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Contractual Insurance Requirements and Anti-Indemnity Statutes

Gregory Podolak | July 1, 2016

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In the construction industry, contractual indemnity and additional insured coverage are widely regarded as separate but parallel risk transfer paths—each with their own nuances, advantages, and pitfalls. The two are ordinarily intended to complement each other. Where one is unavailable, the other may yet be.

In many states, however, indemnity and insurance are being increasingly pulled together. Upstream and downstream parties alike should recognize this trend, appreciate the implications to their unique risk transfer goals, and tailor their risk transfer plan accordingly.

Consider the History

Historically, contractual indemnity was the primary risk transfer tool, governed by the common law and bound only by the clarity of the agreement between the parties. A perceived imbalance in negotiating power between contractors and subcontractors led to the advent of the anti-indemnity statute. Anti-indemnity statutes became commonplace, and contractors diversified their risk transfer efforts. Thus was born modern additional insured coverage, which, much as with early indemnity, is largely governed only by common law contract principles.

To date, 46 states have enacted anti-indemnity statutes that curtail indemnity agreements. 1 The remaining states continue to rely on the common law to assess enforceability. In sum, all states allow limited indemnity provisions under which the indemnitor promises to indemnify the indemnitee for the indemnitor's negligence. The vast majority of states prohibit an indemnitee from assigning its own sole negligence to an indemnitor and only permit indemnification for vicarious liability. Only a scant few permit broad form indemnity provisions in which the indemnitor assumes the entire risk of loss regardless of whether it is the result of the sole negligence of the indemnitee. Those states that permit broad form indemnity agreements require that the agreement be "clearly and unequivocally stated" in the contract.

Some of those statutes have evolved to specifically restrict the insurance that can be provided to an upstream party. Anti-indemnity statutes in Arizona, Colorado, Georgia, Kansas, Montana, and Oregon void as against public policy additional insured coverage for sole negligence. 2 Legislatures in those states generally equate the agreement to provide insurance to the agreement to indemnify; thus, they reason, agreements to provide insurance for an additional insured's own negligence should likewise be void as against public policy.

The extension of anti-indemnity limitations to additional insured coverage is not, however, always so obvious. Several anti-indemnity statutes have been interpreted by courts as applying to insurance, even though the statute otherwise appears silent on the issue or, worse, suggests that insurance agreements are exempt. 3 This diversity of outcome, as illustrated by the case discussions that follow, reinforces the importance for risk professionals not only in being conversant in the statutes themselves, but also their application in case law.

NJ: Additional Insured Requirements Must Follow Anti-Indemnity Rules

In Shannon v. B.L. England Generating Station, 2013 U.S. Dist. LEXIS 168715 (D.N.J. Nov. 27, 2013), where a federal district court examined New Jersey law for which there was no direct precedent, B.L. England Generating Station (BL) contracted with Industrial Process Solutions (IPS) to perform work on an air drying compressor on BL's premises. In the contract, IPS agreed to "defend, indemnify and hold harmless" BL from "all claims, liabilities, and other potential losses arising out of or relating to ... any act or omission of IPS or its employees, contractors, and agents in the performance of the Services." In addition, IPS agreed to "procure and maintain" sufficient insurance to protect IPS and BL from third-party claims arising out of or connected with the performance of the work.

While IPS was performing its operations, one of its employees was injured. The employee subsequently sued BL, alleging that BL, and BL alone, was responsible for his injuries. BL tendered the suit to IPS and Travelers Insurance (Travelers), IPS's general liability insurer, as an additional insured. Both IPS 4 and Travelers 5 refused to defend or indemnify BL.

As a result of Travelers' denial, BL sued IPS for failure to procure insurance. In response, IPS argued that BL was effectively seeking additional insured coverage for its own negligence and that such a requirement would have to comport with New Jersey's anti-indemnity statute, which required that indemnity for sole negligence be clearly and unequivocally written to be enforceable. Notably, New Jersey's anti-indemnity statute (N.J. Stat. Ann. § 2A:40A–1) specifically provides that it "shall not affect the validity of any insurance contract." Nonetheless, the district court sided with IPS and held that absent a clear contractual requirement that IPS purchase insurance to cover BL's own negligence, no such obligation existed. Therefore, IPS could not be in breach.

Importantly, in applying the anti-indemnity limitations to the trade contract's insurance requirements, the court reasoned that to hold otherwise would essentially allow "a back-door attempt at the statutorily prohibited result of indemnification for [BL's] own negligence." As to the statutory language that, facially, seemed to exempt insurance from the statute, the court concluded such language merely meant that any insurance policy purchased in compliance with the statute would otherwise be governed by its own terms.

IL: Insurance Requirements Not Barred by Statute

In St. John v. Naperville, 508 N.E.2d 1128 (Ill. App. Ct. 1987), recently reinforced in 2009 in Clarendon Am. Ins. Co. v. Prime Grp. Realty Servs., 907 N.E.2d 6 (Ill. App. Ct. 2009), the Illinois Appellate Court concluded that the Illinois anti-indemnity statute, which is similar in form to New Jersey's, did not extend to insurance requirements.

In St. John, the city of Naperville contracted with Utility Dynamics Corporation to construct an extension of the Naperville electrical system. As part of the contract, Utility was required to provide certain insurance coverage to Naperville, including insurance "equal to" that described in the indemnity agreement.

While performing operations on site, a Utility employee was injured and sought recovery for his injuries in a suit against Naperville. Naperville then brought a third-party action against Utility for, among other things, failure to procure insurance pursuant to the terms of the contract. Utility sought summary judgment on the basis that the insurance requirements were void under the Illinois anti-indemnity statute, which provides that every promise or agreement to indemnify another for that person's own negligence is void and wholly unenforceable.

Similar to New Jersey's anti-indemnity statute, the Illinois statute (740 Ill. Comp. Stat. Ann. 35/3) includes a caveat regarding insurance contracts, stating that "[t]he Act does not apply to construction bonds or insurance contracts or agreements." The court held that the statute did not apply to Utility's insurance obligations because a requirement to procure insurance is different from an indemnity agreement in that an agreement to procure insurance preserves a potential source of compensation for an injured worker and limits the exposure to the downstream party to the price of insurance premiums, whereas an indemnity agreement places potentially unlimited liability on the downstream entity. Therefore, the court held that the contract was not void under Illinois law. 6

A Few Points to Consider

What is the solution to the potential for inconsistent results presented by the diversity of statutes and case law? In true lawyer fashion, the answer is a resounding "it depends." It depends on where you work, where you bought the policy, your risk transfer goals, and so on. The only way to craft a truly effective risk management plan is to think deeply and carefully about all of these issues and more. In the meantime, there are several general strategies to consider.

Know Which Law Applies

The first critical step in assessing the scope of anti-indemnity application to insurance is to know which statute is likely to apply. For contractors with a national footprint, this can often be a challenging assessment that requires a careful examination of complex choice-of-law principles. Moreover, the relevant contract is most often not the insurance policy, though the dispute is ultimately about insurance, but rather the underlying contract that is the original source of the insurance obligation.

Know the Law

By being familiar with anti-indemnity statutes, the additional insured can tailor its insurance requirements to avoid having coverage invalidated on the basis that the agreement to provide additional insured coverage runs afoul of the anti-indemnity statute. For instance, in New Jersey, a contract can provide for additional insured coverage for the additional insured's own negligence if the contract explicitly states this intention. 7 However, in Kansas, any contractual provision requiring a party to provide insurance covering another's sole negligence is void. 8 If the additional insured used the same contract in Kansas as in New Jersey, the additional insured requirement would be deemed invalid, and the additional insured's risk transfer solution may be nullified. However, with knowledge of the jurisdiction's anti-indemnity statute, additional insured requirements can be crafted to fit within the statutory scheme and provide maximum risk transfer to the additional insured.

"Savings" provisions—language designed to preserve contractual language to the extent permissible by statute where it would otherwise be completely void—have become standard with indemnity provisions. Insurance requirements should include the same language, if that is not done already.

Consider Wraps

In jurisdictions where indemnity and insurance face similar limitations, upstream parties should consider additional alternative risk transfer solutions, including consolidated insurance programs (commonly known as "wrap-up" insurance). The Texas anti-indemnity statute (Tex. Ins. Code Ann. § 151.104), which is among those that void certain additional insured provisions, specifically does not apply to an owner-controlled or contractor-controlled insurance program. These types of insurance programs are purchased by upstream parties but are funded in part by each project participant, including the downstream subcontractors. Wrap-up insurance programs provide general liability coverage to all enrolled parties, thereby avoiding the risk that downstream insurance requirements may run afoul of expanded anti-indemnity laws.

Acknowledgment

The author would like to acknowledge and thank coauthor Michael A. Barrese for his contributions to this commentary.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Footnotes

1 See Construction Anti-Indemnity Statutes, 50-state survey, www.sdvlaw.com.
2 See Ariz. Rev. Stat. § 34–226; Colo. Rev. Stat. § 13–21–111.5; Ga. Code Ann. § 13–8–2; Kan. Stat. Ann. § 16–121; Mont. Code Ann. § 28–2–2111; Or. Rev. Stat. § 30.140.
3 See Transcontinental Ins. Co. v. National Union Fire Ins Co., 662 N.E.2d 500 (Ill. App. Ct. 1st Dist. 1996); Shannon v. B.L. England Generating Station, 2013 U.S. Dist. LEXIS 168715 (D.N.J. Nov. 27, 2013).
4 IPS argued that the indemnity agreement violated New Jersey's anti-indemnity statute in that it did not unequivocally provide that IPS was required to indemnify BL for its sole negligence and, as a result, was unenforceable in the underlying action. BL and the court agreed.
5 Travelers argued that its policy did not grant additional insured coverage to BL because the additional insured endorsement limited coverage to BL's vicarious liability for IPS. The district court agreed, holding that Travelers was not required to provide broader insurance than its policy granted solely because the contract between the named insured, IPS, and BL may have required a broader coverage grant.
6 Notably, the Illinois anti-indemnity statute and New Jersey anti-indemnity statute are similar, with the Illinois statute not applying to "insurance contracts or agreements" and the New Jersey statute not applying to "any insurance contract." Compare 740 Ill. Comp. Stat. Ann. 35/3 with N.J. Stat. Ann. § 2A:40A–1.
7 See Shannon.
8 See Kan. Stat. Ann. §16–121.
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