Companies operating within the construction, resource and energy sectors commonly assume a variety of risks through their contractual arrangements. Whilst many of these contracts may trace their origins to an Australian Standard form, in many cases these contracts will have been ‘doctored’ from one project to the next.
Principals, both across the public and private sectors, increasingly use bespoke contractual terms and conditions which have the effect of minimising their own risks whilst passing on as much exposure as possible down the contractual food chain. Terms such as Novation of Design, Breach of Contract, Deed of Indemnity, Hold Harmless, Proportionate Liability (opting out in NSW, WA & TAS but excluding bodily injury), Fitness for Purpose, Warranties, Guarantees, and Indemnities are all common features of the modern contracting landscape.
There is no doubt contractors face significant challenges when navigating through increasingly complex tender processes in order to secure new work. Trying to identify, negotiate, price, and then assess the exposures with a view to making commercial decisions around whether to accept, avoid, retain or transfer these exposures, is a veritable minefield.
The level of complexity only increases in circumstances where there is limited ability to negotiate contractual conditions with the public and private sector but particularly in a competitive tender process where others players may be inclined to accept these terms with little or no consideration of the potential adverse impact in order to secure the work. This places all tenderers under pressure to also accept risks they may otherwise prefer to decline.
The potential negative impacts of accepting these contractual terms is further exacerbated when one considers that most insurance policies will exclude contractually assumed liabilities. Whilst the definition varies between policies and insurers, the basic premise is that where a contractor assumes a liability that would not have existed but for the existence of the contract, insurance coverage is excluded.
Many insurances commonly contain clauses to affect that:
“Insurers shall not be liable to indemnify the Insured in respect of liability to pay compensation where the liability has been assumed solely under an agreement or contract unless such liability would have attached in the absence of such agreement or contract”.
It is on this basis that contract conditions require careful consideration, because contractors must assess and consider commercial risks prior to acceptance, in addition to ensuring their insurance program responds adequately in circumstances where they may have assumed extensive contractual liabilities, such as those noted above.
For the purpose of illustrating the point, a basic example of a contractual liability is the Hold Harmless provisions contained within many commonly used construction contracts. The Hold Harmless (derived from Latin indemnis which means “not harmed”) provision essentially states that the contractor will indemnify the principal for any damages arising from the works.
The Hold Harmless clause will generally state something to the effect of: “The contractor holds the principal harmless from any damages, claims, liability or loss in respect of the performance of the works.” Under this clause, the contractor cannot make any claim against the principal (even if the principal has contributed to or caused the loss) because the contractor is required to “hold the principal harmless” by ensuring the principal does not suffer any liability as a result of the works.
For the purposes of the Contractual Liability exclusion, this would be deemed a contractually assumed liability and therefore coverage excluded by insurers. Under these circumstances, the Hold Harmless clause would prejudice the contractor’s ability to make a successful insurance claim and insurers would seek to exclude some or all of the loss, depending on the specific circumstances.
The Hold Harmless clause (like all indemnity clauses) involves a waiver of the insurer’s rights of subrogation (defined as the right for an insurer to legally pursue a third party that caused an insurance loss to the insured), which is a critical consideration for all contractors in the context of assuming any contractual liabilities. Effectively it means insurers lose the ability to recover their costs which would otherwise have been possible but for the contractor entering into the agreement.
The potential for adverse consequences with regard to insurance only becomes greater when contractors enter into more complex contractual arrangements involving issues relating to Novation of Design, Breaches of Contract, Deeds of Indemnity, opting out of Proportionate Liability or other capped Liability Schemes, accepting Fitness for Purpose, Warranties/Guarantees, and any number of other general contractual indemnities.
To identify areas of potential concern, contractors should seek advice from their brokers with regard to any Contractual Liability exclusions that may exist within their broader insurance program. It would also be advisable to provide copies of new and existing contracts for the purpose of identifying areas where your insurance program may not accommodate specific contractually assumed liabilities.