The following article originally appeared in Maryland Construction Network magazine in February, 2019. It has been updated for 2021.
Like an alligator in the swamp, every few years this issue resurfaces ready to take a bite out of unsuspecting contractors; namely the abuse of the indemnification clause to shift inappropriate risk.
Indemnification provisions play an important role in managing the risks associated with construction contracting. Indemnity clauses require one party to take on the obligation to cover the loss or damage that has been or might be incurred by another party. Basically, one party to the contract agrees to assume responsibility for certain liability resulting from third-party claims against the other party to the contract. The indemnification agreement may be a separate agreement, or more typically in construction projects, is embedded into the contract.
Contract clauses limiting liability were quite rare in design and construction contracts until the late 1970’s. 3 PHILIP L. BRUNER & PATRICK J. O'CONNOR, JR., BRUNER & O’CONNOR ON CONSTRUCTION LAW § 10:85 (West 2018). Limitation of liability and indemnity clauses, however, have become more commonplace over the years.
Historically, indemnity provisions have been typically interpreted to apply to only third-party claims. Id. at § 10:39; Am.Jur.2d 415, Indemnity § 1 (2005) (“In general, indemnity is a form of compensation in which a first party is liable to pay a second party for a loss or damage the second party incurs to a third party”); C.J.S. 94, Indemnity § 1 (2007)(emphasis added); (“In a contract of indemnity, the indemnitor, for a consideration, promises *1048 to indemnify and save harmless indemnitee against liability of indemnitee to a third person or against loss resulting from such liability”) (emphasis added). See also, e.g., Kodiak Elec. Ass'n, Inc. v. DeLaval Turbine, Inc., 694 P.2d 150, 40 U.C.C. Rep. Serv. 155 (Alaska 1984); Schiavone Const. Co. v. Nassau Cty., 717 F.2d 747, 751 (2d Cir. 1983); L.H. Controls, Inc. v. Custom Conveyor, Inc., 974
N.E.2d 1031, 1047–48 (Ind. Ct. App. 2012).
Some states, however, have interpreted broad indemnity provisions to apply to first-party claims, in addition to third-party claims. In large part, this is due to the fact that indemnity provisions are often not drafted in a way that expressly limits the application to only cases of third-party liability. As a consequence, courts will occasionally interpret indemnity language to apply to claims or losses other than those arising from injury to a third party. Wal-Mart Stores, Inc. v. Qore, Inc., 647 F.3d 237, 243 (5th Cir. 2011) (holding that, upon a plain reading of the contract, the indemnity provision authorized an award of attorneys’ fees in the first-party dispute between Wal-Mart and Qore).
A. Anti-Indemnity Statutes
Because the common law did not void broad indemnity agreements on public policy grounds, anti-indemnity laws were enacted to afford protection to those contracting parties generally not in a position to bargain away broad indemnity obligations.
In fact, nearly half the states have enacted anti-indemnity laws prohibit the enforcement of provisions that purport to indemnify the indemnitee for losses resulting from the indemnitee's "sole negligence," or "willful misconduct." SeeAlaska Stat. § 45.45.900; Ariz. Rev. Stat. Ann. § 32-1159; Cal. Civil Code § 2782; Conn. Gen. Stat. Ann. § 52-572k; Ga. Code Ann. § 13-8-2; Hawaii Rev. Stat. Ann. § 431-453 (now renumbered 431:10-222); Idaho Code § 29-114; Ind. Code Ann. § 26-2-5-1; Md. Code Ann., Cts & Jud. Proc. § 5-305; Mich. Comp. Laws Ann. § 691.991; N.J. Stat. Ann. § 2A:40A-1; S.C. Code Ann. § 32-2-10; S.D. Codified Laws § 56-3-18; Tenn. Code Ann. § 62-6-123; Utah Code Ann. § 13-8-1; Va. Code Ann. § 11-4.1; W. Va. Code § 55-8-14; Ga. Code Ann. § 13-8-2(b).
Yet, those anti-indemnity statutes may not affect whether an indemnity clause applies to first-party claims. For example, Virginia’s anti-indemnity statute for construction and design contracts does not prohibit first-party claims, but simply prohibits a party from indemnifying another for damages caused by the indemnified party’s own or sole negligence. Va. Code Ann. §§ 11-4.1 and 11-4.4.
B. Maryland’s Interpretation of Indemnity Provisions
While Maryland’s anti-indemnity statute is similar in appearance to that of Virginia mentioned above, Maryland courts have arrived at a different conclusion in its application when it comes to “sole” negligence. Pursuant to § 5-401 of the Maryland Code:
A [construction contract] . . . purporting to indemnify the promisee against liability for damages arising out of bodily injury to any person or damage to property caused by or resulting from the sole negligence of the promisee or indemnitee, or the agents or employees of the promisee or indemnitee, is against public policy and is void and unenforceable.
Both Virginia and Maryland courts hold that any indemnity provision in a construction contract which purports to indemnify the indemnitee against liability for damages caused by the indemnitee’s sole negligence is rendered void and unenforceable by law. See Uniwest Constr., Inc. v. Amtech Elevator Servs., Inc., 699 S.E.2d 223, 230 (Va. 2010), opinion withdrawn in part on reh’g, 714 S.E.2d 560 (2011), 699 S.E.2d at 230; Heat & Power Corp. v. Air Prod. & Chemicals, Inc., 578 A.2d 1202, 1206 (Md. 1990). In either Virginia or Maryland, a contractor-indemnitor will not be held liable for the negligence or wrongful acts of a project owner-indemnitee when the project owner-indemnitee is solely responsible.
Maryland and Virginia courts have diverged in their respective conclusions, however, when the contractor-indemnitor and project owner-indemnitee are concurrently liable. In Maryland, where “a particular contract provision or sentence can properly be construed as reflecting two agreements, one providing for indemnity if the [indemnitee] is solely negligent and one providing for indemnity if the [indemnitee] and [indemnitor] are concurrently negligent, only the former agreement is voided by the statute.” Heat & Power, 578 A.2d at 1206. Thus, Maryland courts will only void those indemnity clauses that indemnify the project owner-indemnitee for its sole negligence.
With respect to first party claims, Maryland (like Virginia) has no statutory or common law prohibition on indemnity. In fact Maryland has specifically recognized first party claims are subject to indemnification. Bainbridge St. Elmo Bethesda Apartments, LLC v. White Flint Express Realty Group, 454 Md. 475, 164 A. 3d 978, (Maryland 2017). In that case, the indemnity clause provided the following:
Bainbridge hereby indemnifies, and agrees to defend and hold harmless White Flint … from any and all claims, demands, debts, actions, causes of action, suits, obligations, losses, costs, expenses, fees, and liabilities (including reasonable attorney’s fees, disbursements, and litigation costs) arising from or in connection with Bainbridge’s breach of any terms of this Agreement or injuries to persons or property resulting from the Work, or the activities of Bainbridge or its employees, agents, contractors, or affiliates conducted on or about the White Flint Property, including without limitation, for any rent loss directly attributable to any damage to the White Flint Property caused by the construction of the Project, however Bainbridge shall not be liable for matters resulting from the negligence or intentional misconduct of White Flint, its agents, employees, or contractors. The indemnification obligations set forth herein shall survive the termination of this Agreement indefinitely. (Emphasis added).
During construction of the apartment tower next door, the neighboring White Flint property owner (Indemnitee) detected damage and notified Bainbridge (the Construction Manager) who in turn notified its general contractor (Turner). Turner stopped the excavation and braced the White Flint’s buildings to prevent further damage.
White Flint declared Bainbridge to be in breach of its contract, and then terminated the contractor and filed suit for declaratory judgment to enforce the indemnification obligations under the contract, which it claimed survived the contract termination. The trial judge granted summary judgment finding that Bainbridge’s obligations survived the termination; and that it materially breached the agreement, it owed continuing duties to White Flint, and must pay White Flint’s attorney’s fees.
Moreover the court held that it was not necessary for the indemnity provision to expressly state that it applied to “first party claims,” in order for the court to find that it contained a first-party attorney’s fee shifting to the contractor. Instead, the court looked at the overall “language and structure” of the article to conclude that the damages, losses and attorney’s fees were not limited to those arising out of third party claims. “The inclusion of the words ‘attorneys fees’ together with a reference to damages ‘arising out of … breach’ constituted an express provision authorizing first-party fee shifting….” (Court of Special Appeals decision).
The Court of Appeals affirmed this decision and further explained that the indemnification article ties payment of attorney’s fees to an action for “breach” of the contract. It confirmed the intent of the parties to cover first-party counsel fees by referring to ‘rent loss.’ A first-party loss arising from a breach of the Agreement.
C. Practice Pointers for Indemnity clauses: Or how to negotiate a balanced indemnification clause
So how can contractors deal with the reality in that first party indemnification is allowable in certain jurisdictions? First and foremost, contractors should limit the indemnity obligation to personal injury or property damage. Whenever possible, the contractor or subcontractor should strive to limit its indemnity and hold harmless obligations to items for which it can obtain insurance. Generally, insured obligations involve the concepts of personal injury or property damage. The AIA ¶ 3.18.1 clause limits the indemnification obligation to personal injury and property damage (other provisions pertain to other AIA general condition provisions addressing copyright infringements, liens, and hazardous materials). That clause states:
§ 3.18 Indemnification
§ 3.18.1 To the fullest extent permitted by law, the Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses, and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss, or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them, or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss, or expense is caused in part by a party indemnified hereunder. Such obligation shall not be construed to negate, abridge, or reduce other rights or obligations of indemnity that would otherwise exist as to a party or person described in this Section 3.18.
Broad all-encompassing clauses that require the contractor to indemnify the owner from “all claims arising out of the performance of the contract” or “all claims alleged to have been caused by the acts or omissions of the contractor” are simply too broad and uninsurable. The contractor should carefully scrutinize indemnification provisions to ensure that the clauses in owner contracts are narrowly drafted to come within the insurable concepts of personal injury and property damage.
Second, contractors should limit the indemnity specifically to third party claims. The indemnity clause should be limited to third-party claims and not include the claims of the parties (the owner’s claims) to the contract. Language such as “breach of contract”, “breach of any terms of this agreement” or similar language should be struck. Again, by limiting the indemnity obligation to third-party claims, the indemnity obligation should be insurable.
Third, contractors should narrow the indemnity obligations to its negligence. As set forth in the AIA example above, limiting the indemnity obligation to claims “caused by the negligent acts or omissions of the contractor or others for whom the contractor is responsible” provides further protection to the contractor. Contract claims are thus excluded, and the contractor must be negligent for the indemnity provision to be triggered. The contractor should not be responsible for the payment of claims if those claims do not arise out of the contractor’s negligence.
Finally, it should be recognized that depending upon the jurisdiction, a first party indemnity clause might be a violation of state public policy and in light of the anti-indemnity law of the jurisdiction should not be included in the contract at all. While this is not true in Maryland or Virginia, contractors working in other jurisdictions might have this protection, but with that said, contractors should not merely hope this to be true, but must take proactive measures to limit the indemnity in the contracting phase.
I hope that this is helpful as you are thinking about indemnity clauses in negotiation of future contracts.
Tamara McNulty is a highly experienced construction and government contracts lawyer with over twenty years of practice both as a Partner in Am Law 100 firms and in-house experience as General Counsel and Senior Division Counsel for leading architecture, engineering and construction companies. She recently returned to private practice and is currently a Partner at the law firm of the Potomac Law Group in Washington, DC, where she specializes in complex construction and government contracts litigation. See her full biography at https://www.potomaclaw.com/professionals-Tamara-McNulty or contact her at TMcNulty@potomaclaw.com