Enforceability of the AIA C195 indemnity provision under US law

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Introduction

The American Institute of Architects (AIA) introduced document C195 in 2008 as an internationally integrated project delivery contract form, which requires its members to create a limited liability company the sole purpose of which is to plan, design and construct the project.¹ Sub-clause 12.3.1 of the document provides a broad indemnification obligation on the company which requires the company to indemnify its members for any loss and/or damage under certain conditions. The plain language of the provision covers negligence of an indemnitee. The indemnification contradicts the anti-indemnity statutes operating in the majority of US states. This article investigates the enforceability of the C195 indemnity provision to negligence of an indemnitee by reference to US anti-indemnity statutes.

Contractual indemnification provisions

Indemnity clauses require that one party (the indemnitor) indemnify the other party (the indemnitee) against any losses the indemnitee may suffer. The main purpose of an indemnity clause is to shift the burden of liability onto the party whose ultimate malfeasance results in damages to the other party. For example, a contractor promises to indemnify the owner against claims brought by third parties for damages caused by its own deficient construction as the ultimate responsibility also rests on the contractor.²

The principle underpinning indemnity clauses is that the risk should be shifted to the party that is in the best position to deal with it and has the most control over it.³ For this reason indemnification clauses are also commonly used in commercial contracts as a risk allocation method.⁴ However, improper use of the clauses can result in unwanted situations and leave the party to which the risk is shifted liable for the risk in circumstances outside its control.⁵ Indemnification for an indemnitee’s own negligence is one of these.

The AIA C195 indemnity provision is drafted in broad language. Sub-clause 12.3.1 of the document imposes a broad indemnity obligation on the company in the following terms:

‘ […] the Company shall indemnify a Covered Person, to the fullest extent permitted by applicable law, for any loss, damage or claim the Covered Person incurs by reason of any act or omission performed or omitted by the Covered Person in good faith on behalf of the Company and in a manner reasonably believed to be within the scope of authority conferred on the Covered Person by this Agreement. However, no Covered Person shall be entitled to be indemnified for any loss, damage or claim the Covered Person incurs by reason of its willful misconduct with respect to the acts or omissions.’

As the provision requires the company to indemnify ‘any loss, damage or claim’, it can be considered to impose an obligation on the company to indemnify the covered person for negligent acts or omission of its members. Such an indemnification for an indemnitee’s own negligence, in general, is not accepted by US courts and legislature. The reason that there is a general tendency against enforceability of such indemnifications is that they are unlikely to be accepted by indemnifiers because agreement to such clauses would make them liable for risks outside of their control.⁶ Therefore, the majority of US states have enacted anti-indemnity statutes on the basis of public policy.

Anti-indemnity statutes

The unfair use of indemnification clauses, most commonly in the construction industry between subcontractors and main contractors or main contractors and owners, has led most US states to legislate anti-indemnity statutes.⁷ The bans imposed by the statutes on the clauses vary by states; however, in general, they can be divided into three main categories.⁸ These are discussed below.

Statutes barring indemnification for indemnitee’s sole negligence

The first and most common type of anti-indemnity statute ban indemnification for the indemnitee’s own negligence.⁹ Alaska’s anti-indemnity statute, for example, is of this type. AK ST Code section 45.45.900 (1986) provides that:

‘A provision, clause, covenant, or agreement contained in, collateral to, or affecting a construction contract that purports to indemnify the promisee against liability for damages for […] other loss, damage or expense arising […] from the sole negligence or willful misconduct of the promisee […], is against public policy and is void and unenforceable’.

Statutes barring indemnification for indemnitee’s negligence

The second type of statute imposes more limitations on indemnification clauses by banning the indemnitee to be indemnified for losses if the indemnitee partly or wholly contributes to the loss.¹⁰ In this regard, the anti-indemnity statute of New Mexico NM ST Code section 56-7-1 (1978) provides that:

‘A provision in a construction contract that requires one party to the contract to indemnify, […] the other party to the contract […] against liability, claims, damages, losses or expenses, including attorney fees, arising out of bodily injury to persons or damage to property caused by or resulting from, in whole or in part, the negligence, act or omission of the indemnitee […] is void, unenforceable and against the public policy of the state.’

Statutes barring indemnification of design professionals

The third type of statute targets the design professionals and bans them from indemnification for their negligence in providing their services.¹¹ For instance, the Texas anti-indemnity statute, CIV PRAC & REM Code section 130.002 (2001), provides that:

‘(a) A […] promise in connection with, or collateral to a construction contract is void and unenforceable if the […] promise provides for a contractor who is to perform the work […] to indemnify or hold harmless a registered architect, licensed engineer […] from liability for damage that:

(1) is caused by or results from:

(A) defects in plans, designs, or specifications prepared, approved, or used by the architect or engineer; or

(B) negligence of the architect or engineer in the rendition or conduct of professional duties called for or arising out of the construction contract and the plans, designs, or specifications that are a part of the construction contract’.

The prohibitions are generally justified on two grounds. Firstly, allowing a professional to be free of liability for its own negligence eliminates its incentive to operate or supervise a worksite properly, which results in a dangerous environment for the workers and the general public as a whole. The second justification is that the bans prevent inequity in the construction industry from an inequality of bargaining power and contributes to fair risk allocations among participants, particularly for those with less negotiating power such as small subcontractors and suppliers.¹²

Enforceability of AIA C195 indemnity provision for indemnitee’s own negligence

The AIA C195 indemnity provision falls under each of the three main categories of US anti-indemnity statutes as the broad language of the provision can cover negligent acts or omission of an indemnitee. Since architects are parties to such agreements, the statutes which ban indemnification for a professionals’ negligence would also apply to the agreement.

However, it does not mean the C195 indemnification provision is entirely void. In fact, the provision in section 12.3.1 includes the saving clause, which qualifies the enforceability of the indemnification obligation of the company ‘to the fullest extent permitted by applicable law’. The effect of this qualification is to prevent the courts from holding the entire provision void.¹³ In other words, depending on the applicable law, each statute might ban the enforcement of the provision to the extent that it would be void under the relevant statute.

However, the application of the statutes is not absolute and, in some cases, they are subject to interpretation by the courts.¹⁴ The following section elaborates the application of the anti-indemnity statutes to the C195 indemnity provision with regard to the statutory interpretations.

Statutory interpretation

The judicial power to interpret statutes comes from the Constitution.¹⁵ The Constitution, however, does not contain guidance on how it is to be interpreted – that is the task of the judiciary.¹⁶ Jurisprudence has developed by reference to three schools of statutory interpretation: textualism, intentionalism and purposivism.¹⁷

Textualism

The textualists apply the most restrictive interpretation and contend that the meaning of a statute is only derived from its text and courts should not give effect to extrinsic evidence in order to find a meaning other than what the text itself implies. In fact, textualists consider that when the courts interpret the text of statutes, they have to achieve the objective meaning rather than the subjective intention of the legislature.¹⁸

However, courts have shown flexibility in exceptional situations and allow evidence beyond the text if a result of a statute is absurd.¹⁹ In this regard, I refer to the statement of the US Supreme Court in Caminetti v United States,²⁰ in which although the Court emphasised the importance of the words of statutes in interpretation, it conditioned the interpretation so as not to lead to absurd or impractical consequences:

‘When words are free from doubt they must be taken as the final expression of the legislative intent, and are not to be added to or subtracted from by considerations drawn from titles or designating names or reports accompanying their introduction, or from any extraneous source. In other words, the language being plain, and not leading to absurd or wholly impractical consequences, it is the sole evidence of the ultimate legislative intent.’

I refer to two further cases, Greene’s Pressure Testing & Rentals Inc v Flournoy Drilling Company,²¹ and Weber Energy Corporation v Grey Wolf Drilling Company,²² as examples of a textualist interpretation of the Texas anti-indemnity statute.²³ The statute operates to void indemnification for an indemnitee’s sole or concurrent negligence in the oil and gas field. However, code section 127.005(b) allows unlimited mutual indemnification on the condition that the parties are required by their contract to provide an equal amount of insurance. Furthermore, the statute operates to void indemnification if there is unilateral indemnification up to $0.5m except in circumstances where there is a condition that the indemnitor provides insurance for that amount.²⁴

In the Greene’s Pressure case, the contract contained a mutual indemnification provision which required the subcontractor (Greene) to provide insurance cover of $0.5m. However, the contractor (Flournoy) as an indemnitor in the case had provided more insurance cover but voluntarily. The Fifth Circuit Court of Appeals held that the indemnity provision was void because the contract did not require an equal amount of insurance from both sides.²⁵

In a similar case, Weber Energy, although the contract involved a mutual indemnity provision, it required only Grey Wolf to purchase insurance. Weber Energy voluntarily provided the same amount of insurance. The Court of Appeals, following the reasoning of the court in Greene’s Pressure, held the indemnity agreement void under the Texas anti-indemnity statute.²⁶

Justice Murray Cohen, in pointing out the irrational results of both courts’ decisions, said that their decisions were contrary to the legislative intent. He continued that the statute was enacted to protect contractors from strong oil and gas operators taking advantage of their leverage by imposing oppressive indemnity obligations. In both cases, the operators provided equal and even higher amounts of insurance voluntarily to protect the contractors. By such insurances the purpose of the statute was met.²⁷

Intentionalism

Intentionalists believe that the intent of the legislature is paramount. In this regard, they refer to any evidence of intent such as legislative history to achieve the legislative intent. They also argue that the judiciary is the faithful fiduciary of the legislature and it is their duty to apply the legislature’s intent by determining the meaning of the legislation. In this way, judges have to look at each case from the legislature’s standpoint with regard to the words of the statute and interpret it as the legislature intended by reference to the relevant factual matrix.²⁸

Looking at the historical background of the US anti-indemnity statutes, it is said that the statutes are enacted ‘after pressure from the construction industry, who felt such provisions were the result of inequality in bargaining power between subcontractors/general contractors or general contractors/owners.’²⁹ For example, although, in general, indemnification for an indemnitee’s own negligence is enforceable under Louisiana contract law, the legislature enacted Louisiana’s Oilfield Anti-Indemnity Act (LOIA) to

‘protect oilfield contractors and their employees from the large oil companies who used their leverage to force contractors to enter into MSAs³⁰ requiring the latter to provide defense and indemnification, even for the oil companies’ own negligence’.³¹

In this regard, the view of the US courts regarding the legislature’s intention at the time of legislating anti-indemnity statutes is that ‘such an indemnity is, on principle alone, unfair, and is only agreed to at the insistence of the party with the “whip hand” in the negotiation’.³²

Purposivism

The proponents of the purposive approach are of the view that the purpose of a statute overrides its plain meaning. They believe that courts should first consider the stated purpose of legislation in order to solve uncertainty in the application of statutes in specific cases.³³ They also consider that the courts in interpreting statutes should be guided by the best policy consequences under the circumstances and arrive at an appropriate meaning for each case in light of the practical effect on the case at issue.³⁴ It is said that the society changes and the legislature does not have in mind new circumstances at the time the legislation is drafted, and therefore statutes have to be interpreted as though they had been enacted yesterday.³⁵

Applicability of the anti-indemnity statutes to the AIA C195 indemnity provision

The language of anti-indemnity statutes operates to make the indemnification provision of the C195 clearly void to the extent relevant to each statute. Although the language of the statutes prohibits the enforceability of the C195 indemnity provision, strict application of the statutes will create a result that might not be intended by the legislature or do not fit the purpose of the statutes. Therefore, the application of the statutes to the C195 indemnity provision is subject to interpretation. However, depending on each courts’ attitude towards interpretation, they may arrive at different conclusions.

With regard to the textualists, deviation from their strict approach requires proving that nullifying the indemnity provision is irrational and leads to a completely unreasonable or impractical result. As noted above, risk-sharing is an outstanding feature of IPD (Integrated Project Delivery)³⁶ and the IPD contracts employ mutual exculpation provisions to achieve such a value. The indemnification provisions of the IPDs are also aimed at creating a further risk-sharing culture.³⁷ A negligent C195 participant, seeing itself being indemnified by the company, is likely to be more open to sharing the relevant information, which is important for the overall project performance. Even in circumstances where the participant discloses its own negligence, with no fear of bearing the whole loss or damage individually, there are likely to be benefits to the overall project performance. However, the existence of other features of the C195 contract, such as its mutual exculpation provision and compensation scheme, will keep an indemnitee motivated to contribute to the sharing culture of the IPD even if it is held liable for its own negligence. Therefore, having regard to the anti-indemnity statutes which void the enforcement of the indemnification provision to the indemnitee’s own negligence, it is not likely to lead to an absurd result or make the contract impractical. Accordingly, it is likely that courts taking the textualism approach will not enforce the C195 indemnity provision.

Intentionalists and purposivists take a more flexible approach, as they consider evidence other than the words of the statutes in order to achieve the intention or purpose of the statutes. In this regard, it is believed that the general purpose of all the anti-indemnity statutes is twofold. Firstly, they aim to maintain an indemnitee’s incentive to operate or supervise the worksite with due care, which is crucial to the safety of the workers and the public as a whole. Secondly, the statutes are designed to protect small contractors and suppliers which have less bargaining power from unfair and burdensome indemnity obligations.³⁸ Consideration of the background to the relevant anti-indemnity statute is also relevant for ascertaining the purpose and intent of the legislature at the time the legislation was drafted.

For example, the Arizona Supreme Court made the following comments with respect to the interpretation of the legislative intent of the anti-indemnity statutes:

‘Anti-indemnification statutes are primarily intended to prevent parties from eliminating their incentive to exercise due care. Because an indemnity provision eliminates all liability for damages, it also eliminates much of the incentive to exercise due care.’³⁹

However, regarding the formation of the company under C195, since an indemnitee itself has interest in the company (s 4.1.1), indemnification by the company would affect its own benefit. Therefore, the indemnitee’s incentive to perform with due care would not necessarily be eliminated entirely by the indemnity provision, even though it covers the indemnitee’s own negligence. Furthermore, provisions regarding Target Cost and Actual Cost (s 5), Mutual Management of the Company (s 8) and Incentive Compensation
(s 10.1) still operate to keep an indemnitee motivated to perform with due care and skill, as any defect or problem in the construction would finally affect its own interest.

Moreover, although a small contractor or supplier with less bargaining power may enter into the IPD contract, it is not the indemnitor but the indemnitee whom the indemnification provision is designed. This is in order to protect and reduce their sole liability for their own negligence by sharing it among all the participants by way of creation of the single purpose entity.

In addition, joint control over the project (s 8) by the members reduces the unfairness of the indemnification for an indemnitee’s own negligence which originated from the understanding that ‘the indemnitor is usually in no position to prevent the risk by controlling the conduct of the indemnitee.’⁴⁰ In fact, the indemnification provision of the C195 can be an effective way of avoiding costly and time-consuming litigations as the projects subject to the C195 are normally high-risk and complicated, in which a large number of entities are involved and work side by side.⁴¹ In these circumstances, the agreement is based on efficiency and courts should give effect to the bargain of the commercial parties as a matter of commerce.

In this regard, I refer to the following statement of the Nevada Supreme Court in a case that involved an indemnity obligation which arose in an insurance context, despite the indemnity agreement being against the anti-indemnity statute:

‘as a matter of public policy, we conclude the indemnity contracts in these cases should be enforced because they allocate risk.’⁴²

Finally, the anti-indemnity statutes operate to make certain indemnity agreements void on the grounds of public policy. The New Mexico Court of Appeals in Holguin v FULCO OIL SERVS,⁴³ in clarifying the public policy behind the statute, said:

‘the public policy embodied in both the oilfield and construction anti-indemnity statutes is to promote safety in uniquely hazardous work place environments.’

A public policy justification for the anti-indemnity statutes is endorsed by several other courts.⁴⁴ Based on this argument, what clearly mattered for the legislature was the safety of the workers and the intention was to limit the parties’ contractual freedom right to protect the workers. Recently the US District Court, D New Mexico in United Rentals Northwest, Inc v Yearout Mechanical, Inc,⁴⁵ stressed:

‘The purpose of the anti-indemnity statute is to protect construction workers and future occupants of a building by ensuring that all those involved in its construction know that they will be held financially responsible for their negligence.’

However, for the reasons mentioned previously, clauses 4.1.1, 5, 8 and 10.1 of the C195 operate to incentivise the project participants to take due care in performing the project. These clauses also provide a control mechanism for the contract involving all the participants in managing the matters related to the project which enable them to supervise the project as a whole. After all, the indemnity provision limits the indemnification to the company’s assets, which is ultimately the property of its members. Consequently, all the participants would be jointly liable for the safety of the project workers, and the quality of the project is a matter affecting the benefit of all the participants. Therefore, it is submitted that the indemnity provision of the C195 does not function against the public policy reasons underpinning the anti-indemnity statutes.

Conclusion

The US anti-indemnity statutes are the main barriers to enforceability of the C195 indemnity provision for an indemnitee’s own negligence either in the context of sole, concurrent or professionals’ negligence. However, statutory interpretations can lead to a flexible application of the statutes favourable to the C195 indemnity provision. Nevertheless, it depends on the courts’ approach to interpretation. The strict textualist interpretation of the statutes is likely to result in invalidation of an indemnification for negligence of any company member.

The case law considered shows that some courts, particularly the trial courts, are less willing to interpret the plain language of the anti-indemnity statutes. However, other courts, such as appellate and supreme courts, are more likely to interpret the statutes by reference to the intention of the legislature as a basis to protect the indemnifiers. Appellate and supreme courts are also more likely to interpret the statutes by reference to the purpose of the statutes as being mainly to protect the public. As discussed in this article, it is submitted that the C195 indemnity provision does not contradict the intention or purpose of the statutes.

Since the C195 indemnity provision is designed to share the final loss or damage among its participants, the legislature’s protective intent towards the weaker parties in construction contracts has no effect against the C195 indemnity provision as the entire risk does not rest on one party. The public protection purpose of the statutes is also achieved by the operation of the other provisions of the contract (s 4.1.1, s 5, s 8 and s 10.1) as they keep an indemnitee incentivised to perform with due care and skill, and also to provide a safe working environment for the good of the project as a whole, which is directly connected to its individual interest.

Notes

1 Lisa Dal Gallo, Shawn T O’Leary and Laila Jadelrab Louridas, Comparison of Integrated in Project Delivery Agreements (HansonBridgett 2009), p 5.

2 Construction Law, William Russell Allensworth and others (ABA, 2009), p 1361.

3 J M Adams, and K K Milhollin, ‘Indemnity on the Outer Continental Shelf-A Practical Primer’, (2002) 27(43) Tul Mar LJ, p 48.

4 J Cooper and M Leonard, Indemnification Clauses in Commercial Contracts (GA), (Baker, Donelson, Bearman, Caldwell & Berkowitz, PC, 2017) Practical Law Commercial Transactions, p 3.

5 Ibid.

6 W B Courtney, (2008) 24(2), ‘Construction of Contractual Indemnities–Out with the Old, In with the New’,Journal of Contract Law, 182-195, p 194.

7 A Wallace and V Merritt, (2017), ‘Contractual Indemnities in Construction Contracts: A Contractor’s Perspective’J Can C Construction Law, p 16.

8 G D Podolak and T Casanova, (ABA, 2018), ‘Contractual Indemnity, Anti-Indemnity Statutes and Additional Insured Coverage’, 47, 4 p 33.

9 A H Gwyn and P E Davis (2003) 23(26) ‘Fifty-State Survey of Anti-Indemnity Statutes and Related Case Law’, Constr Law, p 26.

10 Ibid.

11 Ibid, at 27.

12 S G Stein and S K Sato (2007) 27(5), ‘Advanced Analysis of Contract Risk-Shifting Provisions: Is Indemnity Still Relevant’, Constr Law, p 5.

13 Podolak, see n 8 above, at 36.

14 M P Healy (1999) 35(2) ‘Legislative intent and statutory interpretation in England and the United States: An assessment of the impact of Pepper v Hart’,Stanford Journal of International Law, 231-254, p 231.

15 F Cross (Redwood City: Stanford Uni Press 2008), The Theory and Practice of Statutory Interpretation, p 1.

16 E Elhauge (2002) 102 ‘Preference-eliciting statutory default rules’, Colum L Rev, 102, 2162; Ibid.

17 See Healy, see n 14 above, at 234-35.

18 Cross, see n 15 above, at 134.

19 Public Citizen v US DoJ, 491 US 440, 470 (1989) (Kennedy J, concurring in the judgment, recognising that when clear language of a statute leads to an absurd result, the Court may look beyond the statutory text for meaning); Green v Bock Laundry Machine Co, 490 US 504, 527 (1989) (Scalia, J, concurring in the judgment, stating that the Court may ‘consult all public materials, including [...] legislative history’ when the plain meaning of a statutory text is absurd in order to ascertain whether Congress actually intended that meaning); Healy, see n 14 above.

20 242 US 470, 490 (1917); Healy, see n 14, above, at 234.

21 113 F 3d 47 (5th Cir, 1997).

22 976 S W 2d 766 (TexApp-Houston 1st Dist, 1998).

23 Tex Civ Prac & Rem Code ss 127.001-127.008 (1999).

24 T R Fox (1998) 6 ‘“Knock for Knock” No Longer Equal: Reinterpretation of the Insurance Obligations in the Texas Anti-Indemnity Statute’, International Insurance Law Review, 269-74, p 2.

25 Ibid, at 5–6.

26 Ibid, at 6–7.

27 Ibid, at 8.

28 Cross, see n 15, above, at 10.

29 L D Simmons, ‘Indemnities and Endorsements: Protecting the Owner and Developer’, Conference – Update on Indemnification, Anti-Indemnity Statutes and Additional Insured Endorsements, CoreNet Global Network, Charlotte, North Carolina, McGuire Woods LLP, 17 October 2013. Of the 44 US states that have anti-indemnity statutes, only six states permit a contractor to indemnify the owner where the owner is solely responsible for the loss; Wallace, see n 7, above.

30 Master Service Agreements.

31 L Sanchez (2006) 31(177), ‘Charting the Chaotic Offshore Waters: The Validity of Contractual Indemnity Provisions Pertaining to Injuries Sustained Offshore’, Tul Mar LJ, p 188.

32 R W Stone and J A Stone (2005) 54(125) ‘Indemnity in Iowa Construction Law’,Drake L Rev, at 32 (‘many states have recognized that contractors and subcontractors cannot effectively bargain over indemnity provisions and that they accept more risk than is economically prudent’); Wallace, see n 7, above.

33 Y Kim (2009) 97(589), ‘Statutory interpretation: general principles and recent trends’,Nova Science Pub Incorporated, p 24.

34 Cross, see n 15 above, at 2–4.

35 D Patterson, (John Wiley & Sons 2010) A Companion to Philosophy of Law and Legal Theory, p 194.

36 Martin Fischer and others (John Wiley & Sons 2017) Integrating project delivery, p 47.

37 H Ashcraft, (2011) 31(3) ‘Negotiating an Integrated Project Delivery Agreement’, The Construction Lawyer, 17–34, 49–50 Pp 6-7.

38 Stein, see n 12 above, at 1.

39 1800 Ocotillo, LLC v WLB Group, Inc, 196 P 3d 222, 225 (Ariz 2008); B S Beltzer and M A Orien (2010) 30(17) ‘Are Courts Limiting Design Professionals’ Ability to Limit Liability’, Constr Law, p 2.

40 C M Pisano, (1987) 45(169) ‘Judicial Interpretation of Indemnity Clauses’,La L Rev, p 172.

41 Y Aubin and T Portwood, (2001) (6), ‘Mutual Indemnity and Hold Harmless Agreements’, International Business Law Journal, 671–698, p 3.

42 American Fed Savings Bank v County of Washoe, 802 P 2d 1270, 1275, 106 Nev 869, 876 (Nev 1990); R D Brown and M E Fortin (2000) 32(1019) ‘An Introduction to Interpretation of Express Contractual Indemnity Provisions in Construction Contracts under California and Nevada Law’,McGeorge L Rev, p 2.

43 149 N M 98 (N M Ct App 2010).

44 Guitard v Gulf Oil Co, 100 N M 358, 361–62, 670 P.2d 969, 972–73 (Ct App1983); and City of Albuquerque v BPLW Architects & Engineers, Inc, 081, 19, 146 N.M. 717, 213 P 3d 1146 (NMCA.2009).

45 Civ No 08-00050 RLP/CD (D N M 9 Sept 2008), at 4.

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