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Insuring Indemnification

By Christopher L. Lynch

As if companies didn't have enough to worry about trying to insure against their own acts, omissions, and negligence, a frequent provision of modern contracts is the indemnification clause. In a nutshell, these contractual risk-shifting mechanisms require one company (the indemnitor) to assume the liability of another company (the indemnitee) for damages suffered by third parties. For a company that has taken on the role of indemnitor, trying to determine whether its commercial general-liability policy will cover that contractual assumption of liability can be difficult.

Indemnification clauses are typically used where the indemnitee runs a risk of being held liable to a third party who has been injured by the work or goods the indemnitor is providing to the indemnitee. They can go so far as to provide that the indemnitor will hold the indemnitee harmless for any damages relating in any way to those work or goods, even if the damage was the sole fault of the indemnitee.

Often, the parties attempt to meet the risk-transfer goals of contractual indemnification agreements by requiring the indemnitor to have the indemnitee named as an additional insured on the indemnitor's liability policy. But there is another, often overlooked, component of general-liability policies that may provide stand-alone or complimentary coverage for some contractually assumed liabilities.

Standard-form CGL policies cover sums the insured becomes legally obligated to pay as damages because of "bodily injury" or "property damage" or "personal and advertising injury" to which the insurance applies. Most policies contain a contractual liability exclusion that specifically excludes from coverage damages the insured is obligated to pay by reason of the assumption of liability in a contract. At first glance, that would seem to end the possibility of coverage for liability a company has assumed in a contractual indemnification clause.

But with respect to bodily injury and property damage, standard-form policies also contain an exception to the contractual liability exclusion for damages assumed in an "insured contract." The definition of "insured contract" includes "[t]hat part of any other contract or agreement pertaining to your business under which you assume the tort liability of another party to pay for bodily injury or property damage to a third person or organization." (Insurance Services Organizations from CG 00 01 12 07 [Commercial General Liability Coverage Form]). This exception to the contractual liability exclusion provides coverage for liability the insured-indemnitor assumes under a contractual indemnification agreement that fits within the relatively broad definition of an insured contract.

One of the primary benefits of this is the provision of blanket coverage. There is no need to add an endorsement naming a specific contract or indemnitee to be covered. Nevertheless, numerous factors should be considered when trying to determine if contractual liability coverage is sufficient to meet the risk-transfer goals of the underlying indemnification agreement.

For the indemnitee, contractual liability coverage under the indemnitor's policy is indirect. The insurer's obligation is to its insured, the indemnitor. The insurer must pay the amounts the insured-indemnitor becomes obligated to pay to the indemnitee by reason of the underlying hold-harmless agreement. But the indemnitee is not a party to the insurance policy, and this may increase the likelihood of a coverage dispute or necessitate that the indemnitee bring a formal claim or suit against the insured-indemnitor in order to obtain insurance proceeds.

In addition, except for very limited instances (in which, among other conditions, both the insured-indemnitor and the indemnitee are named in the same lawsuit) the insurer has no right or duty to defend the indemnitee. The insurer is obligated to pay the indemnitee's defense costs only if the insured-indemnitor agreed to pay them in the underlying contract. And unlike defense costs paid on behalf of an insured, the amounts paid for an indemnitee's defense costs are considered amounts paid to cover damages, and therefore count against the policy's coverage limits.

Because contractual liability coverage is premised on the existence of an obligation assumed in an "insured contract," the only risks covered are those the insured-indemnitor agreed to assume in the underlying contract. The scope of coverage may be further limited by the terms of the insurance policy and applicable state laws.

Subject to a few exceptions (most notably for employer's liability), the conditions and exclusions in a CGL policy, and any applicable endorsements, limit contractual liability coverage just as they would to any other covered risk. This means that even if an insured indemnitor agrees to assume a certain risk in the underlying "insured contract," the policy itself may exclude coverage for that risk.

Contracting parties must also pay attention to applicable state law. Most states preclude or limit indemnification agreements in certain types of contracts, particularly construction contracts. The scope of these anti-indemnification laws varies, and evaluating the potential applicability of these statutes is important. If the underlying indemnification agreement is determined to be void as a violation of an anti-indemnification law, there will be no contractual liability coverage under the policy. That's because if the underlying contractual indemnification agreement is not enforceable, there is no "insured contract' on which to premise contractual liability coverage.

In sum, like most insurance issues, the determination of whether a CGL policy covers liability assumed in a contract can be a difficult path to negotiate. Contract administrators and risk managers would be wise to carefully review the language of policies, the terms of the underlying contracts, and any applicable state laws to determine whether contractual liability coverage is sufficient to attain the parties' risk-transfer goals.

ABOUT THE AUTHOR

Christopher Lynch is a partner in the Insurance Recovery practice group of Lindquist & Vennum. He can be reached at 612-371-3512 or clynch@lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular question.

riskVue | The webzine for risk management professionals
November 2007