Construction work, by its very nature, is a high-risk type of business. It usually isn’t a matter of if a loss occurs, but when and how much. When a loss does occur, such as an electrical wiring fire, all the parties involved with the project generally point the finger at the other parties.
In the construction industry, having a hold harmless clause in a contract is one way that a specific party can ensure that another party involved shares, or pays the cost of, an incurred loss. General contractors and owners commonly use hold harmless clauses to reduce their exposure to risk, thereby helping them maintain lower insurance premiums.
Hold harmless clauses can be like a cat and mouse game. The owner applies pressure to the general contractor, then the general contractor pressures the subcontractors. The subcontractors then pressure their subs, with each attempting to get their share of express indemnification into the contract during the process.
Express indemnification is a written agreement in the contract that will secure or protect a person from the legal responsibility of a loss. Essentially, it holds a person harmless and a person responsible. The indemnitor is the named person taking responsibility for a potential loss or risk. The indemnitee is the named person to be protected. There are generally three types of these clauses used in construction contracts. Be cautious, as some of these clauses can even be found within the fine print of a purchase order.
A Type Three, also called a comparative fault clause, will hold the indemnitor liable for the loss or extent of loss he/she causes. For example, a contractor could agree an owner will be harmless in any claims related to the project, but only to the degree the claim was partly or entirely caused by the omissions or negligent acts of the contractor.
A Type Two, also called an intermediate form clause, is the most commonly used. The indemnitor assumes all the risk unless the indemnitee is attributed as the lone cause of risk. For example, a contractor could agree an owner will be harmless from any claims related to the project if the claim is caused partly or entirely by an omission or negligent act by the contractor and without regard to if the claim was caused in part by an omission or negligent act by the owner.
A Type One, also called a broad form indemnity clause, involves the indemnitor holding the indemnitee harmless from risk, even if the indemnitee is the cause of the entire loss. For example, a contractor might agree to hold an owner harmless for any and all claims related to the project, without regard to whether or not the owner’s negligence was the sole cause of the claim.
Due to the fact that construction is such a highly competitive business, many subcontractors and contractors often feel forced to assume total liability on a construction project, regardless of fault, in order to win the bid for the project. The contractor can easily go bankrupt if an accident happens with losses more than the contractor can cover. Many states have sought to protect the construction industry by passing laws that limit the types of clauses allowed in contracts. In most cases, the state where the work is being performed will be the applicable state law. For example, a company in Michigan wrote a construction contract with an intermediate form clause for work to be done in Delaware. A loss occurred and the Michigan company attempted to hold the contractor responsible through the clause. Even though Michigan recognized such clauses, Delaware didn’t and threw it out.
Overall, those at the top of the ladder, such as the owner and general contractor, favor hold harmless clauses. After all, they only benefit by leveraging blame downward. For the subcontractors at the bottom of the ladder, these clauses are much less appealing. While a common part of the doing business in the construction industry, having a hold harmless clause with a general contractor or owner that has a reputation for unsafe operations or excessive demands might not be the best idea. Consult with your attorney for more information.
Peter Ryan, CPA, MBA (email@example.com) and Jason Dudas, CPA (firstname.lastname@example.org) both specialize in the construction industry. For questions regarding the Tax Cuts and Jobs Act please contact Peter and Jason directly.
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