Keep It Simple Stupid: Remembering The Basics In A Construction Defect Indemnity Case To Minimize Surprises Down The Road

by Jones, Skelton & Hochuli, P.L.C.
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There is an old saying: familiarity breeds contempt. Admittedly, residential construction defect cases can be repetitive. They usually involve the same Plaintiffs’ attorneys, the same alleged defects, and resolve in the same fashion for the same per-home amount. As a result, there is a dangerous tendency to view new construction defect (“CD”) lawsuits as homogenous. So what happens when the courts in which we practice throw us a curveball? It turns out, as illustrated by recent developments in the authors’ home jurisdiction of Arizona, a curveball can be a blessing in disguise by providing defense counsel a chance to get back to basics.

The Amberwood Case

Arizona CD law was thrown for a loop recently when the Arizona Court of Appeals — the state intermediate appellate court — decided a case interpreting an indemnity provision in a construction contract between a builder and a subcontractor. In an unpublished opinion, the court decided that a subcontractor can be forced to indemnify a contractor for mere defect allegations, even those alleged defects which are neither attributable to any subpar workmanship on the part of the subcontractor nor otherwise actually caused by the subcontractor, unless the contract specifically required a finding of fault by the subcontractor. Amberwood Dev., Inc. v. Swann’s Grading, Inc., 2017 Ariz.App. LEXIS 207, 2017WL 712269 (Ariz. App. 2017)(unpublished opinion), review denied 2017 Ariz. LEXIS 242 (2017). While this may not be a major development in several states, it was the first time that an Arizona court addressed the issue. And defense counsel should consider whether such a development has arisen or may arise in your jurisdiction(s).

Amberwood Development, a general contractor, arbitrated a construction defect complaint brought by numerous homeowners that alleged, among other things, defects attributable to soils movement. The rough and finish grader, Swann’s Grading, provided a defense in the arbitration, but did not otherwise participate in the arbitration. Ultimately, Swann’s Grading did not agree to indemnify Amberwood for any part of the $1.75 million award to the plaintiff homeowners or the additional $723,000 paid in settlement to another group of homeowners. Id. Amberwood, therefore, brought an action for indemnity against Swann’s Grading, relying on the parties’ subcontract. The indemnity provisions of this contract required Swann’s Grading to defend and indemnify Amberwood “from claims, demands, costs, or attorney fees, causes of action and liabilities of every kind whatsoever arising out of or in connection with Subcontractor’s work performed for Contractor….” Id. At *2.

At a bench trial, Amberwood presented expert testimony establishing that 70.6% of the litigation settlement and 72.7% of the arbitration award were attributable, at least in part, to issues that “arose out of” Swann’s Grading’s work. Swann’s Grading’s expert denied causation for the alleged defects, but apparently did not rebut the arguments that the alleged defects themselves arose out of Swann’s Grading’s work. Id. This makes a measure of sense analytically: How can a defective condition arise from or relate to a subcontractor’s work if the defective condition was not caused by a defect in the subcontractor’s work? This has been the common position of subcontractors in litigation for years, and most contractors would likely tell you that they never thought they would have to pay for defect claims unless it was proven that their work was bad. Worse still, defense counsel for Swann’s Grading was not provided the expert’s report and allocation until the day of oral argument, was not granted a stay to analyze or respond to the newly disclosed report, and the report was admitted into evidence over defense counsel’s objection. The trial court ultimately rejected the subcontractor’s position, and the Court of Appeals affirmed the lower court’s decision finding Swann’s Grading responsible for $1.3 million (which included the allotted portion of arbitration award and settlement costs, plus a portion of Amberwood’s attorney’s fees and costs). Id.

The Court of Appeals’ decision in Amberwood is something of a departure from the approach undertaken by the CD defense community. The last Arizona case that had addressed the issue directly provided implicit support for Swann’s Grading’s position. In MT Builders, LLC v. Fisher Roofing, Inc., 219 Ariz. 297, 197 P.3d 758 (App. 2008), the same Court that decided Amberwood was faced with a similar argument: a builder who argued that fault was not a necessary prerequisite to recover indemnity from a subcontractor. The MT Builders case, however, involved a contract that limited the subcontractor’s indemnity to the contractor for claims “arising out of or resulting from the performance or non-performance [sic] of the Subcontractor’s Work under this Subcontract ... to the extent caused in whole or in part by any negligent act or omission of the Subcontractor….” MT Builders, 219 Ariz. at 303, 197 P.3d at 764 (emphasis added). Under the plain language of the contract, the Court decided that a finding of fault was required for the general contractor to receive indemnity. In addition to citing to outside authority (a treatise and cases from nine other jurisdictions across the country), the MT Builders Court made reference to the well-settled rule of contract construction that an ambiguous provision be construed against the drafter. Id. The overall tone of the MT Builders opinion and ultimate result left the “subcontractor bar” feeling emboldened, believing that the same line of argument and reasoning would be applied to other subcontracts as well.

While there is ample room for disagreement with and criticism of the Amberwood Court’s decision, its immediate impact was drastic. The arbitration decision, though only a memorandum, was the first case to address this broader indemnity provision. Its persuasive value was likely high at the outset, and it has now been upheld by a respected trial court judge. A subcontractor’s potential exposure in a CD case has dramatically increased. The pendulum swung drastically in the developers’ direction, and developers immediately took advantage of the shift by taking aggressive positions in settlement negotiations and litigation.

Faced with this drastic swing, the Arizona CD defense bar was forced to re-evaluate its usual strategy for litigating a CD case. But, upon further review, it appears not much has really changed in terms of how CD cases involving indemnification issues should be handled, as long as practitioners remember to stick to the “basics.” So it is helpful to look back at some of the “basic” concepts that are far too often ignored, even by very good CD attorneys.

Ascertain Whether An Indemnity Provision Falls Into A Legal Gap

The Amberwood case surprised Arizona CD counsel because, before Amberwood, there had not been any case that defined the breadth of the type of indemnity provision in question. Absent case law directly on point, defense counsel chose to take for granted that the inevitable interpretation of a broader indemnity provision would be favorable to their clients. That was a mistake.

Most indemnity provisions have been sharpened over time to require little or no showing of fault on the part of the indemnitor to allow recovery. As the Amberwood case illustrated, broad indemnification provisions can be used to recover virtually all of the fees and costs incurred by a general contractor or indemnitee in defending claims made by a third party. See also Continental Heller Corp. v. Amtech Mechanical Services, Inc., 61 Cal.Rptr.2d 668 (Cal.Ct.App. 1997). Express indemnity is the strongest cause of action in almost every case between a general contractor and subcontractor, and therefore, this should be the very first thing counsel analyzes.

Most states we surveyed take a hands-off view of contract interpretation. Thus, where the contract terms are clear and unambiguous, the express terms of the contract will govern the extent of the indemnity obligation. See, e.g., Koppers Co. v. Missouri Pac. R. Co., Inc., 34 Ark. App. 273, 809 S.W.2d 830 (1991); Hagerman Constr. Corp. v. Long Elec. Co., 741 N.E.2d 390 (Ind. Ct. App. 2000); Mautz v. J.P. Patti Co., 298 N.J.Super. 13, 688 A.2d 1088 (App. Div. 1997). All analysis should start with application of the general principles of contract construction, especially if there is no dispute between the parties about the contract terms. It is important to discern immediately what effect an indemnitee’s own negligence has on the indemnity obligation. Most states we looked at have anti-indemnity statutes or rules that either forbid an indemnitee from recovering for damages resulting from its own negligence or otherwise limit the indemnitee’s recovery. See, e.g., New York CLS Gen. Oblig. § 5-322.1 (making agreements for indemnification of one’s own negligence void and unenforceable); Fla. Stat.Ann. § 725.06 (requiring a monetary limitation on the extent of indemnification that is commercially reasonable and specifically incorporated into project specifications and/or bid documents to be enforceable). Likewise, some jurisdictions, like Arizona, require that a contract specifically address the impact of the indemnitee’s own negligence on the recovery to be enforceable. These defenses arise from the mere language of the contract.

THE AMBERWOOD CASE SURPRISED ARIZONA CD COUNSEL BECAUSE, BEFORE AMBERWOOD, THERE HAD NOT BEEN ANY CASE THAT DEFINED THE BREADTH OF THE TYPE OF INDEMNITY PROVISION IN QUESTION.

The larger question is how to proceed when the indemnity language is not crystal clear or is otherwise open to multiple interpretations — a legal gap if you will. Rare is the case where the parties simply agree that indemnity is owed. Knowing how courts have interpreted the same or similar language when presented with disagreements is therefore crucial. Most often, the issue we face as litigators is whether the language in the indemnity provision requires a finding that the subcontractor was at fault for or otherwise the cause of the claimed defect. Because contractual interpretation is usually an issue of law to be determined by the Court, it is important to be aware of how the Court will likely interpret your indemnification provisions.

This is often easier said than done. Courts have interpreted the same or similar indemnification provisions and reached different results, sometimes even within the same jurisdiction. Compare Continental Heller Corp. v. Amtech Mechanical Services, Inc., supra, with Heppler v. J.M. Peters Co., 87 Cal.Rptr.2d 497 (Cal. Ct. App. 1999) to better understand just how important it is to know your jurisdiction’s indemnity cases. In Continental Heller, the California Court of Appeals found that no finding of fault or causation was required for a general contractor to recover indemnity where the subcontractor agreed to indemnify the general contractor for any claim that “arises out of or is in any way connected with the performance of work under this Subcontract” and “shall apply to any acts or omissions … on the part of the Subcontractor.” Continental Heller, 61 Cal.Rptr.2d at 670. The Heppler court, however, reached the exact opposite result when looking at a nearly identical indemnity provision (“arising out of or in connection with Subcontractor’s … performance of the work…”) and held that a finding of fault on the part of the subcontractor was a prerequisite to trigger the indemnity obligation. The Heppler court expressly distinguished the facts at bar from those presented in the Continental Heller case. Specifically, the court noted the following differences in the two cases:

1. Continental Heller involved only one subcontractor positioned to control its work, whereas Heppler involved multiple subcontractors whose work was only a component part and who had no control over the other subcontractors involved in the project.

2. The cases involved different commercial contexts — a large, sophisticated subcontractor in Continental Heller and a smaller, less sophisticated subcontractor in Heppler who could be financially ruined by the potential indemnity obligation without a fault/causation requirement.

3. Continental Heller involved a slightly broader indemnity provision that applied to “any” acts or omissions of the subcontractor.

Since the vast majority of CD cases settle, the practitioner is in the tough position of determining whether he/she wants to obtain a definitive ruling on the breadth of a specific indemnity provision. A motion for summary judgment may clarify the issue, but it also may result in making bad (or good) law for the instant or future cases. In other words, sometimes the devil you don’t know is better than the one you do.

Propound and Conduct Meaningful Discovery

Bad habits can result in parties sending out routine discovery requests which result in routine, less-than-helpful responses by the opposition. Sussing out problematic indemnity issues requires thoughtful strategy. Propounding written discovery asking the general contractor to identify any and all construction defects and/or damages relating to a client’s work telegraphs defense counsel’s intention and usually results in a laundry list of damages that have no conceivable connection to the client’s work. For instance, recently a general contractor stated in discovery responses that a perimeter fence subcontractor’s work caused or contributed to problems with stucco, concrete, drywall, and roofing issues. The issue may be better saved for an expert deposition where the expert may not be prepared for the question or is less likely to strain credulity, especially when the expert knows he/she is likely to be deposed on the same or similar issues by the same attorneys in the next case.

However it is done, a practitioner should take the steps necessary to avoid what happened to Swann’s Grading the Amberwood case-a last minute disclosure of substantially more claims alleged to be “connected to” its work than previously imagined. Because the Arizona Supreme Court denied review of the appellate court’s decision in Amberwood, the risk of last minute disclosure like that allowed in Amberwood remains a nightmare scenario for all defense counsel. Thoughtful discovery requests or strategic expert deposition questions can help minimize the risk of having a drastic increase in potential liability heaped upon a client at the last minute.

Manage Client Expectations

No one likes being sued, and it is natural for contractors to take complaints and lawsuits about their workmanship personally. Contractors worry about the impact that lawsuits will have on their ability to attract future business and/or buy insurance. For these reasons and others, clients are very invested in the outcome of their litigation. A good place to start in any case is advising subcontractor clients about the impact and possible interpretation of applicable indemnity language. Amberwood and other indemnity cases also provide a good teaching opportunity to educate clients on the importance and possible effect of indemnity provisions and to encourage clients to be proactive in attempting to draft and/or revise contractual indemnity provisions for their own benefit. Providing exemplars of ideal indemnity provisions is always well received.

While most developers are savvy enough to know the impact of their indemnity provisions, some misinterpret the strength of an indemnity provision in their jurisdictions. The surest way for a general contractor to hold up a potential settlement is by making a demand that does not reflect and is not supported by the indemnity language provisions of the applicable contract. A general contractor who settled with homeowners early should not expect a full and complete (100%) recovery from the subcontractors when the subcontract’s indemnification language requires a finding of fault. Similarly, general contractors should likewise temper their expectations where they cannot locate a subcontract or, in the rare case, are not indemnified parties under the contract agreement. There is no better way to blow up a mediation or insure protracted litigation than to have a client who is not ready to accept the realities of his/her own case.

This should sound, and is on many levels, elementary. Even so, the importance of remembering the basics cannot be overstated. Many good lawyers, under the demands of a changing and busy profession, can take the likely results of a case for granted. But surprises can and do happen. In order to minimize the likelihood or impact of these surprises, defense counsel must insure that all of the “basic” items discussed above are considered.

Published in the December 2017 issue of FDCC Insights, a Journal for Defense and Corporate Counsel.

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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