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The interplay between indemnity clauses and additional insured coverage

Virtually every construction contract requires a subcontractor to indemnify the general contractor and add the GC (and sometimes other parties) as an additional insured on the sub’s liability insurance policies. This common practice creates hidden coverage gaps for both the GC and the sub. These gaps defeat the purpose of indemnity provisions and AI requirements, which is to shift the risk of certain liabilities from the GC (or other upstream parties, like the owner) to the sub. While a comprehensive review of these issues involved is beyond the scope of this article, so instead we provide a summary of often overlooked issues. 

First, recent versions of the various AI endorsements drafted by the Insurance Services Office – an organization that drafts “standard” policies widely adopted by insurance companies – limit the scope of the AI coverage to that of the construction contract’s indemnity provisions. Prior versions of the ISO endorsement did not contain this limitation, meaning the AI coverage likely was broader than the sub’s indemnity obligation. Thus, you should carefully coordinate the indemnity provisions and the AI requirements.

Second, recent versions of the ISO AI endorsements attempt to limit the coverage to the named insured sub’s “ongoing operations.” Obviously, many construction-related claims – especially construction defect claims – occur after the project is complete. While the term “ongoing operations” is undefined, the obvious intent of this language is to preclude coverage for claims arising from completed operations. This limitation conflicts with most contractual indemnification provisions, which do not limit the indemnitor’s obligations to ongoing operations. 

Third, recent ISO AI endorsements limit the coverage to the lesser of the contractual insurance requirement or the policy limit. This creates a possible coverage gap between the primary general liability policy and any excess or umbrella coverage the sub carries. 

For example, assume that a GC requires a sub to name the GC as an AI on the sub’s primary and excess liability policies. Assume as well that the construction contract requires the sub to carry $1 million per occurrence in primary coverage and $5 million total. Finally, assume that the sub’s primary general liability policy has a $2 million per occurrence limit. 

If a major claim occurs that exceeds the $1 million primary liability limit required in the contract, the primary liability insurer may claim that its obligations to provide AI coverage to the GC are capped at $1 million. The excess insurer likely will claim its coverage is not triggered until the underlying primary policy is exhausted, i.e., the primary insurer pays $2 million. Since the primary insurer’s coverage obligation to the AI is $1 million, this leaves a $1 million gap that the GC (or the sub, depending on the construction contract language) must bridge before the GC can access the excess coverage.

Another often-overlooked aspect of the more recent ISO AI endorsements is the limitation of the AI coverage to those with whom the named insured sub is in contractual privity. This can be problematic, because many construction contracts define the indemnitees to include not only the GC itself, but also its directors, officers, employees, agents, subsidiaries, parent companies, affiliates, etc. 

The sub usually is not in contractual privity with these individuals or entities. Moreover, the construction contract may require the sub to indemnify the owner, architect and other parties. 

The sub may not be in contractual privity with these persons or entities, either. If any of these persons or entities is named as a defendant in a construction-related lawsuit, the sub may be required to indemnify them but the sub’s insurer may deny any defense or indemnity coverage for them. 

Finally, many construction contracts purport to require the sub’s insurance company to provide the GC and other AIs with lengthy advance notice of cancellation, usually 30 days. The contracts also purport to require the sub to provide the GC with a certificate of insurance stating that notice of cancellation will be given in advance. 

However, the standard insurance certificate form states only “notice will be delivered in accordance with the policy provisions.” Setting aside the ambiguity concerning to whom notice will be delivered, the certificate is not part of the policy and creates no obligations on the insurer’s part. In fact, most insurance companies do not even receive copies of certificates.

Moreover, a general liability policy issued to a Colorado sub is likely to contain a statutorily required endorsement stating that the insurer “may cancel this policy by mailing through first-class mail to the first Named Insured written notice of cancellation” 10 days before the before the effective date of cancellation for nonpayment of premium or either 30 or 45 days before the effective date of cancellation for any other reason, depending on whether the policy has been in effect for 60 days or more. Thus, there typically will be no policy provision requiring the insurance company to provide any notice whatsoever to the AI. 

Further, attempting in the construction contract to force the sub or its insurance broker to provide a certificate of insurance purporting to require notice of cancellation beyond what the policy or state law requires is a possible violation of law. Specifically, Division of Insurance Bulletin B-5.21 notes that “Distribution of a certificate of insurance that has been modified, without authorization or the use of a non-standard certificate of insurance not authorized by the insurer, would at the least be misleading and could be in violation of Colorado Insurance Laws.” Thus, an attorney attempting to require a certificate of insurance inconsistent with the policy’s provisions concerning cancellation notice could be engaging in illegal conduct. 

In summary, shifting risk exposure from GCs and owners to subs through indemnity provisions and AI requirements can be complex, and coverage gaps are easy to fall into. Thus, a thorough understanding of what AI endorsements actually provide in relation to the construction contract’s provisions is key. 

This is not a task that can be rushed at the 11th hour, so the prudent attorney will devote significant time early on to understanding these issues in individual contracts and draft accordingly. 

— Damian Arguello is the founder of the Colorado Insurance Law Center.

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