Smith Construction is a road construction contractor, entering all manner of contracts for construction and repair of public roadways. On some jobs, Smith is the only contractor involved, contracting directly with the Department of Transportation and doing all the work alone. Other times, Smith is one of many contractors, all working pursuant to Department of Transportation specifications.
In situations where Smith is the general contractor but it has subcontractors working under it, Smith routinely uses a form contract with all of its subcontractors. One paragraph of that form contract provides that "the subcontractor will indemnify Smith for the negligent acts of the subcontractor." This language is in every subcontract agreement Smith uses, and the subcontractors always sign without question. Logically, Smith assumes that this generic indemnity agreement will protect it from liability when it is sued for claims of negligence by its subcontractors, their employees or members of the general public.
Sure enough, the day comes when one of Smith's subcontractors' employees is seriously injured in the course of his work. It turns out that the worker was seriously burned while preparing hot mix - but the work was being performed in an unsafe manner. Smith's subcontractor (Chang) did not require its employees to wear safety gloves, goggles or other protection, and the mixing was not conducted pursuant to standard safety protocol. Clearly, Chang was negligent in the supervision of its employees and the enforcement of basic safety standards.
When Chang's employee eventually sues Smith (he could not sue Chang as Chang subscribes to Worker's Compensation), Smith believes that the indemnity provision in its contract with Chang will require Chang to defend it in the lawsuit and will ultimately protect it from liability. Smith would be wrong.
What exactly is contractual indemnity?
According to Black's Law Dictionary, which is the Bible of all things legal, indemnity is a noun, defined as "reimbursement of compensation for loss, damage or liability." Black's likewise defined indemnify as a verb, "to reimburse a loss that someone has suffered because of another's act or default." While the duty to indemnify can arise in various settings, in the construction industry, indemnification is generally a matter of boilerplate contract language.
These definitions suggest a pretty straightforward concept - that when Chang has agreed to indemnify Smith, this means that the Chang must reimburse Smith for Smith's losses related to the indemnification agreement. And yet it isn't nearly so simple in the real world.
Defense versus Indemnity
First and foremost, businesses need to understand that in many states (Texas being one of those many) defense and indemnity are two different concepts. "Defense" means literally that - securing an attorney and paying the cost of attorneys' fees, experts, court costs and other expenses incurred in defending a lawsuit. But an agreement to indemnify without an agreement to defend means that Smith (or Smith's own insurer) will have to find and hire its own attorney. Moreover, while Smith will clearly incur defense costs in association with being sued by Chang, these costs of defense are not a part of the loss covered in an indemnity agreement that requires "indemnity" but not "defense and indemnity." Chang will not be required to reimburse Smith for the costs of defense.
In the case at hand, Chang has promised to indemnify Smith. Chang has not promised to defend and indemnify Smith. As such, even if Chang were to acknowledge its indemnity duty to Smith and agree that its employee's claim against Smith falls within the indemnity obligation in the contract, Chang would not be required to pay Smith's costs of defense in the lawsuit that its employee brought against Smith.
Worker's Compensation Law Trumps Contractual Indemnity Language
Even more important for Smith to understand, other areas of the law can operate to make its indemnity agreement with Chang ineffective. While different states have different specific details in their Worker's Compensation laws, many states (such as Texas) have developed rules concerning how the Worker's Compensation bar affects indemnity agreements.
In short, one benefit employers receive through providing Worker's Compensation insurance to their employees is that the employer cannot be sued for negligence by their employees in the event of an employee injury. The rationale is that since the employee has medical and lost wages paid directly by Worker's Compensation insurance procured by the employer, the employee should not be allowed to additionally sue the employer for even greater recovery. The law provides a bar, preventing the injured employee from suing the employer in tort or negligence. The law goes on to prevent any other party from suing an employer who subscribes to Worker's Compensation, if the nature of that lawsuit would allege that the employer was negligent.
How this affects Smith is simple: Smith's right to indemnity from Chang is conditioned on Chang acting in a negligent manner. Under the Worker's Compensation laws, though, Chang is protected from being found negligent, regardless of how safe or unsafe its actual practices may actually be. The courts who have considered this issue have determined that the Smiths of the world cannot recover from the Changs under indemnity agreements such as the one presented above. The courts have explained that because the injured employee has no right to sue Chang for negligence, Smith likewise has no indemnity claim against Chang for negligence. In effect, Chang is not responsible for its acts of negligence - neither to its employees nor to Smith.
What is a Contractor to do?
What is Smith to do? It contracted with Chang for indemnity if Smith is sued for Chang's negligence, and yet, when Chang's negligence causes injury to Chang's employee, the indemnity provision in the contract appears to be meaningless. How can Smith make sure that its indemnity provision is effective? How can contractors make sure that the provisions they place in their contracts are enforceable?
- First and foremost, form contracts need to be routinely reviewed, by an attorney with knowledge of the law of the state in which the work will be performed and knowledge of the law of the state in which the contract is subject to suit. As laws can change without legislative changes - court decisions can alter the way in which a contract is to be construed - a one time review of contract terms is insufficient. Contractors need to routinely guarantee that their contracts provide them with the rights they intend.
- In addition to keeping contracts current and tailored to the jurisdictions in which they are used, contractors need to be sure that they fully understand their rights under contract terms. Contractors are not in the business of practicing law, and being required to understand the nuisance of laws may seem burdensome. But prudent business owners need to understand the limitations and the requirements of their contract, so they are not caught off guard when issues arise.
- Contractors also need to understand Worker's Compensation laws and how those laws affect them. Most businesses understand that subscribing to Worker's Compensation protects them from lawsuits. But businesses need also understand that another contractor's Worker's Compensation may also affect it.
- Because contract terms are not always enforceable, contractors need to always carry enough insurance to protect themselves, rather than relying on indemnity provisions or third-party insuring agreements. The risk of litigation is a cost of doing business, and a contractor's best defense from being caught off guard is to plan accordingly.
The problem of Smith's lawsuit by Chang's employee is simply one example of the problems that may arise in what seems to be a clearly written and easy to understand indemnity agreement. Contractors obviously rely on the terms of their contracts; otherwise, they would never include those terms in the first place. As such, contractors need to understand what those terms actually guarantee and when those terms may become ineffective.
About the author
Elizabeth Weathers, an associate with Sedgwick, Detert, Moran & Arnold LLP, concentrates her trial practice in the areas of environmental liability litigation, commercial and road construction accident and defect litigation, and product liability litigation. Ms. Weathers also has a general liability defense practice, where she uses her trial skills to defend clients in all matter of claims.