Who does not love a good souffle? Enthusiasts will know that a great souffle is not something you can obtain quickly. Rather, it is common in restaurants to order the souffle as dessert at the beginning of the meal because it takes an hour to bake. Risk transfer, like a good souffle, also requires planning, preparation, and the right ingredients.
In construction litigation, attorneys are often not retained until after the project has been completed for several years as the dispute between the homeowner and the general contractor or developer took time to escalate to formal litigation. A significant part of defense counsel’s legal analysis involves assessing and evaluating risk transfer opportunities. For example, in the case of a general contractor or developer who did not self-perform the construction work but instead retained subcontractors to do so, counsel will assess if risk can be transferred from the general contractor or developer to the subcontractors who performed the work which the homeowners allege is defective. In other words, a developer or general contractor can reduce its risk (i.e., liability and money owed) by transferring said risk (i.e., pointing the finger at) to a third party.
Sounds easy, right? Unfortunately, just like the souffle-making process, it is easier said than done. This task can be exceedingly difficult in the absence of contracts that contain strong indemnity and insurance provisions—the essential ingredients to effect risk transfer. Worry not! We have provided “baking” instructions for you below to help you get a great risk transfer souffle time and again.
Plan Ahead
Risk transfer strategies should be evaluated, assessed, and implemented during contract negotiations and before construction work even commences. This requires early planning and recognition that:
- There must be written contracts between the general contractor or developer and the subcontractors.
- The agreements must be signed by both parties.
- These written contracts must contain express indemnity and insurance provisions that require each subcontractor to defend and indemnify the general contractor and/or developer from any and all claims arising from their work at the project (to the full extent of the law) and require the subcontractor to name the general contractor and/or developer as an additional insured on their respective insurance policies.
It is imperative these provisions be included in all subcontract agreements regardless of the size of the project, the scope of work, or the nature of the relationship between the general contractor/developer and the subcontractor (yes, even if they’ve done business together for decades). The time spent preparing, reviewing, revising, and signing form contracts prior to the commencement of construction is time well spent for the protection of our clients in future projects. As the old adage says: “An ounce of prevention is worth a pound of cure.”
Include the Essential Ingredients
Express indemnity
A strong express indemnity provision in a subcontract is essential to allow the general contractor or developer to transfer its risk to the subcontractors who perform the work at the project. This will protect the general contractor and/or developer later on when the homeowner claims the work is defective, incomplete, incorrect, etc. The indemnity provision must state that the subcontractor is required to defend and indemnify the general contractor and/or developer from any and all claims arising from or related to their work at the project. The absence of such provision not only affects the ability of the general contractor or developer to transfer its risk to the subcontractors, but also may affect its primary coverage with its own carriers and its additional-insured coverage under the subcontractor’s insurance policies. It is increasingly common for primary carriers to reduce and/or remove coverage for the general contractor or developer if there is no written subcontract and/or such indemnity provisions are not present in said subcontract. Furthermore, insurance carriers for the subcontractors may also require such contractual language to trigger additional insured coverage under their policies. If no such coverage is triggered, it is difficult to fully transfer risk to the third party.
Insurance requirements
Another essential ingredient is a provision that requires the subcontractor to carry certain insurance limits and name the general contractor/developer as an additional insured under their insurance policy. More often than not, subcontractors’ insurance policies include endorsements that state that additional insured coverage is contingent on a written agreement which requires the subcontractor to obtain such coverage. The lack of a written agreement and the lack of this provision in a subcontract may result in the denial of additional insured coverage—a form of risk transfer. Furthermore, it is also imperative that the subcontract expressly state that the subcontractor’s coverage shall apply on a primary and non-contributory basis, and that any primary coverage of the general contractor and/or developer is secondary or excess coverage. This will ensure the best chance of transferring risk to the subcontractor(s).
Verify the quality of the ingredients
Another essential ingredient to effective risk transfer is for the general contractor or developer to verify that the insurance coverage obtained by the subcontractors in fact complies with the contract requirements and provides actual coverage for the work that the subcontractor was hired to do. In other words, if the project involves construction of residential tract homes, an insurance policy that contains a residential home exclusion is tantamount to no coverage at all and is not only detrimental to the general contractor/developer’s ability to transfer its risk to the subcontractor, but it is also detrimental to the subcontractor who will find itself without coverage for that particular project. Who has not heard of a rough grader who obtained insurance coverage that had a soils exclusion? To ensure a good chance at risk transfer, a general contractor or developer should take the time to confirm the subcontractors’ compliance with the written agreement prior to starting work on the project.
Enjoy your risk transfer souffle
Risk transfer strategies must begin early and prior to the commencement of construction. Developers and general contractors should ensure they have a written form agreement for each subcontractor to sign and that said written agreement includes the provisions set forth above. Further, developers and general contractors should evaluate their form contract provisions annually to determine if any changes are necessary to address changes in the law. A good construction attorney will counsel its clients on necessary adjustments and/or changes to the current contracts that will serve them well in not only their next project but will provide protection for years to come. Early preparation, planning, and the right ingredients are necessary for effective risk transfer just like baking a souffle.
Bon Appétit!