Exceptions to Anti-Indemnification Act May Spell Increase in Construction Costs

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June 7, 2018
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October 25, 2018

Exceptions to Anti-Indemnification Act May Spell Increase in Construction Costs

Jeremiah L. Ritchie

By: Jeremiah L. Ritchie

A recent court decision threatens to affect insurance premiums for contractors and subcontractors by disrupting the status quo when it comes to indemnification provisions in construction contracts.

In February of this year the 10th Circuit held that provisions in a construction contract that require one party to obtain insurance to indemnify the other are exempt from the anti-indemnification statute as long as they are limited to coverage for a specific project, as opposed to coverage for an indefinite period, or an ongoing affair. First Mercury Ins. Co. v. Cincinnati Ins. Co., 882 F.3d 1289 (10th Cir. 2018).

Such a definition would capture the vast majority of construction contracts and related policies, which are limited in scope and duration to the completion of a specified project. This seems to be a departure from both construction and insurance industry norms, and if adopted by New Mexico state courts, this exception could swallow the rule.

Under the anti-indemnification statute, a construction contract that requires one party to the contract to indemnify, hold harmless, insure or defend the other party for their own negligence is generally void and unenforceable. NMSA 1978 § 56-7-1(A). This includes a requirement in the contract to name the other party as an “additional insured,” if that coverage is intended to indemnify that party for their own negligence. § 56-7-1(F).

This statute was intended to promote safety by making each party responsible for their own negligence, rather than allowing them to pass that responsibility on to their contractors or subcontractors. Other states have recognized that such statutes also serve to protect smaller, local contractors and subcontractors from being saddled with all of the risk on a project due to their disparate bargaining power.

At issue in First Mercury was an exception in the anti-indemnification statute which allows a construction contract to contain a provision that:

requires a party to the contract to purchase a project-specific insurance policy, including an owner’s or contractor’s protective insurance, project management protective liability insurance or builder’s risk insurance.

§ 56-7-1(B)(2).

The Court in First Mercury noted that New Mexico courts have not interpreted the meaning of “project-specific insurance policy,” and it was thus a matter of first impression. The court went on to adopt a very literal definition, finding that the contract in that case was for a discrete project—the roof on a farm supply building—and the insurance requirement was limited to work on the same project. As a result, the policy was “project specific” and exempted from the anti-indemnification statute. The insurer was thus required to indemnify the contractor, even for the contractor’s own negligence.

This interpretation would mean that the vast majority of construction contracts, which are typically limited in scope to the completion of a specified project, would now be exempt from the anti-indemnification statute. In addition, the insurers of contractors and subcontractors would now be covering an additional risk—that of insuring against the additional insured’s own negligence. This would necessarily mean that the premiums for those contractors and subcontractors would go up, affecting the cost of construction.

The First Mercury decision is not binding on New Mexico state courts, and it remains to be seen whether state courts will follow it. Under First Mercury, owners and contractors could always adjust the nature and scope of their contract to make it project-specific if they want to circumvent the statute and require blanket indemnification by their subcontractors. It is difficult to imagine that a statute intended to protect an important public policy interest—worker safety—would contain such a sweeping, seemingly arbitrary exception.

It is possible that New Mexico courts will read the exception in the context of the other types of policies enumerated in that provision: owner’s or contractor’s protective insurance; project management protective liability insurance; or builder’s risk insurance. These policies generally protect against vicarious liability of the insured for the negligence of another. Some carriers also refer to project-specific policies in the context of an owner-controlled policy, where a single insurance program is procured to cover all aspects of the project and all of the contractors, in order to eliminate the embedded costs of redundant premiums and the expense associated with the inevitable coverage disputes between contractors. It is easier to understand why the statute might exempt such policies from the act.

Until New Mexico decides this issue, contractors and insurers should give special attention to the indemnification provisions in their contracts, and the venue in which they are bringing or defending an action. As with any change in the law, this may present both risks and opportunities, depending on your position and your needs. We can be sure that insurance carriers will be keeping a close eye on their exposure in these cases. If they are required to indemnify or defend the owners and contractors to a greater extent, they will certainly adjust their premiums accordingly.