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Bench & Bar of Minnesota is the official publication of the Minnesota State Bar Association.

Risk-Shifting Indemnity Agreements in Construction: Are They Finally Demolished?

Minnesota legislation that took effect August 1 seems to have been intended to curtail contractors’ ability to shift their risk of loss for defective construction.  But late amendments to the legislation, including an undefined term “project-specific insurance,” leave uncertain whether the legislative intent has been realized.

Prior to 1984, contractors involved in building-construction projects could shift the risk of loss for defective construction through indemnity agreements.1 Minnesota courts used a “strict construction” standard to determine whether a pre-1984 indemnity provision clearly and unequivocally demonstrated an intent to shift the risk of loss for an indemnitee’s own fault to the indemnitor.2 Signaling its disapproval of this risk-shifting approach to liability for construction projects, the Minnesota Legislature enacted a provision rendering risk-shifting indemnity agreements unenforceable.3 Thus, for construction contracts executed after August 1, 1984, Minn. Stat. §337.02 prevents a contractor from obtaining indemnity when its own negligence causes personal injury or property damage. This statutory provision was meant to ensure that each party involved in a construction project remains responsible for its own culpable conduct.4

Although the statutory ban on risk-shifting indemnity agreements was thus to be the general rule, the legislature simultaneously enacted a “narrow” exception to the general prohibition of indemnity for the indemnitee’s own negligence.5 According to this exception, codified at §337.05, risk-shifting indemnity agreements are allowed if coupled with an agreement to provide specific insurance coverage for the indemnity obligation.6 So even though a risk-shifting indemnity provision is unenforceable under §337.02, a promise to purchase insurance to cover any fault by the promisee is nonetheless valid and enforceable under §337.05. Contractors may thus place the risk of loss for defective construction on insurers by requiring one or more other contractors to insure against that risk.7

A Broadening Exception

Since the enactment of the general rule prohibiting risk-shifting indemnity agreements and the related exception for those agreements that are coupled with an insuring requirement, general contractors—despite often having a deeper pocket than their subcontractors—have regularly incorporated indemnity agreements and corresponding insuring agreements into their construction contracts to shift the burden of loss—including loss resulting from the general contractors’ own fault—to their subcontractors and subcontractors’ insurers.8 As the Minnesota Supreme Court saw it, “the legislature both anticipated and approved a long-standing practice in the construction industry by which the parties to a subcontract could agree that one party would purchase insurance that would protect ‘others’ involved in the performance of the construction project.”9 But as that same court later acknowledged, this method of risk allocation is “singularly inefficient” because it:

simply stacks one layer of insurance (that which the contract with the owner requires the general contractor to procure and maintain), atop a series of second layers (each subcontract requires each subcontractor to procure and maintain insurance covering their contractual undertaking) in order to shift the loss from the general contractor’s insurer to the insurer of whichever unfortunate subcontractor’s work is in some way connected with the injury or damage, whether or not the unlucky subcontractor was causally negligent.10

After years of contesting the legitimacy and parameters of the supposed exception to risk-shifting indemnity agreements (which, in practice, resulted in nearly universal risk shifting of general contractors’ fault to subcontractors and subcontractors’ insurers),11 subcontractors lobbied for and ultimately obtained a 2013 amendment to the §337.05 insuring exception.12 The obvious purpose of the amendment was to eliminate the insuring exception. But last-minute additions to the amendment called into question the extent of any actual changes to the status quo.

Preserving the Status Quo?

In particular, the Minnesota Subcontractors Association, along with 14-17 other trade organizations, proposed a bill that, in essence, would have changed §337.05 to reflect the original sentiment expressed in §337.02. That is, the proposed amendment to subdivision 1 of §337.05 sought to declare risk-shifting insuring provisions—like the risk-shifting indemnity provisions under 337.02—void and unenforceable.13 After leaving the substance of subdivision 1 of §337.05 intact as new subdivision 1(a), the proposed amendment added a new subdivision 1(b) that states:

A provision that requires a party to provide insurance coverage to one or more other parties, including third parties, for the negligence or intentional acts or omissions of any of those other parties, including third parties, is against public policy and is void and unenforceable.14

It is not clear why the proposed solution was not simply to rescind §337.05, eliminating the insuring exception to the ban on risk-shifting indemnity provisions. That approach would have been clean and would have led to only one conclusion: risk-shifting indemnity agreements in construction projects are no longer allowed. After 30 years, the elimination of the insuring exception would finally honor the original sentiment behind the 1983 legislation: to make each contractor in a construction project responsible for its own fault.15 The amendment actually adopted, however, is not quite so simple.

Not So Simple

After the proposed amendment by the subcontractors received support by the House and Senate Judiciary committees, opponents to the bill (general contractors and owners) offered testimony expressing their concerns. In an effort to alleviate those concerns, the author of the bill offered two additional provisions.16 After the Commerce committees approved the modified version of the amendment, the final bill passed and became effective August 1, 2013.17

The second of the two new provisions inserted into the bill does not appear to result in any practical significance. Under that provision, to be codified at subdivision 1(d), new paragraph 1(b) will not affect the validity of a promise to procure insurance for the promisee’s vicarious liability or liability imposed by warranty that arises out of the acts or omissions of the promisor. In other words, provision (d) simply reiterates that subcontractors can still be contractually bound to procure insurance to cover any loss suffered by the general contractor due to the fault of the subcontractor. Neither §337.02 nor the current §337.05 invalidated such efforts. As before, nothing in §§337.01 to .05 restricts any non-risk-shifting efforts.

But new provision (c) is another matter. The intent and import of this last-minute change to §337.05 remains to be seen in action or addressed by the courts. In the interim, owners, general contractors, subcontractors, insurers, and their counsel will undoubtedly initiate steps to take advantage of and ensure compliance with their interpretation of the new provision in their contract documents. That new provision states:

Paragraph (b) does not affect the validity of a provision that requires a party to provide or obtain workers’ compensation insurance, construction performance or payment bonds, or project-specific insurance, including, without limitation, builder’s risk policies or owner or contractor-controlled insurance programs or policies.18

The potential ambiguity in new provision (c) arises through the use of the term “project-specific insurance.” This is not a term of art in construction. Indeed, the term does not appear in any Minnesota case law or statute (other than, of course, this newly enacted provision). Parties will undoubtedly dispute the term: owners or general contractors may suggest that so long as a contract requires insurance for a particular project, risk-shifting indemnity agreements coupled with an insuring requirement remain valid vehicles to shift liability for their own fault. Subcontractors, on the other hand, will suggest that the intent was to negate risk-shifting indemnity obligations when coupled with the typical CGL policies. Counsel for one group of property owners has already recommended that owners require “project specific” language in their subcontracts in an effort to protect the owners more broadly.

Preserving Legislative Intent

If owners or general contractors are hoping to advance their argument that risk-shifting indemnity agreements are still allowed under the new law so long as they are still coupled with an insuring provision and the term “project-specific insurance” now appears in the contract, their hopes may not be particularly well taken. Courts presume that legislative enactments have a purpose.19 Any suggestion that the amendment to §337.05 fails to change the status quo for the typical building-construction project may run afoul of this presumption, leaving those making the suggestion hard-pressed to explain the practical difference between the law as it has existed since 1984 and the law under the 2013 amendment. The amendment must have some significance; the task is to identify that significance.

The subcontractors have a canon of construction on their side: ejusdem generis. Under the rule of ejusdem generis, codified at §645.08(3), “general words are construed to be restricted in their meaning by preceding particular words.”20 The rationale of the rule is that “all words in a writing should be given effect if possible.”21 “[W]here specific words enumerating members of a class are followed by general words capable of including the class and others[,] the former would be rendered meaningless if the latter were given their full and natural meaning.”22 Turning to provision (c), the legislature uses general words—project-specific insurance—followed by specific words enumerating exemplar members of that class. Specifically, provision (c) includes three examples of project-specific insurance that are still allowed in construction agreements: builder’s risk insurance and owner- and contractor-controlled insurance.23

Builder’s risk insurance is not a risk-shifting insurance. That is, the purpose of builder’s risk policies is to protect the insured, typically the owner of the property, from loss due to causes beyond the control of the owner, contractor or third parties, such as fire, hail, and high winds.24 This type of insurance would not normally be implicated in the historical risk-shifting efforts between general contractors and subcontractors. Thus, new paragraph (c) does nothing more than explicitly approve the continued use of certain other types of insurance coverage available in the construction context that do not otherwise attempt to shift the risk of loss for one party’s culpable conduct to another.

Paragraph (c) also expressly allows “owner- or contractor-controlled insurance programs or policies” as another “project-specific insurance” that is exempted from the ban on risk-shifting insuring provisions. Like “project-specific insurance,” the phrase “owner or contractor-controlled insurance programs or policies” is undefined in the amended statute or any other statute. Nor does that additional new phrase appear in Minnesota case law. Unlike the term “project-specific insurance,” however, the terms “owner-controlled insuring policy” and “contractor-controlled insuring policy” are terms of art. Those in the construction industry know what those terms mean even though the statute offers no help to Minnesota courts.

OCIPs and CCIPs

Owner-controlled insurance policies (“OCIPs”) provide coverage for all participants in construction projects: owners, developers, general contractors, and subcontractors.25 While OCIPs have been around for more than 40 years, they have gained significant popularity since the turn of the century. This surge in OCIPs is no doubt due to the proliferation of construction-defect litigation. Indeed, in some western states, it is now virtually impossible for subcontractors to obtain insurance, making the OCIP necessary to provide protection to construction professionals and property owners. Contractor-controlled insurance policies (“CCIPs”) are the same as OCIPs except that a key contractor, typically the general contractor, obtains the policy rather than the property owner. The use of CCIPs is likewise increasing.

It is not entirely clear why owners and general contractors wanted provision (c) added to the amendment to §337.05. But during testimony on the bill, opponents worried that prohibiting risk-shifting agreements would somehow preclude OCIPs.26 To alleviate those concerns—whether the new bill would have resulted in such preclusion or not—the bill was amended to expressly allow use of OCIPs and CCIPs.

OCIPs and CCIPs (commonly referred to as “wraps” or “wrap-ups” because they consolidate insurance, claims management, and loss control into one integrated program) are not used to shift the risk of loss from one contractor to another. In fact, wraps are used to share the burden of insurance and prevent future litigation over responsibility and coverage for a particular claim. Done properly, a wrap allows a construction-related claim to proceed much more quickly and efficiently, eliminating the need for (significant) participation in litigation by the contracting parties.

Historically, at least in Minnesota, contracting parties have relied on CGL policies to protect them from the risks associated with defective litigation. But the “your work” exclusion (the express incorporation into insurance policies of the commonly understood and applied business-risk doctrine that precludes coverage for an insured’s own inferior work) often made actual coverage for the typical construction-defect claims questionable at best. The wrap policy, properly organized, alleviates this risk. Indeed, the point of the wrap is to protect all of the contracting parties from claims resulting from defective construction, so the “your work” exclusion is not an issue for the standard wrap policy. Given that all claims are thus covered regardless of who is to blame or whose work is implicated, there is no need to shift the risk of any claim.

OCIPs and CCIPs are thus the perfect partner to builder’s risk policies. In fact, builder’s risk policies can be and often are incorporated into OCIPs and CCIPs. While builder’s risk policies protect against damages generally beyond the control of contractors, such as fire and storm damage, OCIPs are akin to error and omissions (E&O) insurance. So while the builder’s risk policy protects the property owner against loss where fault is not the issue, an OCIP protects the owner against loss due to faulty work. While pricier than their CGL counterparts, OCIPs provide the protection that both owners and contractors have been seeking since disputes over construction practices escalated in the last couple decades. Instead of fostering argument over coverage and fault allocation, an OCIP provides unquestioned coverage once actual damages are established. Fault allocation is unnecessary. Any disagreement would relate solely to the amount of any damages. And that dispute would involve not the myriad of general or prime contractors or subcontractors on a particular project, but instead just the property owner and the OCIP insurer on behalf of all of the project’s contractors.

To equitably split the burden of the relatively expensive OCIP (or CCIP) coverage, a general contractor typically obtains a quote for such coverage for a particular project, and then allocates the premium(s) for such coverage among itself and the various subcontractors based on some acceptable formula, such as dollar value of the work provided. As part of each subcontract, the subcontractors agree to contribute their allocated share towards the OCIP coverage. Then, should any issues arise either during or after a particular project, there is no argument over which party was responsible for which alleged items of damage:  All contractors are protected by the same insurer, which must pay all of the proven damages resulting from defective construction. Given the plethora of construction litigation over the past 20 years, it is rather surprising that OCIPs have not been more commonly used, at least in Minnesota. (The higher cost of OCIPs is most likely the reason.)

While the statutory amendment to §337.05 will allow the use of OCIPs and CCIPs, it is unclear whether an owner or general contractor may impose the entire burden of obtaining and paying for the OCIP/CCIP on a particular subcontractor. Such a scenario was not discussed in the legislative history. Most likely, such a scenario was simply not contemplated. The administrative burden and cost of an OCIP is significant, likely exceeding the capacity of a typical residential subcontractor. Regardless, the whole point of an OCIP is to consolidate the risks and related costs of liability exposures resulting from a construction project. Premiums are collected based on each contracting party’s history and potential exposure. Following from the purposes of the bill, each contracting party should be responsible for its own fair share of the costs of an OCIP/CCIP.

Coming Full Circle

Ultimately, based on the other terms in paragraph (c), it would not make much sense to argue that the term “project-specific insurance” could implicate CGL-type coverages. If that were true, the exception to the exception would have come full circle and rendered the amendment nugatory, a result seemingly not intended by the legislature.
Unfortunately, given the inclusion of the undefined term “project-specific insurance” in the new bill, the ultimate impact of the recent effort will have to await court resolution. Until then, parties will no doubt continue to rework their construction contracts in the hope of imposing or avoiding risk-shifting indemnity obligations. Ideally, all parties will eventually find protection from a single insuring policy covering all risks associated with construction projects. Then all involved parties to a construction project can focus on their work rather than on the litigation blame game.

Cheryl Hood Langel is a shareholder with McCollum, Crowley, Moschet, Miller & Laak, Ltd., Bloomington, Minnesota. She focuses her practice on motions and appeals in state and federal courts. Her firm has represented contractors, subcontractors, and other parties in construction litigation for more than 15 years.

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