In this age of outsourcing and specialization, construction companies have to depend heavily on subcontractors and other third party providers on most projects. The use of subcontractors helps to ensure projects are completed in a timely and efficient manner, but it also creates a wide range of contractual risks.
Without a properly structured risk-transfer program, a general contractor (GC), owner or property manager would assume financial responsibility unnecessarily for losses caused by a third party, who is contractually obligated to control or prevent those losses. The financial impact could be significant — more so in certain jurisdictions.
Take the case of a New York-based employee of an uninsured or underinsured subcontractor injured on a jobsite.
If the employee sues the upper-tier contractor under the parameters of New York Labor law 240, and the contractor attempts to tender a claim to the subcontractor's insurer, per the indemnification or hold harmless wording in the contract, the insurance carrier would likely deny coverage. This, in turn, forces the contractor's insurance policy to respond to the claim.
New York Labor Law 240 claims run on average at about $ 1 million per claim: A loss of this magnitude could result in a 50% to 200% increase in the upper tier contractor's renewal program.
Related: How technology is revolutionizing construction risk mitigation
|The basics of contractual risk transfer
Contractual risks come in all shapes and forms — when you purchase components or raw materials from a supplier; lease a building; or in the case of a builder or property owner, hiring all the various subcontractors on a construction project.
Any time a construction company enters into a performance contract, lease agreement, purchase order, service agreement or supply contract, the business is exposed to liabilities automatically.
There are three components to a Contractual Risk Transfer program:
- Indemnification is the contractual obligation of the subcontractor to return the upper tier contractor (GC/Owner/Property Manager) to the same financial condition that existed prior to the loss and/or to represent the GC as the sole source for financing the legal liability.
- Hold Harmless. This is when the subcontractor agrees to shield the GC and take on the legal liability that would have been placed on the GC.
- Waiver of Subrogation . This is a provision requiring the subcontractor to waive its right to recover against the GC.
Related: Insurance coverage for business income: What contractors need to know
|Common subcontractor policy exclusions
Companies should be mindful of the various common subcontractor exclusions, such as:
- Third-party action over exclusion, which excludes coverage for liability assumed under an insured contract when a lower tier subcontractor agrees to shield upper tier contractor.
- Subcontractor Warranty or Hammer Clause, which states that if all conditions in the warranty are not met with the subcontractor, the policy will either deny coverage or invoke a large deductible.
- Residential Exclusion, which restricts and excludes work on residential projects based on the policy language.
Seek expert advice
Construction companies need to work with a risk expert who can provide guidance for structuring insurance and indemnification provisions contained in contracts. He or she can help with reviewing subcontractor contracts and recommend preferred risk transfer methods (additional insurance or otherwise) as well as provide language to improve a company's risk position based on current coverage terms.
Additionally, an experienced risk professional can assist a construction firm with reviewing policies to ensure that the subcontractor has the necessary insurance limits and endorsements to be contractually compliant.
Contractual risks exist in virtually every construction transaction, so having a solid program in place combined with sound, expert advice enables you to consider all of your options and leaves no stone unturned.
Tommy Williams, USI Uniondale vice president, can be reached at [email protected] or by calling (516) 419-4095.
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