Firms that take the time to review and attempt to negotiate their contracts know to strike the word “defense” if they want to avoid having to pay a client’s attorneys’ fees out of their own pocket. But if the words “arising out of” remain in an indemnity clause, firms unknowingly could be taking on the same uninsurable obligation.
The clause “Engineer shall indemnify client, but only to the extent arising from or relating to Engineer’s negligence” sounds innocuous. However, the phrase has potentially significant liability implications. The words can expand the scope of an indemnification obligation and even put a firm in breach of contract for failure to secure adequate insurance coverage.
In Federal Ins. Co. v. Tri-State Ins. Co. (1998), the court stated that the majority rule that “the phrase ‘arising out of’ should be given a broad reading such as … ‘growing out of’ or ‘flowing from’ or ‘done in connection with’ — that is, it requires some causal connection to the injuries suffered but does not require proximate cause in the legal sense.” The broad interpretation of these three words has led to several surprising decisions affecting the potential liability of design professionals and the breadth of their insurance coverage.
In Penta Corp. v. Town of Newport v. AECOM Technical Services, Inc. (2016), the engineer had contractually agreed to indemnify and defend, “but only to the extent arising from” its negligence. Engineer argued that there was no duty to pay the other party’s defense costs unless it was found negligent.
From a professional liability perspective, an indemnitee’s reasonable attorney’s fees become insurable only after a determination that those costs were caused by the insured’s negligence.
The dispute did not involve fault on the part of the engineer. But the court reasoned that the engineer owed its client a duty to defend based on the “arising from” language in the indemnity clause: “Arising out of does not mean that any losses or claims must have been caused by negligence or breach of contract. A claim merely has to involve an alleged negligent act or omission in the performance of the contract.” Thus, inserting the words “to the extent” in front of “arising from” did not alter the broad intent of “arising from.” Had the clause read “but only to the extent caused by engineer’s negligence,” the outcome would have been different. But with the language above, Engineer ended up with the uninsured obligation to pay the other party’s significant defense costs.
A common insurance requirement is that the A/E make the owner an additional insured (“AI”) on its general liability policy for claims “arising out of” the A/E’s services. Prior to 2004, the Additional Insured endorsement in general use (ISO CG 20-10, edition 11/85) provided in part that the AI is covered for liability “arising out of” the insured’s ongoing operations. Numerous court decisions have applied the broad interpretation of “arising out of” in the context of the CG 20-10 endorsement. In many cases, the mere fact the named insured was performing services for the AI was enough to invoke the “arising out of” language.
This broad interpretation was not the intent of the endorsement. For that reason, in 2004, insurers changed the language from “arising out of” to “caused in whole or in part by your (the named insured’s) acts or omissions.” The broad coverage provided by the liberal interpretation of the 11/85 language is a great potential benefit to the AI. Owners therefore often include the old language as a contractual requirement. The problem is that it is very difficult for most A/E firms to secure AI coverage using the 11/85 coverage formula.
Some contracts do not specify the edition date but require that coverage for the AI be secured for claims “arising out of” the A/E’s services. If the applicable AI endorsement is a current one, the A/E is possibly in breach of contract for failure to provide the required coverage.
Failure to identify and address the “arising out of” language in an indemnity provision or insurance requirement could very well expose the design professional to an unintended obligation and possibly a breach of contract claim.
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Reach out to Darren Black on LinkedIn or by email: aepro@risk-strategies.com