What is Contractual Risk Transfer?

May 3, 2022

Construction Company reviewing their contractual agreements.Image credit: Freedomz/shutterstock.com

Contracts are often complicated and if you are not an expert in reading them, sometimes important details can be overlooked. There are significant risks inherent in every construction project. These risks can be driven by site conditions, the scope of work, an owner, or the contractors themselves. Regardless of the origin of the risk(s), they all have one thing in common - each contract executed will contain a clause transferring those risks from one party to another. This is done to eliminate a party’s exposure to risk.

As defined by the IRMI, Contractual Risk Transfer is:

“The use of contractual obligations such as indemnity and exculpatory agreements, waivers of recovery rights, and insurance requirements to pass along to others what would otherwise be one’s own risks of loss.”

Key Terms to Know

An Indemnification Agreement also referred to as a Hold Harmless Agreement, is a contract under which one party agrees to assume the liability of a second party. The parties to these agreements are the:

  • Indemnitor (often referred to as the transferee)
  • Indemnitee (often referred to as the transferor)

The Indemnitor assumes the liability of the legal claims that may be brought against the indemnitee because of the activities the contract covers.

Indemnity provisions come in three forms:

  • Broad Form indemnification
  • Intermediate Form indemnification
  • Limited Form (sometimes referred to as comparative fault form) indemnification

State Statutes place limitations on hold harmless agreements to protect the public by preventing contracting parties from engaging in unacceptable behavior. This preserves fairness and fosters economically appropriate allocation of loss exposures and actual losses.

A Waiver of Subrogation is a pre-loss voluntary relinquishment by an insurer of its right to seek damages that were caused by a party other than the insured. An individual or organization can relinquish its right to sue in contract or tort by including a waiver of subrogation clause in their contracts.

An Exculpatory Clause is similar to a waiver. It is a contractual provision purporting to excuse a party from liability resulting from negligence or an otherwise wrongful act. Many states use the terms “waive” and “exculpate” interchangeably.

In conjunction with the above contract clauses, a requirement to provide an Additional Insured Endorsement is common in construction contracts. An Additional Insured Endorsement obligates the transferee’s insurer to pay (or pay on behalf of) the third-party after it has suffered a loss.

The Importance of Contractual Risk Transfer

Contractual risk transfer’s function is to place the financial burden of a loss on the party best able to control or prevent the incident leading to injury or damage. Owners and upper-tier contractors seek to avoid the financial costs that can arise out of bodily injury or property damage to a third-party caused by a lower-tier/subcontractor for which they (the upper tier) could be held vicariously liable.

It is critically important to the success of a contractor’s risk management program that the contractor can identify the form of the indemnification agreement contained within the contract. The contractor must also determine whether their insurance program will respond in support of that indemnification. Bear in mind that you may enter a contract where the indemnification language is legal and enforceable, but your insurance program may not respond.

Furthermore, a cornerstone of a contractor’s sound risk management practice is to replicate the upstream contractual indemnification and insurance requirements in their subcontracts whenever possible.

Construction companies sign contracts on a regular basis. Understanding contractual risk transfer in these contracts is critical to your business’s bottom line. Work with a Broker that is experienced in contract review for both risk management and insurance programs. Contact TSIB today and speak with one of our Risk Consultants.

Learn more about the TSIB Difference!

TSIB’s Risk Consultants are currently servicing the following locations:

East Coast: New York City, NY; Bergen County, NJFairfield County, CTPhiladelphia, PA

Texas: Austin, San Antonio, Houston, Dallas

California: Orange CountyLos Angeles County, Riverside County, San Bernardino County, San Diego County

Topics: Contracts, Contractual Risk Transfer

Written by The TSIB Team

All Authors and TSIB