As a builder, you can be held liable for any losses that happen while working on a construction site. Before you sign your next construction contract, you should pay attention to the indemnity clause. Not reviewing the indemnity clause could be costly for your business. This article will explain what builders should look for in an indemnity clause when reviewing a construction contract.
What is an Indemnity Clause?
An indemnity clause is a promise by one party in the contract to provide protection and compensation to the other party if the loss, damage or costs occur.
When a party fails to comply with its contractual obligations the other party may be entitled to damages that would put them in the position they would have been in if the contract was performed as originally intended.
However, the award of damages can be reduced due to factors such as:
- causation;
- remoteness; or
- mitigation.
An indemnity clause allows parties to circumvent these limitations and allocate risk.
A well-drafted indemnity clause distributes risk between parties who are willing to bear the risk. This process is known as “apportioning liability” between parties. Depending on the party’s wishes, the clause can cover a broad or narrow range of losses.
The most common types of indemnities in contracts cover:
- intellectual property breaches;
- breaches of work, health and safety laws;
- negligent acts or omissions;
- injury or death; and
- property damage.
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Why Are Indemnity Clauses Important in Construction Contracts?
Indemnity clauses help to distribute the risk of certain losses between principals and builders. In a typical construction project, the principal engages a builder, and the builder engages subcontractors to complete some of the work. The builder will usually indemnify the principal in their contract. The subcontractor will then indemnify the builder in their contract. This approach is known as “passing through” risk down the contracting chain.
As the builder, you need to ensure you know who you are indemnifying and how you are indemnified for the particular losses. While you cannot avoid indemnity clauses altogether, you can negotiate a fairer indemnity clause. For example, an indemnity clause can state that one party will only indemnify the other party against one particular loss, not all causes of potential losses. The most common example is a clause that indemnifies for losses arising from a breach of contract.
An indemnity clause can provide certainty about who is liable for particular losses. The most obvious benefit is that the indemnified party does not have to prove fault.
Continue reading this article below the formHow Can the Builder Indemnify the Principal?
Firstly, you need to understand the scope of your indemnity. Are you indemnifying the principal broadly for any losses, damages or costs? As the party who is indemnifying, you would want to make sure that the indemnity clause is precise and drafted as narrowly as possible.
You should review and amend your indemnity clause so that it aligns with the common law position as closely as possible. Additionally, you should link the indemnity to a particular loss, such as losses linked to a contractual breach.
For example, if Builder John Pty Ltd accidentally scratched a wall panel while delivering services and Builder Darcy later attempted to repair it but damaged the adjoining panel, then Builder John would only be responsible for indemnifying the damages related to the original small scratch. Builder Darcy would be liable for the additional damages caused by his repair attempt.
Liability Caps
Another way to control the risk associated with indemnities in a contract is to ensure the indemnity is subject to an overall liability cap. A limitation of liability clause limits the total amount of damages or losses that a party can be held liable for. It establishes a maximum financial exposure or “liability cap” for each party under the contract.
By capping the indemnity obligation to the agreed liability limit, you can better manage your contractual risk and potential liability.
How Can the Subcontractor Indemnify the Builder?
If you engage subcontractors, you want them to indemnify you for all types of losses. Your indemnity clause should set out the subcontractor’s liability for losses or damage that occur in a construction project. Ensure the indemnity clause covers all the risks associated with any goods or services you provide. You can cover many types of losses in an indemnity clause as long as the clause does not become so broad that it becomes ambiguous.
For example, suppose that in a construction contract, the subcontractor agrees to provide services to the builder for a lump sum of $40,000. The subcontractor breaches the contract by negligently causing a fire that burns part of the principal’s premises. The principal sends the builder a bill for $30,000 to repair the damage. The indemnity clause in this situation will mean the subcontractor is responsible for paying the $30,000.
Key Takeaways
Indemnity clauses highlight who is liable for certain risks that arise in projects. You can have a broad or narrow indemnity clause depending on who you indemnify or who will indemnify you. When drafting these clauses, it is important to remember:
- who you are indemnifying; and
- for what types of losses.
If you are drafting an indemnity clause, our experienced construction lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1800 532 904 or visit our membership page.
Frequently Asked Questions
Typically, in a construction contract, a contractor seeks to limit their liability to a specific amount or a percentage of the contract sum. Sometimes, a principal may also have a cap on their liability. A liability cap limits a party’s liability under a construction contract (so far as the law permits).
Typically, construction contracts concern work for the construction, demolition or repair of buildings,
structures and roads. It is important that you know what kind of contract you are engaging in, as this will determine certain obligations such as progress payments.
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