Contractual Risk Transfer for Construction (USA)

As with any project, construction projects come with potential financial and operational risks for contractors when working with third-party providers of products and services. Through Contractual Risk Transfer (CRT), a business seeks to identify and to manage its contractual liabilities arising out of these type of business relationships with other parties such as contractors, owners, architects and engineers. CRT simply requires that a business take responsibility for its own actions (and their consequences), while requiring its business partners to assume a share of risk relative to their ability to control that risk.

Effective risk transfer can save you money by lowering your overall cost of risk and keeping you competitive in the markets you operate. Because your business may be a party in a number of contractual relationships at any one time, it is essential to control the type and magnitude of the liabilities you may assume via a contract. Conversely, you should look for opportunities to manage your risk by having others contractually assume their proportionate share of liability.  

Written contracts

Construction projects can involve activities by several businesses (contractors, vendors, suppliers, etc.) at a work site.  As a result, in the event of a lawsuit, an injured person may sue multiple parties, particularly if it is unclear who may have been responsible, or partly responsible, for the injuries. On construction projects, in particular, it is essential for contractors to clarify their responsibilities, duties and rights by means of written contracts.

Construction contracts need to be in writing and signed by both contractors. They should generally contain two methods for transferring accident risk and completed operations risk from the higher-tier (indemnitee/promisee) contractor back to the lower-tier (indemnitor/promisor) contractor. One is an indemnification clause where the lower-tier (subcontractor) contractor agrees to protect the higher-tier (general contractor) for injury or damages resulting from the lower-tier contractor’s work.  It is important that you consult with attorney knowledgeable in construction law in the state(s) work is performed to develop effective wording. The other method is an insurance requirement of the lower-tier contractor for the higher-tier contractor to have additional insured status under the policy of the lower-tier contractor. If the higher-tier contractor is sued in connection with the sub’s work, the sub’s liability policies will generally respond on behalf of the contractor.  Your insurance agent also can help you understand your insurance needs.

Additional insured status is also generally effective for the higher-tier contractor because:

• It creates direct rights applicable to the other party’s insurer.
• It can provide for a defense by the other insurer in the event of a lawsuit.
• It supports indemnity and hold harmless agreements.
• It provides an additional source of insurance funds in the event of a loss.

Assess your organization’s implementation of its contractual risk transfer program

A CRT program supports a contractual risk transfer process. It should:

• Be in writing.
• Be supported and administered by senior management.
• Have clear lines of authority spelled out for language modifications or exceptions.
• Have a clear documentation trail into the job files.
• Be reviewed at least annually by legal counsel to ensure compliance with changes in applicable laws, regulations and court precedents.

This CRT process should include:

• Goals for higher-tier contractors:
  • Require written contracts with every subcontractor, vendor and supplier.
  • Contract should include broadest legally allowable form of indemnification/hold harmless agreement to protect your interests.

Contract should include a provision naming the higher-tier contractor as an additional insured on the subcontractor’s liability policies, with the subcontractor’s insurance primary and non-contributory.

• Goals for lower-tier contractors:
  • Review indemnification/hold harmless agreements to determine the scope of liability assumed. Confirm that the scope is limited to the lower-tier contracto’s work.
  • Consult legal counsel on the applicable state statutes and case law regarding indemnification/hold harmless agreements to develop an understanding of your rights when contracting.
  • When you are required to provide additional insured protection for higher tiers, limit the scope of coverage you are required to provide to the scope of the work being done.
• Contract administration:
  • Confirm that the contracts has been received, signed and dated prior to work being done.
  • Confirm insurance and indemnity provisions have been specified in the contract.
  • Obtain Certificates of Insurance (COI) and Additional Insured endorsements And review to confirm they meet the contract requirements.
  • Employ a diary system to obtain new COI at expiration date on original COI?
• Your CRT policy should require that all subcontractors carry insurance appropriate to their work, including:
  • Commercial General Liability*
  • Automobile Liability (Comprehensive)*
  • Commercial Excess Liability (Umbrella)*
  • Workers’ Compensation and Employers Liability*
    *with limits equal to or greater than yours

The need for records

All contract documents relating to a job should be retained. This includes copy of contracts, additional insured endorsements, and certificates of insurance. Contractors should develop ways to maintain necessary records to enable them to defend potential future claims. Claims against the contractor may involve the owner’s (or tenant’s) allegations of construction defects, third party claims from the subcontractor’s employees, or from subcontractor insurance companies seeking subrogation for workers’ compensation claims that were paid to subcontractor employees.

A record retention policy should be established and communicated to all management and supervisory personnel with a project. Length of time that records should be kept may vary depending on the jurisdiction or state in which the contractor works. The key here is to maintain records for the length of time that they may be needed.  For example, states typically have a “statute of repose,” which restricts the time in which a claim may be brought against a contractor.  It begins to run from the “substantial completion” of the project and extends for several years. In this setting, records should be maintained, at minimum, for the period of time set by the statue of repose in the state the work was performed. Given the complexities o f this issue, it is best to consult legal counsel to determine the length of time that you should keep your records.