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Subcontractor Agreements – The Indemnification Clause

Doug Staebler, Custom Concrete Company, Inc., Westfield, IN

You have just landed that big customer you’ve been working on for two years. Prices and scope of work have been agreed to and everyone is ready to begin. There is one last detail to take care of, the Subcontractor Agreement. At this point in the game, the last thing you want is to delay starting work by haggling over a contract. But before you start, it’s important to understand what is in the agreement, and the risks it may pose to your business.

We previously looked at why these agreements have become so prevalent and some of the administrative provisions and payment terms typically found. Most of these agreements are drafted heavily in favor of the builder, and provide little, if any protection for the subcontractor. In this article, we will look more closely at the indemnification clause, probably the most important section of the agreement.

What exactly does “indemnification” mean? To indemnify means to make whole, reimburse, or otherwise compensate for another’s loss. An example in our business is a builder who is sued by a homeowner for defective work on a home. The builder is forced to pay damages to the homeowner. If the damages were due to defective work of a subcontractor, the subcontractors will likely be required to “indemnify” the builder for its losses. If reasonably worded, such provisions are appropriate and acceptable. After all, we expect to be held responsible for defects in our work. The problems arise in the way most agreements are drafted.

Indemnification provisions will often use terminology like “claims arising from the work” or “claims related to the work”. This could serve to make the subcontractor liable for claims even if there was nothing wrong the subcontractor’s work. For example, a subcontractor could be held liable for mold claims that are related to the basement, even if all work was performed properly, and according to building codes. All that would be necessary is for a builder to demonstrate that the claim is related to the basement.

Standard AIA contracts use additional language limiting the subcontractors responsibility to indemnify to claims and damages “but only to the extent caused by the negligent acts or omissions of the Subcontractor…” This language is far better because it requires that negligence or omissions be found before the subcontractor is liable, instead of simply being related to the work of the subcontractor.

Carefully review AIA contacts. Although AIA documents are generally considered to be relatively balanced, they are often modified by the builder or developer in exhibits or addendums.

Another important consideration is the issue of proportional liability. In most cases, problems are caused by a number of factors. Often, the builder, architect and subcontractor all bear a share of the responsibility. Unfortunately, many indemnification clauses provide that the subcontractor must indemnify the builder, if the claim is due in part to actions of the builder. A better solution is to make responsibility proportional. If the subcontractor is deemed to be 40% at fault, then the subcontractor is responsible for 40% of the damages.

The impact of these losses can be increased substantially in class action type situations. Zaring (Cincinnati) and Trinity Homes/Beazer (Indianapolis) are both examples of builders that became embroiled with a large number of mold related claims, involving hundreds of homes. In cases like these, plaintiff attorneys will seek to recover from every source possible, including subcontractors. These losses could easily exceed the coverage limits of your general liability insurance policy. Additionally, most insurance policies have excluded mold claims from policies, leaving subcontractors uninsured for mold related claims.

The increased use of indemnification is a direct result of the explosion of liability claims by homeowners against homebuilders. These claims pose significant problems to builders. Insurance has become increasingly difficult to obtain for builders. Their response has been to push as much of this exposure down to the subcontractor as possible. Since we are supplying most of the labor and materials for our work, we will be the final stop on this trail of liability claims. Our long-term survival may depend on our ability to manage this exposure to liability claims. Insurance will be part of the solutions, but these claims can exceed our coverage limits, and if claims losses become excessive, our insurance coverage may be jeopardized.

As with other important contract provisions, it is often possible to negotiate changes with builders, even large national builders. In the next article, we will look at the best strategies for negotiation changes to subcontractor agreements.

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