The Indemnity Clause Battle Continues Two New Changes

The Indemnity Clause Battle Continues

Two New Changes

By

William C. Last, Jr

Attorney at Law

Indemnity construction contract clauses are the primary contractual vehicles for shifting the risk associated with bodily injury and property damage on 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 and property damage claims to general contractors. In turn, general contractors are passing that risk on to their subcontractors. As a result, the cost of complying with these contract clauses has increased the financial burden placed on general contractors and subcontractors.

Over the past year various construction trade organizations, including the American Subcontractors Association, have lobbied the Legislature to limit such indemnity clauses. Effective January 1, 2005, there will be a new law in California that limits indemnity clauses for residential construction. However, a recent California appellate court decision broadened or limited the reach, depending on your perspective, of obligations under indemnity clauses. This article will start out by discussing the types of indemnity clauses and then discuss the two recent developments in the indemnity clause battle.

An Overview of Indemnity Clauses

Indemnity clauses are the primary contractual device that is used to shift risks associated with a party's negligent acts from one party to another. In essence, one party (indemnitor) promises to pay the other party's (indemnitee) attorney's fees and any judgment that may result from one or both parties' wrongful conduct. If there is no indemnity clause in a contract, the liability and resulting damages for the negligent acts of multiple parties will be allocated according to the comparative fault of each of the respective parties.

In the construction industry, the project owner will want to shift the responsibility for negligent acts from itself to the design professionals and the general contractor. In turn, the general contractor will want to shift that risk 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 general's negligence.

However, under California law there is a limitation 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 acts. Any such clause in a contract is void as a matter of law. Thus under California law, a person at fault can only seek indemnity from another party who also has some degree of fault for the harm that results in the liability.

California courts have categorized indemnity clauses into three basics types. 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 expressly and unequivocally provides that the subcontractor will indemnify the general contractor against the negligence of the general contractor. Under this type of clause, the general contractor is indemnified whether the liability results from his negligence alone, or from his co-negligence combined with that of third parties. Civil Code section 2782 limits such provisions such that contractor cannot contract for indemnity against injuries caused by his or her sole negligence or wilful misconduct or that of his or her agents, employees, or independent contractors.

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 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. As a result, if the general contractor actively participated in the negligent act, he or she would not be able to seek indemnity.

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 indemnification against the subcontractor whether or not he or she contributed to the general contractor's liability. Type II and Type III clauses are sometimes called "general indemnity agreements."

The Recent Appellate Court Decision

The recent case concerns a General Contractor who, along with its subcontractor, was found liable for wrongful death of worker who fell through a hole on the roof at a job site. The General Contractor paid its percentage of the judgment and sought indemnity, pursuant to a subcontract indemnity clause, from a sheet metal subcontractor who cut the hole and did not cover it, contending doing so was outside its scope of work. The General Contractor directed a second subcontractor to cover the hole, but the cover was defective.

The trial court found that the subcontractor should indemnify the general contractor, despite finding them both actively negligent. It found the general was responsible for supervision, was aware of the hazard, and had taken control by directing that the hole be covered without inspecting the second subcontractor's work. The first subcontractor was actively negligent in that its contract required it to comply with regulations and failing to cover the holes violated OSHA regulations.

The subcontract indemnity provision was a Type III, which called for indemnity for liabilities "on account of, or related to, any act or omission ... of the Subcontractor." Active negligence on the part of the general contractor would ordinarily bar recovery under such a clause. However, in Morton Thiokol, Inc. v. Metal Building Alteration Co. (1987) 193 Cal. App.3d 1025, a court of appeal held that a Type III clause could be interpreted as affording indemnity if doing so furthers the intent of the parties under the contract and the liability would not have arisen without the indemnitee's negligence.

The trial court reasoned that indemnity should given because the general contractor's negligence was only in failing to remedy a dangerous condition caused by the subcontractor's breach. The Court of Appeal reversed and ordered judgment entered for the subcontractor. The appellate court, however, concluded that the subcontract indemnity clause did not require indemnity from the subcontractor for active negligence of the general contractor, and there was nothing else in the contract suggesting that the intent of the parties was to provide indemnity under these circumstances. The court distinguished the case because in Morton Thiokol the indemnitor (a general contractor) had contracted to assume full responsibility to repair an existing dangerous condition. As a result the appellate court applied the general rule that an actively negligent indemnitee cannot recover under a general indemnity contract.

The New Residential Indemnity Statute

This new law (Assembly Bill 758) becomes effective on January 1, 2006 and limits the ability of general contractors to require indemnity against construction defect liability not caused by a subcontractor's work. It adds a new subsection to Civil Code section 2782 and provides that for residential construction contracts that are entered into after January 1, 2006, agreements requiring a subcontractor to indemnify a builder against claims for construction defects are unenforceable to the extent the claims "relate to the negligence of the builder or the builder's other agents, other servants, or other independent contractors who are directly responsible to the builder, or for defects in design furnished by those persons, or to the extent the claims do not arise out of, pertain to, or relate to the scope of work in the written agreement between the parties."

The provisions of the new law cannot be waived by the parties to the construction contract. However, contractual provisions, clauses, covenants, or agreements not expressly prohibited can still be the subject of an agreement between the parties to a construction project. Furthermore, a subcontractor and builder can mutually agree to the timing or immediacy of the defense and provisions for reimbursement of defense fees and costs, so long as that agreement, upon final resolution of the claims, does not waive or modify the provisions new law.

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 these 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.

A number of construction industry trade associations are continuing to lobby the California legislature to limit contractual indemnity obligations. 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, 8 2005, was written by William C. Last, Jr. of Last & Faoro. Mr. Last is an attorney who has been specializing in Construction Law for over eighteen years. Mr. Last also holds a California A&B contractors license. If you have any questions Mr. Last can be contacted at 415-764-1990 or 650-425-7679. He has other articles on his web site: lhfconstructlaw.com. This bulletin is published periodically to provide general information about current legal issues. If you have a specific legal question or need legal advice, you should contact an attorney.