By Mark Jackson, JCJ Insurance Agency
It is extremely important to know the risks involved in the agreements you sign. Oftentimes during contract negotiations, design firms are determining their level of comfort with the risk verses rewards for that specific project. Having high, uninsurable, out-of-pocket costs is a risk many firms would like to avoid. However, agreeing to a Duty to Defend is doing just that – putting your firm at financial risk by agreeing to an uninsurable obligation. Before we get into specific details regarding the Duty to Defend, it helps to understand the Duty to Indemnify.
Most contracts between a design professional and their client contain an Indemnification clause. The Duty to Indemnify is a contractual obligation by one party (typically the design firm) to pay or compensate for the losses, damages or liabilities incurred by another party to the contract (project owner) or a third party. When you indemnify someone, you are compensating them for a harm or loss that they have suffered because of your actions. Typically, you will sign a contract with a client that includes an indemnification provision in which you agree to indemnify the client against losses or damages that arise out of the contract – such as damages caused by negligence in the performance of your services.
There may be instances in which another party, such as a subconsultant, might indemnify you. If you become liable for damages caused by the services of your sub-consultant, your sub-consultant will compensate you for any money you have to pay to satisfy your obligations. In a typical design-bid-build contract, if your firm is the Prime, you will indemnify the Owner and your subconsultant will indemnify you. If you are the subconsultant, you typically indemnify the Prime and the Owner. You should never indemnify the Contractor in a design-bid-build project.
An Indemnification clause may include any, or all three, of the following obligations: indemnify, hold harmless, and defend.
- “Indemnify” means to reimburse your client following a claim.
- “Hold Harmless” prohibits you from bringing a suit against the indemnified party for any money you paid on their behalf.
- “Defend” is an obligation to provide the indemnified party with legal defense against a claim, regardless of your fault.
This is an example of typical indemnification clause:
“The Design Professional will indemnify, hold harmless, and defend the Owner, its employees and officers from damages, claims and losses to persons and property to the extent caused by the negligence of the Design Professional or its Consultants during the performance of their duties under this agreement.”
We do not have any concerns with agreeing to indemnify and hold harmless your clients for your negligent acts or omissions. This type of claim is covered under your Professional Liability insurance when there is a claim alleging your negligence. However, we strongly recommend that the Duty to Defend clause be removed from every contract that you sign.
The Duty to Defend is separate from the Duty to Indemnify. It refers to your obligation to provide the indemnified party with legal defense against claims. It is triggered as soon as the claim is made. And it applies regardless of whether you are found liable for any damages.
If you agree to “defend” your client, be prepared to pay out-of-pocket for these expenses. A duty to defend is based on your contractual commitment, and not common law, and these costs are likely uninsurable. Essentially, when your client is involved with a claim, they can hire an attorney of their choice and send you the monthly invoice. This obligation can extend through the entire litigation process including any appeals so these costs can be quite substantial. You are incurring your client’s legal expenses as they defend themselves against a third-party claim, and you may not even be responsible for the claimed damages. How is this fair?
Fair or not, if you agree to it in a contract you are now obligated. There have been court cases where a design professional was found to be not negligent in a claim but was still ordered to pay the client’s defense cost in the matter due to the contract language. In these cases, the obligation to reimburse the Owner is not covered by your Professional Liability insurance.
When there is a claim, you want your Professional Liability policy to respond. Indemnifying your clients is the right thing to do and, when tied to your negligence, it is covered by your Professional Liability policy. Oftentimes, the clients also want the Professional Liability policy to be triggered but they still ask for the duty to defend.
What happens if an Owner is not willing to strike “defend” from their agreement? An alternative is a split duty to defend. You can agree to defend your client with the exception of professional liability claims. The majority of contracts that we review for our clients include a requirement that the Owner is listed as an Additional Insured on your General and Auto Liability policies. As an Additional Insured, the insurance company has a duty to defend them against a third-party claim. Sample language would be as follows:
“Except for Claims arising out of Design Professional’s professional negligence, the Design Professional will indemnify, hold harmless, and defend the Owner from damages to the extent caused by the negligence of the Design Professional or its Consultants during the performance of their duties under this agreement. Solely for Claims arising out of Design Professional’s professional negligence, the Design Professional will indemnify and hold harmless the Owner from damages to the extent caused by the negligence of the Design Professional or its Consultants during the performance of their duties under this agreement”.
It is imperative to know the risks involved in the agreements you sign. You do not want to pay out of pocket expenses (uninsurable) when you are not negligent. If you have any questions or doubts about what your client is asking you to sign, contact your attorney or your A&E insurance specialist.
Mark Jackson is a founding partner with JCJ Insurance. Mark specializes in professional liability and other commercial insurance for architects and engineers. Mark provides an array of services, including contract review. He is past President of a/e ProNet, a network of insurance brokers who specialize in serving design professionals. Mark graduated from UCF and has earned the Associate in Risk Management (ARM) designation.