ended in 42 claims being indemnified by a transit operator who, despite being surrounded by a storm of fault, was itself fault free. The fault free operator nevertheless remained obligated to indemnify Community Transit, who admitted to being negligent for purposes of the Court’s decision.

First Transit (the operator and indemnitor) had an agreement requiring it to indemnify Community Transit against all losses except those arising solely from Community Transit’s own negligence. Because the indemnity provision required indemnification for everything but Community Transit’s sole negligence, the Court reasoned that the parties had ‘clearly and unequivocally’ shown an intent to indemnify Community Transit from other types of losses, including losses only partially caused by Community Transit’s negligence, losses caused by third parties such as the other drivers, and losses that First Transit had nothing to do with.

The ‘clear and unequivocal’ standard became central to the Court’s analysis because even though Washington generally allows parties to indemnify against losses resulting from someone else’s (the indemnitee’s) fault, parties must express this intent in clear and unequivocal terms. The Court added that such an arrangement, when expressed clearly and unequivocally, was not against public policy; if anything, the Court explained, it was against public policy not to enforce the parties’ intentional risk-allocation scheme. Using Washington common law and drawing on multiple cases from around the country for support, the Court held that as a matter of law, indemnification for everything but sole negligence of the indemnitee requires indemnification against the indemnitee’s own concurrent negligence and third-party negligence. Further, because First Transit’s indemnity obligation arose under the contract, it did not matter that First Transit had not itself been negligent.

Thanks to the anti-indemnification statute mentioned earlier, the impact of the Community Transit decision on construction contracts is largely muted. This is true even for construction contracts adopting indemnity provisions to the full limits allowed by Washington’s anti-indemnity statute. Nevertheless, contractors and their legal counsel are not entirely out of the Community Transit woods.

One feature that neither the anti-indemnification statute nor many standard subcontract forms (such as the AGC of Washington’s standard subcontract) have is an exclusion from indemnification where the indemnitor has not acted negligently, or where the loss is caused by negligent third parties. This becomes a problem under the Community Transit decision’s inference that broad losses left unaddressed by specific exclusions to the contract’s indemnity obligations may be liabilities shifted to the indemnitor. In construction contracts, because indemnity clause are typically broad with specific exclusions for the indemnitee’s negligence, under the Community Transit decision a court might interpret these specific exclusions as impliedly requiring indemnification for all other losses, including those arising from third parties or despite the contractor acting reasonably.

In the Community Transit case, First Transit”s bus got caught between an oncoming car that had just been rear-ended and a Community Transit-operated bus following behind the First Transit bus. By virtue of being in the wrong place at the wrong time, the oncoming car hit First Transit’s bus instead of the bus operated by Community Transit. The Community Transit bus then rear-ended First Transit’s bus, leaving First Transit to deal with its own losses in addition to the other 42 claims tendered to it.

It is not hard to imagine similar bad luck in construction. For instance, a mason is building a wall when a driver careens into it, toppling the brick wall onto owner-furnished equipment. The mason did nothing to cause the car to lose control, and the car would have caused the same damage to the owner’s equipment (if not more) had the brick wall not stood between the two. Regardless, the mason could find itself being the indemnitor of the driver despite having no control over the driver, no fault of its own, and being the least efficient party for bearing such risk.

Construction contract indemnity provisions are often broad in covering losses related to the indemnitor’s work. If owner and contractor (or contractor and subcontractor) do not take the additional step of expressly allocating the risk of losses from negligent third parties, or clarifying that the contractor or sub must be negligent in order to trigger that party’s indemnity obligations, the Community Transit decision undermines the contract’s effectiveness in saving the contractor from risks it has no control over and cannot efficiently bear. Consequently, the Community Transit decision gives reason to revisit the indemnification clauses at the center of your construction contracts and decide if more specificity is appropriate to ensure the most efficient risk management possible.