What Is Inefficient Risk Transfer? The Use of Indemnification in Construction Contracts

As a father of seven children, I am always being asked to determine the “responsible party” when something breaks, gets lost, or is simply missing.  In parenting, there is no written contract between the adult and to child to transfer the responsibility for the loss or damage.  In construction, there should be a written contract to transfer the risk when you are stuck between a rock and a hard place.

Rock

Understand that an indemnity clause in a construction contract is merely a written agreement to transfer some type of risk on the project to one or more of the parties, which may looks something like this:

Contractor agrees to hold harmless and indemnify the Owner, the Architect, the Lender and each of their agents and representatives for any losses, claims or other damages involving personal injury or property damage, other than to the Work itself, caused directly or indirectly by Contractor’s or its Subcontractors’ acts or omissions.

In a recent article in the Journal of the Canadian College of Construction Lawyers (2017 J. Can. C. Construction Law 1), Andrew Wallace and Victoria Merritt give a contractor’s perspective to contractual indemnity provisions in construction contracts.  While the authors recognize that indemnification provisions are standard for many construction contracts, certain indemnification provisions “raise serious concerns for parties involved in the construction project in so far as they reflect inefficient risk transfer between contracting partners.”

Since indemnification can be created by statute or by common law (or case law), the authors suggest that indemnity provisions should be included in construction contracts for two simple reasons: (1) to explain the legal principle that already exists by statute or common law; and (2) to expand one party’s exposure beyond what already exists by statute or common law.

Perhaps “inefficient risk transfer” (alluded to by the authors) comes when parties try to transfer risk opposite or beyond what the law addresses. Perhaps it comes when parties transfer risk to the party who ultimately cannot control they circumstances given rise to the loss. In the end, a court or arbitrator will be asked to determine the validity of the indemnification clause and whether the law will allow such a transfer of risk given the particular situation.

 

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What Is Inefficient Risk Transfer? The Use of Indemnification in Construction Contracts

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