03 June 2004
Key Points:
When preparing insurance and indemnity clauses, it is prudent to specify whether the contractual indemnities are to have primacy over, or be co-ordinate with, the insurances. Project participants that fail to do so could find that they, or their insurers, are unexpectedly required to contribute to project losses.
It is common for contracts for services (including concession agreements and construction contracts) to contain obligations upon the contractor to indemnify, and obtain insurance cover for, the principal to protect the principal against any loss that may arise in the course of a project. In addition, prudent principals usually have their own insurance which protects them regardless of the contractual arrangements imposed on the contractor under the services contract. Consequently it is not unusual for a principal to enjoy three indemnities protecting it should a loss arise in the course of a project: its own insurance, the contractor's indemnity and the project insurance.
Such multiplicity of protection can lead to disputes concerning where liability for a loss should ultimately fall. The essential issue for determination in such disputes is whether one indemnity has primacy over any other and, therefore, is responsible for the entirety of the loss. The alternative is that the indemnities are equal or co-ordinate, which means the burden is shared proportionally amongst the indemnifiers.
The answer to this question obviously can have a dramatic impact on the fortunes of the indemnifiers. It can also impact on the principal in terms of higher insurance renewal costs. Consequently, unless care is taken in drafting the services contract, particularly the insurance and indemnity clauses, it is possible that the burden might fall in an unexpected way.
Recent cases in the United Kingdom and Australia illustrate the importance of proper drafting to effect accurate risk allocation. In the UK a series of decisions arising out of the Piper Alpha disaster in 1988 culminating in the House of Lords in Caledonian North Sea Ltd v Norton (colloquially known as Elf) addressed the issue of whether the contractor's indemnity was primary or co-ordinate with the principal's own insurance. In Australia, the Full Court of the Supreme Court of Western Australia in Speno Rail Maintenance Australia v Hamersley Iron Pty Ltd addressed the issue of whether the contractor's indemnity was primary or co-ordinate with the project insurance.
Although not entirely beyond doubt, both cases appear to establish that the status of an indemnity is subjective in that it can be fixed by the parties to the services contract. In neither case had the parties elected to nominate the status of the contractual indemnity. Yet in both the court found that the circumstances in which the services contracts were prepared and intended to govern meant the contractual indemnity should be construed as primary.
However, it is not safe to assume that these cases stand as precedent that a contractual indemnity always will be considered primary. In Elf, the House of Lords gave strong indications, albeit in a manner which it is not binding on future courts, that they would treat a contractual indemnity and project insurance as co-ordinate. Although this is at odds with the result in Speno it, perhaps paradoxically, is not inconsistent. The leading judgment in Speno made it clear that the status of the contractual indemnity and the project insurance will be determined by a proper interpretation of the services contract: in other words it will be determined from the circumstances peculiar to each case. Furthermore, neither case involved consideration of whether project insurance can be co-ordinate with a principal's own insurance.
Various contractual mechanisms are available to impose priority on alternative indemnities or, if desired, making them co-ordinate in order that any burden be shared over a community of interests rather than a single interest.
In summary, it remains prudent, when preparing insurance and indemnity clauses to consider whether it is intended to give priority to any of those indemnities and, if so, how that is to be achieved. Otherwise parties may find that they, or their insurers, are unexpectedly required to contribute to losses arising in the course of a project.
For further information, please contact Douglas Bishop.
