Often, organizations agree to accept the liability of another party (or business) as a standard practice. Such practice is known as “risk transfer,” and the transfer is either embodied in a written contract or agreed to, verbally, by the parties. Contractual risk transfers are commonly found in construction agreements, landlord/tenant agreements, service contracts, and purchase orders, but may also appear in a host of other agreements. The two most common elements of risk transfer clauses are “indemnification” and “hold harmless” provisions. These provisions may be used together or independently, and create a duty to pay (indemnification) and a duty to defend (hold harmless).

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Parties to indemnification agreements are known as “indemnitors” and “indemnitees.” The indemnitor is the party who agrees to accept the liability of another and the indemnitee is the party receiving protection from liability. As a matter of law, such contractual provisions must be clear and unequivocal in expressing the intent of the parties who transfer such risk.

It is important to recognize that a business that agrees to become an indemnitor is assuming liability, which in the absence of the agreement, may not exist. The construction industry is known for routinely incorporating broad indemnification provisions in contracts, and transferring liabilities for not only bodily injury, but also for pollution, design flaws, delay in construction and other perils not typically understood or contemplated by the indemnitor. Therefore, it is critical that the indemnitor understand the extent of potential liability for the risks assumed.

Both the indemnitor and the indemnitee should determine whether insurance coverage is available to the indemnitor to cover the risks assumed (or transferred) by the indemnification agreement. And, as insurance contracts typically provide coverage for only certain types of loss, it is probable that certain risks will not be financed by either the indemnitor’s or indemnitee’s respective policies.

Indemnitees will often, and prudently, request to be named as an Additional Insured on an Indemnitor’s policy, providing the indemnitee with direct access and legal rights to the benefits of the policy. While it is not suggested that an indemnitee rely solely on additional insured status for the funding of a loss, largely because the limits may be inadequate as they are shared with the named insured, and the policy terms are largely controlled by the named insured, additional insured status is, nonetheless, the standard to finance loss of the indemnitee.

Additional insured endorsements vary widely by insurance company and often require that the contract between the parties transferring liability be in writing. Indemnitees as well as indemnitors need to scrutinize an insurer’s policy language when additional insured status is requested because both parties are financially exposed if a risk that is thought to be financed (insured) is actually not.

Each party needs to, first, understand that an Additional Insured is only provided protections covered by the insured’s “natural” policy language, so economic loss, for example, from “a delay to market,” while an indemnifiable loss, will not be financed by a general liability policy that requires a trigger of bodily injury or property damage. Each party also needs to be aware of the insurer’s definition of Additional Insured, including whom the insurer defines as an Additional Insured, and the limitations drafted within the endorsement. If any of the language within the additional insured endorsement is inadequate, an indemnitor may very well find themselves financing an obligation without the benefit of insurance, and an indemnitee may be caught financing a loss intended to be assumed by an another (indemnitor).

Insurers typically limit coverage to the current policy term, not when a claim is made, so particular attention must be paid to whether the additional insured language includes coverage for “ongoing operations” or completed work, referred to most recently, in policies, as “your work.” It is also important to note that many additional insured endorsements will not provide coverage for acts emanating from the sole negligence of the Additional Insured, and yet contract language may attempt to transfer this liability.

Careful consideration needs to be given to the potential exposure of the indemnitee and indemnitor if it is determined that the insurance policy and additional insured endorsement do not extend to cover the assumed obligation(s). So, prior to entering into a risk transfer agreement, ask yourself the following:

  • What are the terms and implications of the indemnification and hold harmless clauses in the agreement?
  • Is the indemnitor required to obtain additional insured status for another?
  • Is the language of the additional insured endorsement adequate, covering the indemnitor’s responsibilities or must additional measures be taken to ensure that contractual obligation are properly financed?

Any questions on the matter should be addressed with your insurance agent or attorney.