Signing the one-sided contract

I recently settled a lawsuit in which the dispute concerned an industrial construction project. As drafts of the settlement agreement went back and forth, the owner’s attorney inserted a clause that my client would indemnify and hold the owner harmless from any claims of third parties arising out of the construction. This provision was unacceptable and was deleted.

All construction contracts contain some forms of risk-shifting clauses, some more abhorrent than others. Examples include the seemingly innocuous “site inspection” clause to “no damages for delay.” There are written “notice” clauses, which purport to waive untimely claims, no consequential damages, pay-if-paid and other devices that, generally, are designed to avoid extra payment for anything but approved changes to the technical scope of work. Then there are the indemnity provisions, which are a catch-all and, in many ways, create the greatest risk
exposure of all to the contractor.

There have been many attempts to justify placing so much risk of loss on the contractor. One such attempt actually was reduced to what are known as the
Abrahamson Principles. Named after the author of a 1974 article in the Journal of the British Tunnelling Society, the Abrahamson justification is as follows:

1. Place the risk on the party who can control the risk.
2. Make sure that party can spread the risk to others (e.g., insurance companies, subcontractors).
3. The party with the greatest risk gets the greatest economic benefit from controlling it.
4. The party bearing the risk will become more efficient and innovative.
5. There is less uncertainty and lower expense in placing the risk on that party, rather than on someone else.

Do these elements really apply to a broad indemnity clause? Do you take any of these elements into account when you sign a contract?

My experience is owners put risk-shifting clauses in their contracts because they can. Contractors may gripe about them, but they still sign.

In a sense, the Abrahamson Principles reduce to the old maxim: “Necessity is the mother of invention.” For example, the contractor has the most to lose from delays, so he will try to prevent them. Of course, there are underlying assumptions about psychology (personal motivation), individual abilities and economics, which are unproven although they may sound logical.

With indemnity clauses, these “Principles” begin to fall apart as the risks may be unknown or unknowable; these risks also may be noninsurable, and because indemnities get activated only after the fact, incentives and innovation do not play a role in controlling the risks.

For any contractor, there is a benefit to looking to the above five considerations. They force the contractor to consider whether the contract is worth the risks involved. In addition, they should lead the contractor to question whether the contract language can be modified to make it more reasonable.

One of the basic tenets of negotiations is that you cannot negotiate as an equal player unless you are prepared to walk away. That toggle-switch approach may not be the only alternative when you confront a patently unfair, one-sided contract. On the other hand, not signing must be seriously considered.

Perhaps as evidence of the optimism of contractors, there is one regularly asked question: Is there any one provision in the terms and conditions that should be a deal breaker? This question presumes the contractor may be willing to accept a pay-if-paid clause, a no-damages-for-delay provision or a similar harsh, though common, clause.

Certainly, every contract has its own phrasing, which can change meaning, as can the “intent of the parties” that the contract language is supposed to clarify. With this caveat in mind, contractors should be sensitive to any clause that places unwanted or unwarranted design responsibility on them. Wording that attempts to shift design to the contractor can appear in a variety of places, including the warranty clause and even the indemnity clause.

Any indemnity clause also deserves special attention. In many standard form contracts, indemnity is limited to instances of personal injury and property damage, but that need not be the case. There are indemnity provisions that extend to any claims, by any person or entity, and the contractor is agreeing to indemnify a whole list of people, including the owner, architect and others. Typically, there is no limit to your exposure, and your insurance limits can be exceeded.

For example, there’s a lawsuit in Washington, D.C., with tens of millions of dollars at stake—all because of 10 cents’ worth of solder.

The specifications for a luxury commercial building forbade lead solder. Many years after the building was completed, the owner decided to sell a part interest in the structure for hundreds of millions of dollars. The purchaser ordered inspections before the deal would be finalized, and trace amounts of lead were detected in water in one bathroom in this process. The deal fell through. After months of further study, including tearing out wall sections, the forbidden lead solder was found.

The owner sued the general contractor in negligence for the lost sale, testing and repairs costs, and for other expenses, including attorney fees. The general contractor brought the plumber into the lawsuit as a defendant.

The plumbing subcontract had a broad indemnity clause, which required the plumber to indemnify and hold harmless the general contractor and owner from all claims, including attorney fees and costs. The plumber’s insurance company disclaimed coverage as there was no personal injury, and there was no damage to property caused by the plumbing work.

It is important to try to amend these indemnity clauses. In the D.C. example, had the provision been limited to personal injury (there was none) and property damage, the subcontractor’s risks would have been greatly reduced. If the clause were further limited to the extent of insurance coverage, the exposure to loss would be defined.

Do not be dissuaded by the other party’s argument that you are the only one who has challenged the contract terms. That statement is probably not true, and it proves your attention to detail.       EC