New Indemnity Law Protects Subcontractors

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[author: Maria Giardina]

California Senate Bill 474 prohibits a contract provision requiring a subcontractor to indemnify a general contractor, construction manager, or other subcontractor for claims arising out of their "active negligence." This bill, which becomes effective January 2013, represents a major legislative victory for subcontractors and establishes other important protections for contractors.

 

New Law Precludes Indemnity or Cost of Defense for Active Negligence
Civil Code section 2782 presently prohibits contract clauses that promise to indemnify another from liability arising from their "sole negligence" or "willful misconduct" or for defects in design that they furnish, but does not prohibit indemnity for their "active negligence." General contractors often include indemnity provisions in their subcontract documents that require subcontractors to defend and indemnify them from liability regardless of whether the general contractor is partially at fault –the typical "Type I" indemnity clause. In sponsoring this legislation, subcontractors complained that the present law allows a general contractor who is 99 percent at fault for an injury or damage to shift the entire risk to a subcontractor who is only one percent at-fault or a subcontractor who is not at fault at all, but peripherally involved in the claim.

 

In response, SB 474 adds Civil Code section 2782.05 which, most significantly, precludes indemnity where the party to be indemnified is "actively negligent." Section 2782.05(a) makes void and unenforceable any contract clause whereby a subcontractor "purports to insure or indemnify, including the cost to defend"

  • a general contractor, construction manager, or other subcontractor against liability to the extent the claims arise out of their "active negligence" or "willful misconduct" of that of their other agents, servants, or independent contractors; or
  • for defects in design furnished by them; or
  • to the extent the claims do not arise out of the scope of work of the subcontractor.


Subcontractor's Defense Obligation

Section 2782.05(e) also sets out the steps a general contractor or construction manager must take to perfect a demand for a defense from a subcontractor. Importantly, a subcontractor has no obligation to defend unless and until the general contractor or construction manager provides a written tender of the claim. The tender must include the information that the claimant provided to the general contractor or construction manager relating to claims caused by the subcontractor's scope of work. In addition, the general contractor or construction manager must provide a written statement setting forth how it determined the share of fees and costs allocated to the subcontractor.

 

Upon tender of a claim, the subcontractor has two options: It may defend the claim with counsel of its choice or pay an allocated share of the defense fees and costs.

 

If the subcontractor elects to defend, it must provide written notice of its election no later than 30 days following receipt of the tender. The subcontractor must provide a "complete defense" of the general contractor or construction manager of all claims or portions thereof to the extent alleged to be caused by the subcontractor, including any vicarious liability claims resulting from the subcontractor's scope of work. Conversely, the subcontractor has no obligation to defend claims resulting directly from the general contractor's scope of work or the work of any other party. (§2782.05(e)(1)).

 

If the subcontractor does not elect to defend, it must pay, within 30 days of receipt of an invoice from the general contractor or construction manager, no more than a reasonable allocated share of the defense fees and costs on an ongoing basis during the pendency of the claim. The allocated share of defense fees and costs that the subcontractor is to pay is subject to reallocation, including any amounts reallocated when the claim is resolved by settlement or judgment. (§2782.05(e)(2)).

 

The allocation of defense fees and costs must be based on claims allegedly caused by the subcontractor. In arriving at the subcontractor's allocated share, the general contractor or construction manager must allocate a share of the defense fees and costs to itself "to the extent a claim or claims are alleged to be caused by its work, actions or omissions" and a share to each subcontractor "to the extent a claim or claims are alleged to be caused by the subcontractor's work, actions or omissions," regardless of whether a tender has been made to any particular subcontractor and regardless of whether that subcontractor is participating in the defense. Notably, the general contractor or construction manager may not collect any amounts not collected from one subcontractor from any other subcontractor. (§2782.05(e)(2)).

 

Right to Enforce Defense Obligation

If a subcontractor elected to defend but fails to do so, the general contractor or construction manager may pursue a claim against the subcontractor for any resulting compensatory damages, consequential damages, and reasonable attorney's fees. If the subcontractor elected to pay an allocated share of defense fees and costs but fails to pay, the general contractor or construction manager may pursue a claim for any resulting compensatory damages, interest on defense and indemnity costs (at 2 percent per month), consequential damages, and reasonable attorney's fees incurred to recover these amounts. (§2782.05(f)).

 

Right to Seek Reallocation of Defense Fees and Costs

A subcontractor has a right to request the general contractor or construction manager to reallocate defense fees and costs. If the general contractor or construction manager does not reallocate within 30 days of final resolution of the claim, the subcontractor has the right to pursue a claim for any resulting compensatory damages with interest (at 2 percent per month). (§2872.05(f)).
 

Matters Left to Agreement of the Parties

SB 474 gives the parties freedom to enter into agreements that establish the "timing or immediacy of the defense" and "provisions for reimbursement of defense fees and costs," so long as they are not otherwise prohibited. (§2782.05(e)) For example, the parties may agree that the subcontractor is not required to provide an immediate defense until there is a determination of the subcontractor's liability.

 

Other Significant Changes

SB 474 also contains other significant changes that amend Civil Code section 2782.

  • Amendments Affecting Residential Construction

Section 2782 now contains similar provisions that prohibit liability-shifting clauses in residential construction contracts. (§§2782(d)-(i)).

  • Amendments Affecting Public Agencies and Private Owners

 

Section 2782(b) presently bars contract clauses that shift liability for a public agency's active negligence to a contractor. The amendment extends this protection is to subcontractors and suppliers. It bars construction contracts that "purport to impose on any contractor, subcontractor or supplier," or "relieve the public agency from liability" for its "active negligence." (§2782(b)(2)). Similarly, newly enacted 2782(c) now bars private owners from shifting liability for their active negligence to contractors, subcontractors, or suppliers.

 

Under these amendments, the defense obligation may be broader than the agreement to indemnify. Section 2782.05(m) provides that "nothing in this section shall be construed to affect the obligation, if any, of either a contractor or construction manager to indemnify, including defending or paying the costs to defend," a public agency or private owner against claims arising from their "alleged" active negligence. Therefore, a general contractor or construction manager may contract with a public agency or private owner to defend or pay the cost to defend claims arising out of the public agency's or private owner's alleged active negligence, but may not agree to indemnify them against their actual active negligence.

 

Insurance

SB 474 does not restrict contract clauses that require a subcontractor to purchase insurance, including additional insured coverage for a general contractor or construction manager under the subcontractor's general liability policy. (§2782.05(b)(6)).

 

Published In: Administrative Agency Updates, Civil Remedies Updates, General Business Updates, Construction Updates, Insurance Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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