Considerations for drafting effective contractual risk transfer provisionsAugust 15, 2018
Any Wisconsin business owner knows that risk is inherent in most business transactions. In many commercial endeavors, such as installing new production lines, constructing new buildings or transporting goods, the risk of injury or property damage is present. Companies understandably want to limit their exposure to such risks.
Two common devices utilized to manage such risks are (1) indemnification agreements and (2) agreements to procure “additional insured” insurance coverage. These tools, while undeniably useful, also present challenges for attorneys and business owners during the drafting process. Awareness of the state of the law in various jurisdictions will assist in ensuring the parties succeed in allocating risk as they intended.
Contractual indemnity is a common risk-transfer tool in today’s commercial world. In a typical indemnity provision, one party (the indemnitor) agrees to indemnify the other (the indemnitee) for loss the indemnitee experiences arising out of the indemnitor’s work. These agreements allow the parties to effectively shift the risk between them as to certain types of losses. Typically, a project owner, employer or general contractor will want to shift the risk of claims “downstream,” onto a subcontractor, vendor or other business partner performing the work that creates the risk. This way, the financial consequences of a risk are borne by the party who is best equipped to manage the employees, materials and processes that give rise to the risk. Parties have wide latitude to shift the risks presented by a project in a way that will reduce the risk of claims as well as the project’s overall cost.
It should be noted, however, that not all aspects of indemnification are considered beneficial. In situations where the contracting parties have substantially unequal bargaining power, indemnification provisions can create a situation where the indemnitor does not have sufficient financial resources to effectively protect the indemnitee and, by extension, to compensate injured persons. For this and other reasons, some states have enacted anti-indemnification statutes prohibiting such agreements. While most such statutes are limited to certain industries (most notably, the construction industry), attorneys and business owners negotiating indemnification agreements must consult the laws of their jurisdiction or risk drafting a void indemnification agreement. Wisconsin does not currently have an anti-indemnification statute.
Another popular risk transfer device are agreements to procure “additional insured” insurance coverage. These provisions require one party – again typically the downstream party – to purchase insurance coverage for the other party for claims arising out of the downstream party’s work or operations. These provisions are in some ways preferable to indemnity agreements because the indemnification obligation is backed with funds from an insurance carrier (in exchange, of course, for a premium). While such provisions are increasingly popular, parties should take care to ensure that the insurance coverage ultimately issued by the carrier is in complete conformity with the agreement’s requirements. In addition, some states include additional insured requirements within the scope of anti-indemnification statutes, potentially making the agreements void.
Attorneys and business owners trying to maximize the beneficial aspects of indemnification agreements and “additional insured” requirements should take care to understand the unique risks presented the particular transaction or project. If you would like advice or assistance with these issues in your commercial contracts, feel free to contact the author.