Q&A: Avoiding Risk Management Mistakes
In counseling clients on insurance coverage and risk transfer issues, we frequently see clients unknowingly enter into construction contracts that expose them to potentially avoidable and sometimes uninsured risks. Generally, these mistakes can be avoided if clients understand the risks and how to avoid them.
Q: Is there one thing that your construction clients do when entering into contracts that keep you awake at night?
A: If I was to pick one, and there are many, it is entering into contracts without fully understanding the contractual indemnification obligations they are assuming and the insurance requirements to which they are agreeing. It is crucial for general contractors (GCs) who are contracting with owners, and subcontractors (SCs) who are contracting with GCs, to understand what the indemnity and insurance provisions in the contract actually mean from a business-risk standpoint. I always recommend that clients, at a bare minimum, have these provisions reviewed by their insurance professional to determine (a) whether they are assuming an uninsured risk by agreeing to the indemnity provision; and (b) whether their current insurance program complies with the insurance requirements. Ideally, contracts should be reviewed by both an attorney and insurance professional. If the insurance professional is unwilling or unable to do so, you need a more sophisticated and capable professional. It is important to review these provisions when they are part of a bid package and to discuss any problematic requirements with the owner prior to submitting the bid. It is often difficult to negotiate changes in these requirements after the bid has been accepted.
Q: Have you seen changes in the indemnification and insurance provisions that are being required by owners and GCs?
A: Sophisticated owners and GCs understand how important it is to shift the risks associated with a construction project to those who are actually doing the work. An owner wants to shift that risk to its GC and the GC, in turn, wants to shift that risk to its SC. In construction, risk transfer rolls downhill. Effectively transferring that risk starts with a solid form contract that contains (a) a comprehensive and enforceable indemnification provision; and (b) insurance requirements that ensure that all contractors have appropriate insurance coverage for the work they are performing, including additional insurance requirements for the owner and GC. Generally, large GCs and experienced owners have the most comprehensive (meaning lengthy and burdensome) indemnification provisions and the most detailed insurance requirements. If it has been a few years since you had your form contracts reviewed by counsel (or if you have never done so), we would recommend that you do so to make sure that your form contract provides you with as much protection as possible. We often see form contracts that appear to have been “cut and pasted” together and that are not only missing key provisions but have provisions that are incomprehensible and incomplete.
Q: Why is this risk transfer so important to contractors?
A: Construction projects can be dangerous – expensive property gets damaged and people get badly injured (or even killed). Maintaining a safe project site is critical. But even at the safest sites, accidents happen. By effectively shifting the risk of responding to these property damage and personal injury claims down the contracting chain to the responsible party — for example, from GC to SC — the GC can minimize the expense to its own general liability carrier. Fewer, less expensive claims means better loss ratios and lower premiums, all of which can give a GC a competitive advantage in the marketplace. Similarly, for the SC who has assumed that risk (by agreeing to indemnify a GC for injury claims brought by the SC’s employees), the SC needs to make sure that the risk it has assumed is insured. If not, the SC is assuming an exposure that could financially cripple, if not bankrupt, the company.