Construction Risk

Indemnification Clauses: Uninsurable Contractual Liability

Professional consultants are judged by whether or not they satisfied the professional standard of care (i.e., were not negligent in the performance of their services). That is what is covered under a professional liability policy; therefore, it is critical that the indemnification obligations be limited to damages to the extent caused by the consultant’s negligence. Anything more is barred from coverage pursuant to the contractual liability exclusion of the professional policy. By agreeing to more than that, the consultant effectively agrees to a higher standard of care that is uninsurable. Under the common law of the states, the professional consultant is not held to a standard of perfection, but instead is required only to meet the generally accepted standard of care. Language is sometimes buried deep within the insurance article of a contract that states the consultant must provide insurance with contractual liability coverage for the indemnity agreement. This is not acceptable for professional liability, as those policies do not provide such contractual liability coverage for defense costs. Additionally, they will not cover damages within the indemnity costs other than what would have been incurred in the absence of the contractual indemnity provision.

Strike Any “Duty to Defend” Language

There is no common law duty of a consultant to defend its client against third-party actions. That duty can only arise as a result of a contractual liability created through the indemnification clause of the contract. Since this is a contractual liability, it is excluded from coverage pursuant to the contractual liability exclusion of the errors and omissions policy.

Courts interpreting indemnification provisions that include “duty to defend” language have explained that this means the consultant must defend its client (i.e., pay legal fees on behalf of) as the litigation is ongoing. It cannot wait until the conclusion of the litigation to determine whether the consultant is found to have negligently performed services and therefore owe a separate duty to indemnify. The courts see the duty to defend and the duty to indemnify as two separate and unique duties. The professional liability insurance policy only covers damages to the extent they are caused by the consultant’s negligence — and that determination can only be reached at the conclusion of the case or by settlement to which the carrier agrees.

Although it is theoretically possible that the damages awarded by a court might include some attorney’s fees if there is a statute that requires the same, attorney’s fees are generally not awarded as part of a judgment in the American system of justice. Therefore, a clause stating that the consultant will defend (pay on behalf of) or indemnify (pay attorney’s fees after judgment is rendered) may create uninsurable liability. Agreeing to defend on behalf of a client, however, is the far worse situation. The consultant would be paying out of its own pocket its client’s attorney’s fees as they are incurred to defend against a third-party claim. Ultimately, that claim might not even be found to have been caused by the consultant’s negligence.

Typical advice to professional consultants from risk managers and insurance professionals is that any duty to defend the client pursuant to an indemnification clause, or other provision of the contract, is uninsurable pursuant to the contractual liability provision of the contract. Therefore, it should be struck from the contract language accordingly.

It is not good enough that the contract states that the duty to defend and indemnify is limited to damages resulting from the negligent performance of professional services. Even where the trigger is limited to “negligent performance,” a court could reasonably interpret the duty to defend to be such a broad duty that the consultant could be expected to begin defending a claim on behalf of its client (paying attorney’s fees as they are incurred) as soon as any allegations of negligence are made. This could be true regardless of whether those allegations are frivolous and ultimately disproved.

Although the results vary by state, it is generally the case that the duty to defend that is agreed to as part of an indemnification clause is comparable to the duty to defend that an insurance carrier has pursuant to an insurance company. An insurance company doesn’t wait to see if you are negligent before defending you. Rather, the company defends you as the battle is being waged in the hope of proving you are not negligent. Waiting until negligence has already been proven before starting the defense would be like waiting until the war has been lost before deciding to join the battle. The same principle applies to defense duties assumed by a consultant in an indemnity clause.

For a more detailed commentary, see the newsletter I wrote for publication in the most recent  Zurich A/E Briefings, spring 2012.

http://www.zurichna.com/internet/zna/sitecollectiondocuments/en/products/construction/designprofessional/aebriefings/aebriefing_2012_spring.pdf#page=1

 

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