The Indemnification Nightmare

by Paul Deffenbaugh | 4 April 2021 12:00 am

The trouble, however, is that the size and nature of the problems that typically trigger these clauses can be catastrophic for a company. What starts as an unpleasant dream for anyone can quickly escalate into an awful nightmare for the unsuspecting.

Consider the following scenario, which comes from a case I litigated during the course of my career. The names and non-essential facts have been changed to protect those involved.

A subcontractor has its crew on-site working to install HVAC duct work in the ceiling of a partially finished space. One of the workers is on a ladder connecting ducts when he reaches up to move some electrical lines that were roughed in by the electrician the prior week out of the way. It’s not known to him at the time, but someone left the wire hot and did not lock or tag out the electrical box. The worker is immediately electrocuted when he grabs the wire, is knocked off the ladder, and sustains a serious head injury and electrical burns.

The subcontractor has the appropriate worker’s compensation coverage and pays out on that policy; and as is their custom as a good employer, the company generously covers some of the employee’s other bills while he is unable to work.

The subcontractor’s employee later sues the owner, the design team and the general contractor on the project claiming that they were negligent in the way that the work site was managed. Thinking he was safe because the company was immune under applicable workers’ compensation laws and not named in the lawsuit, the owner of the subcontractor considers the matter closed and holds the worker’s job for him until he is able to return to work.

For his part, the employee is grateful for how the subcontractor has handled the situation and represents that he has no intention of pursing any claims against his employer.

Several months later, however, the subcontractor is served with papers joining it to the employee’s lawsuit. This case eventually morphs into three separate pieces of litigation and the expenditure of in excess of $250,000 in legal fees for the subcontractor.

The initial case arises from an argument by the general contractor that the subcontractor was negligent for the way it managed its own workers on the site. There is also a claim by the general contractor that the subcontractor’s insurance should cover the general contractor for the loss. The subcontractor’s insurance carrier, however, has indicated that its policy does not cover the accident.

The subcontractor now finds itself defending a claim for which it already paid under its workers’ compensation coverage because the indemnity clause in its contract contained language that the general contractor insists is a waiver of the immunity provision of the workers’ compensation law.

It is this language that the general contractor argues that the subcontractor is responsible to indemnify the general contractor for both the subcontractor’s liability and that of the general contractor. Separately, the general contractor claims that the subcontractor breached the agreement because it did not purchase the correct insurance. This contention is driven by the fact that the subcontractor’s insurance carrier denied the general contractor coverage for the loss as an additional insured. As a result, the subcontractor was forced to sue its own insurance carrier separately to obtain coverage for the loss.

In essence, the subcontractor was facing a potential loss of several million dollars with no contribution from the other responsible parties— and this was separate from having to pay its own legal fees. In order to resolve all the claims, the parties had to exchange thousands of pages of documents and complete numerous depositions to sort out the facts and evaluate the claims for trial. Because the case was a matter of survival for the subcontractor, the owner was forced into finding a way to cover the litigation costs to defend the underlying lawsuit while the suit against its own insurance carrier for coverage on the claimed loss and the resulting attorneys’ fees expended to defend a matter was resolved.

After being in the court system for many years, the court decided that the subcontractor did not owe indemnification to the general contractor; but the same court determined that the subcontractor breached the contract to the extent the carrier did not cover the loss.

Fortunately, the insurance carrier was eventually convinced it owed coverage to a sufficient level that all the cases could be resolved. Resolution of the dispute took over six years and $1.5 million in combined attorneys’ fees and costs when all the parties were counted though. This can surely be classified as a nightmare by any standard.

The lesson to be learned is that indemnity and insurance clauses are worth the time to review and understand. While they don’t often come up in litigation, the nature of both the case and the pain it can inflict is significant.

A simple change in the indemnity clause would have prevented the entire dispute described above for the subcontractor; and in what may have been the most painful part for the subcontractor’s owner, he read the contract before he signed it and glossed over the indemnity and insurance provisions because he assumed his insurance would cover anything that might happen. Contractors who take this approach—and there are still too many—risk a similar outcome.

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Josh Quinter is a commercial litigation attorney with a focus on construction law. He is also a member of the board of directors and a department chair at his law firm, Offit Kurman[1]. Active in a number of construction trade and business organizations, he presently serves as the president of the Mid-Atlantic Chapter of the Metal Building Contractors & Erectors Association[2] (MBCEA), serves on the MBCEA national board and is the organization’s general counsel. Contact him at jquinter@offitkurman.com[3] or for more information go to www.offitkurman.com/attorney/joshua-quinter[4].

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