Indemnity Clauses: What Are They And What Risks Do I Assume When I Have One In My Contract?

Indemnity Clauses: What Are They
And
What Risks Do I Assume When I Have One In My Contract?
By
William C. Last, Jr. and Frederick J. Northrop
Attorneys at Law

Contractors are regularly am faced with or making demands for indemnification when someone is injured on the job or there is a claim of defective workmanship. Increasingly, subcontractors are being asked to shoulder obligations of defense and sometimes indemnification which may have little or nothing to do with the work they perform or the products they install. Moreover, these obligations are sometimes uninsurable and coverage is frequently contested when it exists.

Indemnity construction contract clauses are, along with additional insured provisions, the primary contractual vehicles for shifting the risk associated with bodily injury and property damage connected with a construction project. Project owners, typically at the insistence of their insurance carriers, use indemnity contract clauses to shift a disproportionate share of the risk of third party personal injury, property damage, and intellectual property claims to general contractors. In turn, general contractors are passing that risk on to their subcontractors. Many prime contracts actually require them to do so.

Indemnity provisions are often written extremely broadly to protect not only the owner and general contractor, but architects and others connected with the project. Such clauses impose obligations which exceed available insurance coverage and they typically extend well beyond the completion of the project. As a result, the cost of complying with these contract clauses has increased the financial burden placed on general contractors and subcontractors. The provisions are often presented on a "take it or leave it" basis, without any real opportunity to bargain or negotiate.

An Overview of Indemnity Clauses

Indemnity is the shifting of a loss or liability from one party to another. Equitable or implied indemnity involves a claim where the law implies a right of indemnification as a matter of justice. Contractual indemnification involves indemnity based on the agreement of the parties. These terms typically involve a party agreeing to indemnify, defend, and hold a party harmless against a list of possible harms. The scope of the indemnity is triggered based upon a pre-determined threshold. The definition of the scope of harms and the style of the threshold define exactly how much risk the subcontractor assumes.

Indemnity clauses are the key contractual devices used to shift liability risks associated with a construction project from one party to another. In essence, one party (the indemnitor) promises to pay the other party's (the indemnitee) attorney's fees and any judgment within a defined scope of claims.

In the construction industry, project owners seek to shift the risks of claims and losses from themselves to the design professionals and the general contractor and, sometimes, its subcontractors. In turn, the general contractor will want to shift those risks, along with its own risks, to the subcontractors and suppliers. For example, the project owner who seeks to shift the risk to the general contractor will include in the contract with the general, a clause that clearly and expressly obligates the general to defend the owner from liability and pay any damages that may result from the performance of the work. The exact scope of the risk is, in general, controlled by the terms of the agreement and the scope of the work itself. The scope may be limited to third party claims of personal injury and property damage, but can also be extended to regulatory fees and fines and intellectual property claims.

However, under California law there are limitations as to how much of that risk can be shifted. By statute, you cannot have another party indemnify you against damages that result from your sole negligence, or willful negligence. With some exceptions any such clause in a contract is void as a matter of law. Additionally, any contract which seeks to exempt a person for his or her fraud, willful injury, or violation of law is likewise void.

Past California appellate courts have categorized indemnity clauses into three basic types. Recent decisions have moved away from these categories, but they remain a part of the parlance. For the purposes of explaining these three types of indemnity clauses, this article will assume that the general contractor is the one seeking indemnity (indemnitee) from the subcontractor (indemnitor).

A Type I Clause is one that clearly and explicitly provides that the subcontractor will indemnify the general contractor regardless of any negligence, active or passive, of the general contractor whether or not the general contractor is concurrently responsible. Under this type of clause, the general contractor is indemnified whether the liability results from his negligence alone, or from his negligence combined with that of the subcontractor or others. Civil Code Section 2782 limits such provisions such that a party cannot contract for indemnity against injuries caused by his or her sole negligence or willful misconduct or that of his or her agents, employees, or independent contractors. Civil Code Section 1668 declares any contract which even indirectly seeks to exempt a person from liability for his or her fraud, willful injury to another, or violation of law is void as against public policy.

A Type II Clause is one that provides that the subcontractor will indemnify the general contractor for liability without expressly stating that it covers the active negligence of the general contractor. For example the clause may promise indemnity against liability "however same may be caused;" or "arising from the use of the premises, facilities, or services of;"or "which might arise in connection with agreed work;" or "caused by or happening with the equipment or the condition, maintenance, possession or operation or use thereof;" or "from any and all claims for damages to personal property by reason of the use of leased property."

Under Type I and II Clauses, the general contractor is indemnified for his or her own acts of "passive negligence." Under Type I Clauses the general contractor is also indemnified against claims based on his or her "active negligence." Passive negligence exists when there is a mere nonfeasance (failure to act); and active negligence exists when the party participates in the affirmative act of negligence. The crux of the difference is whether or not the party has had some direct participation in the negligent act that resulted in the liability for which indemnity is being sought. Under a Type II Clause if the general contractor actively participated in the negligent act, he or she would not be able to seek contractual indemnity, but could still use equitable indemnity to seek an allocation of the loss between it and the subcontractor.

It should be noted that under both Type I and Type II Clauses, there is no need to show that the subcontractor is actually at fault for the injury. All that needs to be shown is that the alleged loss falls within the scope of the clause. An extreme case, arising in Pennsylvania, involved a slip and fall accident which occurred in a grocery store during renovation. The plaintiff tripped in a hole in the floor. The owner sought indemnity from the general contractor who sought indemnity from the electrical subcontractor who happened to be working in the area of the accident. The court there held that because the indemnity clause required indemnification against damages arising from the location of the subcontractor's work rather than from the work itself, the subcontractor was required to indemnify the general contractor.

A Type III Clause, provides that the subcontractor will indemnify the general contractor for the general contractor's liability caused by the subcontractor, but does not provide indemnification for liability that was caused by anyone else. Under a Type III Clause, any negligence on the part of the general contractor, either active or passive, will eliminate contractual indemnification against the subcontractor whether or not he or she contributed to the general contractor's liability. The general contractor would still be able to Type II and Type III clauses are sometimes called " general indemnity agreements."

Aside from the obligation to indemnify itself, most indemnity clauses encompass a duty to defend, as well. This duty is also subject to statutory and contractual definition. Owners and general contractors are increasingly including provisions which obligate the indemnitor to defend claims based on allegations within the scope of the indemnity clause. In this regard the courts have held that the subcontractor is obligated to defend claims for which it was ultimately held blameless. As if this were not onerous enough, many provisions now attempt to give the indemnified party nearly unlimited control over that defense. Given that such claims frequently present conflicts which prevent a single law firm from defending all the indemnified parties, the potential liability flowing from such clauses is staggering.

Statutory Attempts to Limit the Clauses

A number of national construction trade associations have been proactive in seeking legislation in the fifty states to limit the risk that subcontractors take on when they sign subcontracts that have the most stringent of indemnity clauses. The results have varied from state to state.

For example, in California, there are the following statutes

Civil Code Section 2782(a) voids provisions in construction contracts which indemnify against liability arising from the sole negligence or willful misconduct of the indemnitee or of the indemnitee's agents, employees, or independent contractors directly responsible to the indemnitee or for defects in designs provided by them. The provision does not apply to insurance contracts however and there are specified exceptions as to accommodation agreements, indemnification of engineers providing inspection services, certain limitations as to design defects, and hazardous waste identification by an engineer or geologist.

Civil Code Section 2782(b) voids provisions indemnifying public agencies for their active negligence.

Civil Code Section 2782(c) voids provisions in residential construction contracts executed after January 1, 2009 which purport to insure, indemnify, or provide a defense by a subcontractor in favor of a builder or general contractor as to claims for construction defects to the extent that claims arise from the negligence of the indemnitee or its agents, employees, or independent contractors or from defects in designs by them. Subsequent subdivisions of the statute outline rules for providing a defense and other details.

Civil Code Section 2782.8 prevents public agencies from requiring design professionals to indemnify them except to the extent the claims arise from the professional's negligence, reclessness, or willful misconduct.

Civil Code Sections 2782.9 through 2782.96 contain provisions restricting indemnity provisions where the project is subject to a Wrap-Up insurance policy.

Other states have enacted similar laws and some have gone farther in limiting the risks which can be transferred to subcontractors. For example, New Mexico Code Section 56-7-1 broadly forbids agreements which require a party to indemnify, hold harmless, or defend the indemnitee for claims arising from the indemnified party's negligence, act, or omission.

Other states with legislation in this area include Arkansas, Colorado, Delaware, Florida, Georgia, Hawaii, Kansas, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Nebraska, New York, North Carolina, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, and West Virginia The degree of protection varies among them. Some have statutes very similar to California's, others more akin to New Mexico's.

In California, subcontractors' have seeking new legislation that would encompass all subcontracting work, would bar an indemnitee from obtaining contractual indemnity from a subcontractor except for losses incurred because of the subcontractor's or its agent's negligence, violation of law, or other wrongful act or omission, and then only in proportion to the subcontractor's proportionate liability.

Suggestions

When you are considering submitting a bid or proposal for a project, obtain the terms and conditions of the contracts that you will be required to sign for that project. Examine your contracts to confirm if you have, or can obtain, the appropriate insurance coverages. Also ask your insurance professional to review the contract requirements before you submit your proposal or bid.

Until the law is changed so that indemnity obligations are standardized, contractors should closely review such obligations and be familiar with their legal obligations under such clauses.

This article, ©2011, was written by William C. Last, Jr. and Fred Northrop. Mr. Last is an attorney who has been specializing in Construction Law for over 30 years.. In addition to belonging to a number of construction trade associations, Mr. Last holds a California "A" and "B" license. He can be contacted at 415-764-1990 or 650-696-8350. A number of his past articles can be found on his website (lhfconstructlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.