Download - November 2013 Brochure
What’s your appetite for risk?
November 2013
Much of this, our third brochure of 2013, is dedicated to the topic of risk allocation in construction contracts, and in particular, the practice of ‘risk shifting’. It is a practice which appears to have increased markedly in recent times, perhaps as a result of the slowed activity in the sector over the last few years. As Director, Alastair Oxbrough, explains in his paper on the subject – which he presented to a gathering of the Building Dispute Practitioners’ Society in June 2013 – shifting risk down the supply chain, in the absence of any proper analysis, can lead to unintended results for the procuring party and does not necessarily protect such a party from the financial consequences of risk.
The debate surrounding proper risk allocation has been ongoing for some time and is set to continue. Industry leaders and academics are starting to talk about a thorough review of the Australian Standards suite of contracts in the next few years. Research projects
are also being considered in order to evaluate how successful the current suite of contracts has been in delivering construction projects, particularly in terms of the financial outcomes and the impact on the parties’ commercial relationships. As Alastair explains in his paper, risk allocation can have a significant influence on both of these areas.
Keeping with the risk theme of this edition, we have also included an article on the subject of no-fault indemnities. This type of indemnity is now regularly being used as an alternative to the traditional liability-based remedies of breach of contract and negligence. Whether you are a principal, contractor or consultant, it is important to know how to spot these provisions and the elements they are likely to contain, so that you can negotiate them effectively.
We hope that you find the articles in this edition of interest.
Risk shifting in building contracts 2
No-fault indemnities 14
Discussed inside:
Risk is part and parcel of carrying out construction work. While it has always been and will continue to be a hot topic during contract negotiations, a careful and considered apportionment of risk in the construction contract, along with good risk management practices during project execution, can go a long way to mitigating any adverse consequences for the parties if risks do eventuate.
In recent times, we have noticed a strong tendency in the industry towards more one-sided contracts, where the vast majority of the risk is sought to be shifted onto one of the parties. In order to achieve this, contract drafting has become more sophisticated, with lengthy, bespoke building contracts being preferred over standard forms, such as the Australian Standards. In those instances where standard forms are still being used, they are being amended heavily. The risks are often then flowed down the contractual supply chain to some of the more vulnerable subcontractors and suppliers.
Risk shifting in building contracts
Author Alastair Oxbrough
Based on papers presented to the
Building Dispute Practitioners’
Society (Victoria) in June 2013
and the Law Society of South
Australia’s Construction Law
Conference in October 2012.
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As this research suggests, onerous contracts and clauses can lead to disputation and a general breakdown in the commercial relationship between the contracting parties. The cost of these disputes, both in terms of the legal expenses and lost management time, can be significant.
In exploring the utility or otherwise of risk shifting, it is instructive to consider the following issues:
(a) What are the traditional concepts of risk allocation and risk transfer, their underlying principles and are they still being applied in today’s industry?
(b) What are some examples of onerous provisions that currently appear to be popular in the market and are they onerous, when one has regard to traditional risk allocation principles?
(c) What are some of the reasons why the perceived increase in onerous provisions might be occurring and what are the consequences?
This trend has not gone unnoticed by other players in the industry. For example, consultants AECOM conducted a global survey of development costs recently and found that Sydney ranked as the fifth most expensive place in the world in which to build commercial developments, high rise and hotels.1 AECOM cites high labour costs and a less collaborative approach between stakeholders as the key reasons behind its finding. It also suggested that Australia’s construction market is the most adversarial in the world.2
A similar trend may be emerging in the United Kingdom. Global built asset consultants, EC Harris, in their latest Global Construction Disputes report, titled A Longer Resolution, state that:
“… UK disputes tend to be attributable to parties taking a less collaborative approach to projects than in other markets. For example, the employer imposing change and conflicting party interests feature highly.
2012 saw an increase in disputes arising from parties failing to understand their contractual obligations which on the larger, mega projects often arise as a result of clumsy, sometimes over legalistic, drafting of the generally bespoke contracts. If owners / employers adopted standard forms with less amendments this problem could be reduced.” 3
The outcome of onerous contracts is often disputes and a breakdown in the parties’ commercial relationship.
1 AECOM, Blue Book 2013 (15th Edition), 2013.
2 Blue Book 2013, above n 1 at 6. See also AECOM & Davis Langdon, Infrastructure Construction Sentiment Australia Survey, June 2012.
3 EC Harris, Global Construction Disputes: A Longer Resolution, 2013, at 10.
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All construction projects involve risk and there are many risks which are common to most construction projects, for example, inclement weather and ground conditions.
If these risks eventuate on a construction project, adverse consequences are likely to result. The immediate consequence might be delay to the completion of the works, but almost always the ultimate consequence is a financial one.
One of the primary purposes of a construction contract is to record the parties’ agreement as to who is to bear the responsibility for these risks and their financial consequences, or whether the risks are to be shared in some way. The process of risk allocation is simply the determination of which project party is to bear the responsibility for the risks that have been identified in respect of the particular project at hand, which is then recorded in the construction contract.
An appropriate allocation of risk can become an important part of a project’s risk management strategy.
An appropriate allocation of risk in a construction contract can become an important part of a construction project’s overall risk management strategy.
This ‘responsibility’ for a risk is typically reflected in a contractual obligation; for example, the contractor might be obliged to complete the works by a specified date, which carries with it the risk for delays other than those for which it might be entitled to an extension of time.4 Those delays for which an extension of time may be granted are at the principal’s risk. If the contractor does not achieve completion on time because of a risk it agreed in the contract to bear, then it is likely to be liable to pay damages (liquidated or otherwise) to the principal as a consequence.
Risk allocation and transfer
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The concept of risk allocation has been around for some time, and a number of principles have been developed. Arguably the most well-known set of principles are those expounded by construction lawyer Max Abrahamson, commonly referred to as the ‘Abrahamson Principles’5. The principles were also adopted and championed by the Joint Working Party of the National Public Works Conference and the National Building and Construction Council in their 1990 report No Dispute: Strategies for Improvement in the Australian Building and Construction Industry (No Dispute). Page 6 of No Dispute sets out the Abrahamson Principles, as follows:
“… a party to a contract should bear a risk where:
•The risk is within the party’s control;
• The party can transfer the risk, e.g. through insurance, and it is most economically beneficial to deal with the risk in this fashion;
• The preponderant economic benefit in controlling the risk lies with party in question;
• To place the risk upon the party in question is in the interests of efficiency, including planning, incentive and innovation;
• If the risk eventuates, the loss falls on that party in the first instance and it is not practicable, or there is no reason under the above principles to cause expense and uncertainty by attempting to transfer the loss to another.”
While there has been some debate about the particular application of some of these principles in practice,6 their main thrust – namely, that risks should be allocated to the party best able to deal with them, both physically and economically – in the author’s view, still holds true today. Indeed, they are still reflected at State and Federal Government level within the National Public Private Partnership Guidelines, in which a full risk analysis is recommended for all PPPs.7
The adoption of sound risk allocation methods is also seen as one way of reducing cost and the incidence of claims and disputes in the industry. For example, Young and Bhuta in their paper Effective Risk Apportioning in Contracts, list a number of benefits of good risk allocation, such as the following:
a. Those most capable of controlling a risk have the ultimate capability of minimising the risk eventuating.
b. It can reduce costs for the party initiating the contract, as the other party should not build high prices into the contract to cover risks they are incapable of controlling.
c. The costs associated with carrying out effective risk management may be shared by both parties in such a manner that the ultimate cost to a client would be reduced.
d. …
e. Allay disputes. Contract conditions that are viewed by a party to be inequitable or unreasonable, by their nature, only serve to enhance the volatility of a project.
f. …
g. Create more equitable and harmonious relationships between parties.
h. …
i. Would encourage more competitive bids.” 8
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4 See the discussion in NPWC/NBCC Joint Working Party, No Dispute: Strategies for Improvement in the Australian Building and Construction Industry Report, May 1990, at 6-9.
5 M Abrahamson, Risk Management (1983) 1 ICLR 241.
6 See for example D Ulbrick, No Dispute? Testing the Wisdom of Abrahamson (2010) 21 ILJ 96.
7 National Public Private Partnership Guidelines, Overview, December 2008, at Section 5.1.
8 W A Young & C J Bhuta, Effective Risk Apportioning in Contracts 47 ACLN 11, at 13.
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The practice of ‘risk shifting’, as it has been called,11 can lead to the opposite result: it tends to increase the costs for the procuring party in two main ways:
(a) through the contractor’s need to price the risk; or
(b) by encouraging tendering by contractors who will not price the risk in order to make the tender more competitive, but who will then make claims if the risk eventuates, irrespective of what the terms of the contract might say about the allocation of that risk.
The by-product of this is a more strained, adversarial relationship between the contracting parties, which becomes a breeding ground for disputes. The ensuing costs, not only of lawyers brought in to deal with the claims, but also of internal management and administration, can often outweigh the perceived benefit of having shifted the risk in the first place. In other words, has the ‘risk shifter’ really benefited in the long run?
Notwithstanding these apparent benefits, and as some commentators have previously observed,9 there appears to be an inherent aversion to risk by procuring parties, and an attitude that the best approach is to offload as much risk associated with the carrying out of the project as possible, in the belief that this will somehow insulate the procuring party from the risks and any claims from the other party. In other words, often the objective appears not to consider a proper risk allocation at all. It is this potential failure to consider the proper risk allocation that could see a project lose its way. As Peter Megens observed in his article Construction Risk and Project Finance, in many ways the contract itself then becomes another risk for the project.10
A failure to consider the proper risk allocation could see a project lose its way.
Similarly, for those of us who are asked to provide advice on such issues, there is much to be said for starting with a standard form, and then considering carefully whether the terms – and particularly the default risk allocation – need to be tailored to the specific circumstances of the project at hand.
It may be the case that for major projects with more generous margins, contractors and suppliers are better equipped to deal with onerous risk allocations. But for lower value projects, where the market is extremely competitive and margins tend to be smaller, the problem does seem to be more acute. Careful attention to risk allocation in small projects is just as important as in major projects. Yet the risk allocations in smaller projects do appear increasingly one-sided. At times, there seems to be an attitude that analysis of the risks is not really necessary if an acceptable tenderer can be found who is prepared to bear the bulk of the risks set out in the tender contract. The efficacy of this approach should be questioned.
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This is not to suggest that contractors and subcontractors should always be relieved from some or even the greater proportion of the risks in particular projects; often, there is a case for arguing that they should not be. It is also not to suggest that the practice of risk shifting is exclusively a top-down phenomenon. On the contrary, it is common to see contractors placing more onerous requirements on subcontractors that are not referable to obligations created up the line by the principal.
Good risk allocation, as part of an overall risk management strategy, requires an early analysis and evaluation of the risks for each individual project, leading to informed decisions about which party is best placed to deal with the risks that have been identified. If required, bespoke contract drafting can then reflect the outcomes of the analysis and evaluation.
In the absence of a proper risk evaluation, parties should consider adopting a suitable, current standard form, which are thought to reflect the most balanced and considered approach to the allocation of common construction project risks. This was in fact the recommendation of the No Dispute report.12
9 See for example, No Dispute, above n 4; Young and Bhuta, Effective Risk Apportioning in Contracts, above n 8; P Megens, Construction Risk and Project Finance, 8 Journal of Banking & Finance Law & Practice 23.
10 P Megens, Construction Risk and Project Finance, above n 9 at 25.
11 See for example, Young and Bhuta, Effective Risk Apportioning in Contracts, above n 8 at 12-13.
12 No Dispute, above n 4 at 12.
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The concerns regarding the concept of risk shifting may be illustrated by reference to some basic examples. These examples are not particularly novel. Rather, it is the prevalence of their use and the fact that they are finding their way into much smaller value building contracts (including being passed down to subcontractors) which are considered to be of concern.
Latent conditions
The first example is a provision which shifts all risk from the principal onto the contractor in respect of latent site conditions.13 Often these clauses have several facets to them, namely:
(a) An express acknowledgement that the contractor has agreed to assume the risk for the physical conditions or characteristics of the site and its subsurface conditions, and therefore has no claim against the principal;
(b) That the contractor is deemed to have thoroughly inspected the site and satisfied itself as to the suitability of the site to carry out the works; and
Examples of onerous provisions
(c) That the contractor has not relied on any information provided by the principal regarding the characteristics of the site, the principal does not warrant the accuracy of the information and that the principal’s liability in respect of any such information is expressly excluded.
These types of clauses are regularly finding their way into bespoke contracts or amended versions of the Australian Standards. The difficulty with such provisions is that they are often used in circumstances where the contractor does not have the ability to properly inspect the site and carry out testing, and is reliant on information provided by the principal. In such circumstances, it is not possible for the contractor to properly allow in its price for this risk if it were to eventuate (especially the risk of delay, where a liability for liquidated damages may result). The traditional risk allocation principles explained above might suggest that the risk of latent conditions should be borne by the principal in this situation.
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Importantly, there is a benefit to the principal accepting the risk in that it only has to bear the financial consequences of the risk if it in fact materialises. If the risk is shifted onto a prudent contractor who prices the risk, then the principal pays for the risk regardless of whether it materialises. But for the reasons explained earlier, a contractor who chooses not to price the risk at all in order to keep its tender price down creates additional risk for both parties in the event that latent conditions are discovered.
The risk allocation in respect of latent conditions in clause 25 of AS4000-1997 is quite different. It provides for the contractor to be entitled to additional time and money for any physical conditions “… which differ materially from the physical conditions which should reasonably have been anticipated by a competent Contractor at the time of the Contractor’s tender if the Contractor had inspected …” information made available by the principal, by making reasonable enquiries and by inspecting the site. It is suggested that this is a more balanced risk allocation, in that the contractor can price for the conditions of which it is or ought to be aware. Both parties therefore take on some degree of the risk.
Ambiguities or discrepancies
Another common provision is one which attempts to shift all risk of ambiguities or discrepancies in the contract documents onto the contractor (and, often in turn, the subcontractor) by reserving the power on the part of the principal or superintendent to resolve the ambiguity in any manner they see fit and in their absolute discretion, while removing any entitlement to compensation for the contractor.
Such ‘blanket’ risks are often difficult or impossible for a contractor to price, and leave the contractor essentially at the mercy of the principal for what could involve significant departures from the work originally envisaged. This is especially so in cases where the contract documents, or large portions of them, have been prepared by the principal or its consultants. Such clauses can also act as a disincentive to the principal and its consultants to take proper care in the preparation of the documentation, especially in relation to the definition of the scope of work.
Attention to risk allocation in small projects is just as important as in major projects.
Clause 8.1 of AS4000 leaves the risk of inconsistencies, ambiguities or discrepancies with the principal. This allocation arguably favours the contractor more than it should, even in a construct-only context, because it appears to compensate the contractor if the direction resolving the inconsistency, etc. causes the contractor to incur more cost, regardless of whether the contractor knew or ought to have known about it. A more balanced allocation of risk would be to place some degree of responsibility on the contractor for checking the contract documentation, and to limit the entitlement to relief to circumstances where the inconsistency, etc. could not reasonably have been identified by the contractor at the time of tender. This is in fact the approach adopted in clause 8.1 of the older AS2124-1992 form as well as the design and construct form, AS4300-1995, and reflects the fact that both parties have, to some degree, the ability to control and deal with the risk.
13 It should be noted that the default position at common law is that the builder normally assumes this risk: where a builder agrees to complete a building for a fixed price, it is not entitled to additional payment or other relief simply because conditions do not turn out as anticipated. See for example J Bailey, What Lies Beneath [2007] ICLR 394 at 395-398. In the author’s view, the common law position does not necessarily reflect an appropriate contractual risk allocation in many instances.
The advantages of including these sorts of clauses in construction or construction related agreements should be considered carefully. Not only do such provisions potentially shift risks which, at least on Abrahamson principles, should not be shifted, but their enforceability might also be open to challenge. For example, in the case of site possession and principal-instructed variations, is it really possible to contract out of the prevention principle? Does the principal run the risk of setting time at large by removing any entitlement to relief on the part of the contractor, if the contractor is also subject to liquidated damages for delay under the contract?
In relation to MFN clauses, there are the usual difficulties of proving breach due to challenges of accurately benchmarking against other projects or customers, particularly where the contract terms are materially different and the consultant (or its competitors) owes a duty of confidentiality to its other clients. It is suggested that it would be particularly difficult to successfully enforce an MFN clause in this context, given the highly variable nature of construction projects. There is also the risk of contravening sections 45 and 46 of the Competition and Consumer Act 2010 (Cth).
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Clauses which reverse traditionally allocated risks
There are a number of more novel clauses also starting to appear in the market that have the effect of reversing risks traditionally borne by principals, even under more onerous styles of contract, which again increase the prospects of a dispute between the parties.
These include clauses which deem a failure to give possession of the site to not be a breach of contract, and clauses which limit the contractor’s entitlement to seek relief in respect of principal-directed variations to the work (including related extensions of time) to the submission of a mere ‘proposal’ instead of a claim, which the principal is free to accept or reject as it sees fit.
‘Most favoured nation’ (or MFN) clauses, which are typically used in an attempt to control price competitiveness for the supply of goods and more standardised services, are now finding their way into consultancy services agreements for complex project deliveries, so that the supplier remains on risk for the price of delivery, rather than the parties sharing that risk (which would be normally be the case under a fixed price arrangement).
There appear to be a number of possible explanations as to why risk shifting is on the increase:
(a) Prevailing market conditions remain very tight in the aftermath of the GFC. Funding for projects is scarce, and where funding is being made available it is usually very tightly controlled. Banks have traditionally been viewed as highly risk averse,14 and often look for ‘certainty’ by passing down as much risk as possible to the contractor, who of course, then seeks (and in fact is often required by the contract) to pass it through to subcontractors on similar terms. It is those lower down in the contractual supply chain that tend to have less appreciation of the potential difficulties that onerous provisions and risk allocations can cause, and less financial ability to absorb them.
(b) Less work in the market can result in less balance in the bargaining positions of the parties. Accordingly, tenderers are often more ready to accept onerous contracts than they might have been in the past.
(c) Notwithstanding the literature on risk allocation and reports like No Dispute, there seems to be an attitude in some organisations that the ‘safest’ option is still to lay off as much risk as possible. From an internal accountability perspective, it may be that this sort of approach is less likely to attract criticism when compared with a more carefully thought-out risk allocation.
(d) There appears to be an emerging culture of ‘copy-paste’, where what are seen as desirable clauses from a risk-minimisation point of view are being taken from contracts on other projects. This approach flies in the face of proper risk allocation.
(e) Finally, the more that onerous risk allocations are adopted by parties, the more acceptable they seem to become in the market, and this makes them more difficult to negotiate. It also might result in lawyers believing that they have a duty to adopt onerous risk allocations and clauses in contracts for their clients, irrespective of whether the client has asked for them, because everybody else appears to be doing so. The most important thing is to have a discussion with the client about its preferred risk allocation for the project at hand, including any advantages or disadvantages of that allocation, and to then draft the contract accordingly. This applies irrespective of where the client sits in the procurement chain.
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Why are contracts getting more onerous?
14 See, for example, J Bremen, Risk Allocation, Project Finance and Trends in Project Delivery, (2002) 21 AMPLJ 254, at 255.
increases the risk. That ambiguity often arises - not because of poor drafting – but because of fraught negotiations between the parties in an attempt to water down the effect of the clause. This only increases the prospect of disputes down the track.
(b) Bespoke contracts tend to involve more work. They require tenderers to have a greater degree of sophistication than would be the case if standard forms were being used. One wonders whether the recent increases in the use and size of in-house legal teams may in part be driven by the increased burden of these more complex contracts.
(c) In some instances, clients have reported being told that departures from the proffered contract terms would render the tender non-compliant and hence would not be considered. This has led to some clients simply walking away from tenders because of overly aggressive contract terms and risk allocations.
There appear to be a number of possible side effects of the perceived increase in onerous contracts:
(a) The most obvious is disputes. When market conditions are good, not only might the practice of risk shifting decrease, but those having the benefit of the resulting clauses might be less inclined to enforce them. That is certainly not the case at the moment, from the anecdotal evidence available to us.
Leaving aside the direct and indirect costs that disputes cause to a business, it is also important to understand that onerous provisions resulting from aggressive risk shifting practices are not always enforced by the courts, notwithstanding their general willingness to uphold the parties’ bargain. Clauses which lead to unjust results in a given case will be closely scrutinised. Ambiguity in such clauses is also common and this
What effect might onerous contracts be having in the industry?
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After a difficult few years for the construction industry, signs of life are beginning to emerge. Nonetheless, if market conditions are having some degree of influence over the way projects are being procured, as we suspect, then it is difficult to see the current, perceived trends in contract drafting changing significantly any time soon.
Having said that, it may be that we are heading into a situation similar to that faced by the Joint Working Party in the late 1980s, which ultimately resulted in No Dispute. Not long after that report was issued, some significant Australian Standards, in particular AS2124 and AS4300, were produced and became very popular, at least for a time. While those contracts have seen some revision over the intervening years, query whether the construction industry now needs to revisit them and the subject of proper risk allocation generally. Some renewed leadership in this space would be welcomed.
Ultimately, our view is that traditional risk allocation principles remain relevant to today’s market. While there have of course been technological advancements in the construction industry, many of the risks facing construction projects are the same today as they have been in the past.
It is suggested that there needs to be a greater emphasis on risk analysis and assessment in the early phases of any project’s development – big or small – before tender and before contracts are drawn up. Decisions on risk allocation can then influence both the form of procurement adopted as well as the terms of the proposed contract.
Principals and their advisers should take time to listen to tenderers on questions relating to risk, and to negotiate the risk allocation in the contract accordingly.
Conclusion – the way forward
This includes legal advisers, for although they are often instructed on behalf of principals to prepare bespoke contracts or heavily amended standard forms with the intention of transferring risks down the supply chain, it is still prudent for them to warn principals of the potential difficulties that this may cause down the track if it appears that, in respect of the particular project at hand, it would be more appropriate for particular risks to remain with the principal (and for those risks to be managed more proactively during the delivery phase).
For contractors, sometimes just walking away from what looks like too onerous a contract is not the best solution. Even if agreement to proposed contract terms is stated to be a condition of a compliant tender, contractors should still be prepared to submit an alternative bid, and to make any departures on the contract terms clear. Principals are often willing to consider alternative bids and to negotiate, particularly if it can result in lowering the cost of the job. n
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Many of our clients have noticed the steady increase in the use of indemnities in agreements in the Australian market over the last 10 to 15 years. Often the trigger for liability under the indemnity is fault-based. That is, liability to indemnify is triggered in a particular scenario if there has been a breach of contract or negligence by the contractor. However, some of the indemnities may be ‘no-fault’. That means the principal is entitled to seek indemnification, without having to prove that the loss was caused by breach of contract or negligence. No-fault liability raises a number of obvious concerns, especially if there is no insurance available in the market to cover the risk.
When considering a proposed contract, it is important to identify whether it imposes no-fault liability in certain scenarios and, if so, to consider whether it is prudent to accept such risk. There may be valid commercial reasons for no-fault indemnities in some situations but accepting such risk requires proper consideration.
No-fault liability for death and personal injury
It is easy to justify no-fault liability in certain circumstances. The most obvious example involves claims for death and personal injury where no-fault liability provides a pragmatic solution to assist in management of a complex area of risk. The availability of insurance enables parties to mitigate the associated risk.
It is common for contractors to be required to indemnify the principal against claims arising from death or personal injury to any person arising out of or in connection with the work. As a general rule the contractor’s obligation to indemnify is no-fault; that is, the obligation to indemnify in this scenario arises irrespective of any breach of contract or negligence by the contractor. The obligation to indemnify the principal may be subject to a qualification to the extent that the death or personal injury was caused or contributed to by the act, omission, negligence or default of the principal.
‘Knock for knock’ indemnities for death and personal injury to employees are another form of no-fault indemnity. They are also known as ‘mutual hold harmless’ indemnities because the principal and contractor exchange mutual indemnities and agree to accept full responsibility for compensation of their own employees, irrespective of who was at fault.
Knock for knock indemnities are standard in the oil and gas sector, as noted by Lord Bingham in the decision of Caledonia North Sea Ltd v London Bridge Engineering Ltd [2002] UKHL 4:
“As would be expected, a market practice has developed to take account of the peculiar features of offshore operations. The standard practice during construction is thus described by Sharp, Offshore Oil and Gas Insurance (1994), p 108:
…The position in respect of employers’ liability is invariably dealt with by the exchange of mutual indemnities in respect of injuries to or deaths of employees. There is perhaps a simple reason for this. If an individual is injured he will expect to have a right to sue any party who may have been guilty of negligence leading to the circumstances which caused the injury. This party may be another contractor, the Principal or his employer, or any combination of all three. The issue can become complicated by reason of contributory negligence. Determining liability and awarding costs can be a lengthy process in these circumstances, and this can only add to the anguish of the injured party, or the dependents of the deceased who may have been the sole breadwinner. The employer therefore accepts a responsibility to provide for his employees and will generally give the party with whom he is contracting a full indemnity in respect of any suit or action brought against that other party.”
No-fault liability for other loss
No-fault liability only makes commercial sense in a narrow range of scenarios, such as death and personal injury of employees.
Contractors should be wary about taking on no-fault liability for liability outside the narrow range. The fact that a particular type of indemnity may be increasingly common in the Australian market does not necessarily mean that it is appropriate. Contractors should critically assess any proposal for no-fault liability – why is no-fault liability considered necessary and appropriate in this scenario? Is there a legitimate commercial reason? Is the real reason that it would make life easy for the principal by simplifying the claims process?
Identifying a no-fault indemnity
Generally, no-fault indemnities are not difficult to spot in the draft agreement. A fault-based indemnity will often draw a clear link between default by the contractor and loss. For example, the clause in the agreement may read as follows:
Contractor shall indemnify the Owner against all claims for loss or damage to any property arising out of or as a consequence of breach of contract or negligence by the Contractor in carrying out the work under the Contract.
No-fault indemnities
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Disclaimer
The content of our publications is intended only to provide a summary and general overview on matters of interest, current at the time of publication. The content is not intended to be comprehensive, nor does it constitute legal advice. You should seek legal or other professional advice before acting or relying on any of the content.
In contrast, the trigger for a no-fault indemnity is loss or damage, irrespective of whether there has been a breach of contract or negligence. In such an instance, the indemnity may be along the lines of:
Contractor shall indemnify the Owner against all claims for loss or damage to any property arising out of or as a consequence of the Contractor’s work under the Contract.
Other examples of no-fault indemnities that may present themselves include:
Contractor shall indemnify the Owner against all claims arising from any occurrence on the Site, however caused.
Contractor shall indemnify the Owner against all claims for loss or damage to the Owner’s property intended to be incorporated into the Works while in the Contractor’s care, even if the loss or damage results from the Owner’s negligence.
Contractor shall indemnify the Owner against all claims for loss and damage arising out of, or in connection with, the Contractor’s work under the Contract.
Questions
If there is a no-fault indemnity in the draft agreement, there are a number of questions to consider, including:
• Would your insurance policies apply? If not, what does this mean for you and your business? What is the risk involved, and can you manage it? Would you be able to seek reimbursement from the party who was actually to blame?
• Does the cap on liability under the contract (if any) effectively cap liability under the indemnity?
• Does the indemnity create exposure to liability for financial loss suffered by third parties? Would the consequential loss clause (if any) protect you from a claim under the indemnity for financial loss suffered by third parties?
•When does the indemnity expire?
Query whether it may be appropriate to ask for some carve outs. For example, it is common for contractors to request an amendment to carve out negligence by the principal. Depending on the particular indemnity, this may not necessarily be a complete solution. There may be other parties on site (for example, other contractors engaged by the principal) who need to be considered.
As with all indemnities, care should be taken to ensure the drafting of the indemnity is clear and accurately reflects the intended scope of the indemnity being negotiated.
Extended limitation period
Finally, when considering your appetite for risk, it is important to consider when your potential liability under the indemnity will expire. Indemnities are a tool used to manage risk by expanding a party’s scope of recovery in certain circumstances. As a result, the statutory limitation period that would ordinarily apply can be extended under a contractual indemnity. It is important to bear in mind that indemnities remain alive long after the work has been completed. For example, if a contractor agrees to an indemnity for breach of contract, the principal’s rights under that indemnity continue after the usual six year period. This should always be factored into your assessment when negotiating any indemnity, whether it is a no-fault indemnity or otherwise. It may be appropriate to propose a sunset date on the indemnities. n
Tony Molino
Director
MolinoCahill Lawyers
T +61 3 9606 3210
Meghan Cahill
Director
MolinoCahill Lawyers
T +61 3 9606 3299
Penny Swain
Director
MolinoCahill Lawyers
T +61 3 9606 3209
Alastair Oxbrough
Director
MolinoCahill Lawyers
T +61 3 9606 3215
Brigid Lloyd
Director
MolinoCahill Lawyers
T +61 3 9606 3202
Level 22, 181 William Street, Melbourne, VIC 3000, Australia
Telephone +61 3 9606 3200 Facsimile +61 3 9606 3222
www.molinocahill.com.au
