Letter from the Editor
by James J. Sienicki
Welcome to the first edition of our Under Construction newsletter for 2016.
Indemnity laws and clauses are a big part of construction contracts. They can make or break a project. Defend and indemnify obligations have the potential to impose the most drastic consequences on a party to a construction contract, forcing a party to assume a wide variety of obligations and risks that may or may not be insurable and may be beyond the party’s reasonable ability to control. The law of indemnification varies from state to state. It is essential that owners, developers, contractors and subcontractors understand that fact. Because of this, we’ve compiled a set of articles that address some of the nuances of indemnification in Arizona, California, Colorado, Nevada and Utah. When negotiating construction contracts, it is important to pay attention to the indemnity clauses, know the applicable law and ask questions before signing any contract.
We hope you will find these articles informative and enlightening on this very important subject. Please let us know if you want us to address a specific construction issue in a future newsletter. Cheers to a great and successful year ahead!
Indemnity Is a Risky Proposition in Arizona Unless It Is a Specific Obligation
by Richard G. Erickson and Nicole Sornsin
Indemnity is too often litigated in construction cases because contracting parties do not tailor their written agreements to correspond with state law governing the project. Forgetting to incorporate the correct governing law and indemnity language means contractors may assume they have more indemnity rights than the applicable law allows, or it could mean a contract has no teeth to force a party to defend and indemnify a claim arising from the project.
Then again, if contracting parties neglect to include an express defense and indemnity provision altogether, a party seeking indemnity may wind up with an all-or-nothing gamble in trying to prove implied indemnity under common law principles. Without express indemnity provisions in the contract, a party that is itself at fault may be precluded from the benefit of general or implied indemnity, unless that party can prove their fault is merely passive and that they are, therefore, free of active negligence.
On Arizona construction projects, remember these basic rules governing indemnity claims:
Public policy prohibits indemnity when a party is solely negligent.
On public construction projects, no party can be indemnified for its own negligence.
On private construction projects, subject to the sole negligence exception above, Arizona courts will interpret and enforce the duty to defend and indemnify in accordance with the express terms upon which the contracting parties have agreed.
If you want to be indemnified on a private project for your own partial fault, it is vital to have indemnity contract language that specifically commits a party to defend and indemnify regardless of any fault by the party seeking indemnity.
If the contract lacks an express indemnity clause, on the other hand, a party seeking implied indemnity has the burden of proving it had to pay for the negligence of another party when the negligent party was the one totally at fault.
One Arizona case provided that a party seeking indemnity, after reasonably settling a claim that was properly tendered to the responsible party first, may still be indemnified despite the party’s own fault, but the indemnity damages will be apportioned according to the comparative fault of each party.
Since indemnity liability may depend upon proving, in the first instance, the fault or non-negligence of the parties involved, litigating indemnity claims is usually inordinately expensive and may take years before a party is made whole again. Indemnity claims come with significant out-of-pocket risk and expense.
A way to avoid protracted indemnity battles on private projects, or at least to rest more assured of prevailing on an indemnity claim in the end, is to make sure to include a specific indemnity clause in a construction contract—a clause that commits a party to defend and indemnify regardless of the other party’s own fault. A party who wants protection and indemnity (the indemnitee) should also include a requirement in their contract that requires the other party (the indemnitor) to name the indemnitee as an additional insured on the indemnitor’s insurance policies, and then follow through and make sure this happens before work begins. Contracts on public projects need to be consistent with anti-indemnity law. In addition, before choosing to spend the money necessary to enforce your indemnity rights, make sure that the other party either has the insurance or the solvency to satisfy a judgment. It makes no sense to chase indemnity against someone that doesn’t have two nickels to rub together.
Limitations on Indemnity Provisions in Construction Contracts in California
by Mark D. Johnson
Typically, in construction contracts, indemnity provisions are found in contracts between owners and general contractors and in contracts between general contractors and subcontractors. In contracts between owners and general contractors, indemnity provisions usually require the general contractor to reimburse the owner for any loss from a claim or claims brought by a third-party arising out of work performed by the general contractor. Contracts between general contractors and subcontractors generally have indemnity provisions requiring the subcontractor to reimburse the general contractor for any loss from a claim or claims arising out of work performed by the subcontractor. Indemnity provisions also may have a duty to defend the indemnified party or indemnitee in a lawsuit or other legal proceeding such as arbitration. These defense provisions might also require the indemnifying party or indemnitor to defend the indemnitee using counsel selected or approved by the indemnitee.
However, many states, including California, place limits on the permissible scope of indemnity provisions. The main limitations on indemnity provisions in California are the following:
No Indemnity for Active Negligence or Willful Misconduct
Civil Code section 2782.05 provides that indemnity provisions in construction contracts entered into on or after January 1, 2013 in which a subcontractor is required to indemnify and/or defend a general contractor, construction manager, or other subcontractor for their active negligence or willful misconduct, for defects in design furnished by such persons, or for claims that do not arise out of the scope of work of the subcontractor are void and unenforceable.
No Indemnity for Sole Negligence or Willful Misconduct
Civil Code section 2782(a) provides that indemnity provisions in construction contracts in which an indemnitor is required to indemnify an indemnitee for their sole negligence or willful misconduct are void and unenforceable.
No Imposition of Liability on Contractor for Active Negligence by Public Agencies
Civil Code section 2782(b)(1) provides that indemnity provisions in construction contracts with public agencies entered into on or after January 1, 2013 that purport to impose on the contractor, or relieve the public agency from liability for the active negligence of the public agency are void and unenforceable.
No Indemnity by Public Agencies for Active Negligence
Civil Code section 2782(b)(2) provides that indemnity provisions in construction contracts with public agencies entered into on or after January 1, 2013 in which a general contractor, subcontractor or supplier of goods or services is required to indemnify a public agency for its active negligence are void and unenforceable.
No Indemnity by Private Builder Not Acting as Contractor
Civil Code section 2782(c) provides that indemnity provisions in construction contracts entered into on or after January 1, 2013 with the owner of privately owned real property (in which the owner is not acting as a contractor or supplier of materials or equipment) in which a general contractor, subcontractor or supplier of goods or services is required to indemnify the owner for its active negligence are void and unenforceable. However, this section 2782(c) does not apply to homeowners performing home improvement projects on their own single-family dwellings.
Limitations on Indemnity in Residential Construction Contracts
Civil Code section 2782(d) provides that indemnity provisions in residential construction contracts entered into after January 1, 2009 in which an indemnitor is required to indemnify and/or defend a builder or general contractor are unenforceable to the extent that the builder or general contractor is negligent, for defects in design furnished by the builder or general contractor, or if a claim does not arise out of the work of the indemnitor.
Limitations on Indemnity by Public Agencies Against Design Professionals
Civil Code section 2782.8 provides that indemnification provisions in design professional contracts entered into with a public agency after January 1, 2007 in which a design professional is required to indemnify and/or defend a public agency are unenforceable except for claims that arise out of negligence, recklessness, or willful misconduct of the design professional. This section shall not be waived by agreement of the parties.
Limitations on Indemnity in Wrap-Up Insurance Policies
Civil Code sections 2782.9 through 2782.96 provide that indemnity provisions in residential construction contracts with a wrap-insurance policy, also known as an Owner Controlled Insurance Policy entered into after January 1, 2009 in which an enrolled and participating subcontractor or other participant in the Owner Controlled Insurance Policy program is required to indemnify and/or defend another party for any claim covered by the wrap-insurance program are unenforceable.
Construction and Construction Contract Indemnity in Colorado
by Daniel R. Frost
Generally speaking, indemnity clauses in Colorado construction contracts are enforceable in accordance with their terms, where the terms are clear and unambiguous. Indemnity obligations can be either found in contract provisions or common law indemnity principles. And indemnity provisions in a construction contract may allow the parties to shift certain risks and obligations to other parties. Often times these provisions can be drafted quite broadly and can be quite onerous without affecting their enforceability.
There is one notable exception to the enforceability of indemnity provisions in Colorado - the anti-indemnity statute. The Colorado anti-indemnity statute significantly affects the enforceability of indemnification provisions in Colorado construction contracts. With some limited exceptions, construction contracts requiring a party to a construction agreement to cover losses associated with another party’s own negligence are void.
Colorado’s anti-indemnity statute does not apply to property owned or operated by railroads or public districts; nor does it apply to rental agreements. However, for virtually all other types of construction contracts entered into after July 1, 2007, any provision in a construction agreement that requires a person to indemnify, insure or defend in litigation another person against liability for damage caused by the negligence or fault of the indemnitee is void.
Colorado statutes do provide for allocation of liability between tortfeasors, which some trial courts will follow even in the case of a breach of contract claim. Thus, a party can be indemnified to the extent some other party was found to be the cause of the plaintiff’s damages. But, as noted, only in very rare circumstances can a party to a construction contract be indemnified for its own negligence.
It is also worth noting, in the litigation context, that claims for indemnity “arise at the time the third person’s claim against the claimant is settled or at the time final judgment is entered on the third person’s claim, whichever comes first.” Such claims must be brought within 90 days after the claims arise. The 90-day rule does not act as a ‘tolling’ provision for Colorado’s six-year statute of repose, meaning that a party asserting an indemnity claim may not wait until final judgment to bring indemnity claims, if final judgment is not entered before the end of the repose period.
In response to Colorado’s anti-indemnity statute, the Insurance Service Offices (ISO) has developed several Colorado-specific forms that take into account the issues resulting from that legislation. These forms limit coverage consistent with the limitations of the statute. As a further caveat, Colorado prohibits any provisions in a construction agreement that requires one party to insure another party against liability on a construction project.
To address these issues, contractors or developers can consider requiring subcontractors to obtain ongoing and completed operations coverage, naming the contractor or developer as an additional insured. Subcontractors should evaluate whether their policies cover, to the extent possible, their indemnity obligations. Indemnity and insurance provisions in construction contracts should be carefully tailored to deal with these issues. And parties wishing to assert indemnity claims based upon settlements or judgments must act promptly to preserve their rights.
Construction Contract Indemnity in Nevada
by Leon F. Mead II
Nevada’s law related to construction indemnity has undergone significant alterations over the last few years. Nevada law historically supported the concept of freedom of contract, and previously even enforced Type I contractual indemnity and defense provisions - requiring indemnity for an actor’s own negligent acts. This draconian protection of the freedom to contract began creating havoc in the residential construction defect world after the adoption of Nevada’s residential construction defect laws in 1995, found at NRS 40.600 through 40.695, inclusive (collectively herein “Chapter 40”).
Negligence played a significant role in Chapter 40 claims. Unlike the majority of jurisdictions, the Nevada Supreme Court (the "Court") found in Olson v. Richard, 120 Nev. 240, 89 P.3d 31 (2004) that the then unsettled status of the State’s common law regarding the applicability of the economic loss rule when Chapter 40 was enacted, must have meant that the legislature intended to allow negligence claims for residential construction defects. This brought the availability of insurance coverage in a residential construction defect case to the fore. Subcontractors who signed such Type I indemnity clauses were forced to incur hundreds of thousands of dollars in legal costs incurred by their customers, often even when the subcontractors own work was not claimed defective by impacted homeowners.
At the same time, Type I indemnity and defense obligations in the commercial and industrial construction industry had little impact on subcontractors. Commercial project owners were able to resolve conflicts more simply because they were far more interested in resolving deficient construction work than in recouping financial windfalls. The few attempts to claim that the economic loss rule did not apply in commercial construction cases met with little support from the Court who, in cases such as Terracon Consultants Western, Inc. v. Mandalay Resort Group, 125 Nev. 66, 206 P.3d 81 (2009) and Halcrow, Inc. v. Dist Ct., 129 Nev. ___, 302 P.3d 1148 (2013), carved out a separate distinct indemnity path for commercial construction cases where the parties contractually allocated such risks. In commercial construction defect cases, the economic loss rule applied to bar claims for negligence, and such claims were resolved through contractual indemnity provisions.
Despite the lack of any meaningful distinction between defect claims in residential construction and commercial construction, the disparate impacts generated by these decisions became harder for the Court to justify. But as the legislature failed time and again to craft a statutory solution, the Court began imposing limited restrictions on Type I indemnity in residential construction defect cases, requiring strict and explicit language notifying a subcontractor that it was responsible for the negligence of others before such indemnity clauses would be enforced. In George L. Brown Ins. V. Star Ins. Co., 126 Nev. ___, 237 P.3d 92 (2010), the Court required express or explicit reference to the indemnitee’s own negligence as a requirement for enforcement of a Type I indemnity obligation. In Reyburn Lawn & Landscape v. Plaster Dev., 127 Nev. ___, 255 P.3d 268 (2011), the Court took this even further by extending the explicit language requirement to contributory negligence claims. Then in United Rentals v. Wells Cargo, 128 Nev.Adv.Op. 59 (2012) the Court limited “to the extent caused” indemnity provisions to provide defense obligations only after the proximate cause of an injury was established. While all these cases demonstrated a diminished desire from the Court to enforce Type I and Type II indemnity provisions for negligence in construction cases, they could still be enforced provided contracts were drafted in the correct manner, and claims were properly asserted. Once again, however, the practicality that such provisions were more often enforced in residential construction cases did little to help the residential subcontractor under Chapter 40 cases.
Finally, with the 2014 election installing a conservative majority in both legislative houses for the 2015 legislative session, substantial reform for Chapter 40 was achieved. AB125, while virtually eliminating residential construction defect claims entirely, has substantially restricted the application of indemnity, defense and hold harmless provisions in residential construction defect cases to Type III indemnity only – that is, residential subcontractors can only be obligated to defend and indemnify home builders from construction claims related to their own work. Any claim for indemnity based on a Type I or Type II indemnity provision that relates to the work of a third party subcontractor is not enforceable. Further, subcontractors included in “wrap-up” insurance coverage cannot be charged multiple deductibles for each residence in a subdivision. Each wrap-up policy must be limited to a specific project only, and the cost of such policies to indemnifying subcontractors may not exceed the cost of the subcontractors otherwise available insurance coverage outside the wrap-up policies. Indemnity clauses violating these statutes are void and unenforceable, as against the public policy of the State.
AB125 specifically does not apply to non-residential projects (including apartment buildings) and other commercial projects. The distinctions between residential and commercial construction defect claims, however, continue to be minimal. Moreover, the significance of a stated statutory public policy not to enforce Type I and Type II indemnity provisions cannot be completely lost on the Nevada appellate court judges. Whether the Court will use the statutory prohibitions to begin closing the residential – commercial construction project distinction remains to be seen.
Allocating Risk Under Utah Anti-Indemnity Laws
by Allison Brown
Before the first forms are up or site prep has even begun, most frameworks for bearing the risk of a construction project have already been secured. Owners, general contractors, subs, suppliers and design professionals frequently incorporate indemnity provisions in construction contracts to shift the financial responsibility of worksite accidents and losses. Most often, that responsibility is shifted to subcontractors or their insurance companies through “hold harmless,” “indemnify” and “defend” provisions. Through these indemnity agreements, a subcontractor becomes an “indemnitor” and promises to defend and reimburse the “indemnitee” against various losses incurred in relation to the construction project.
Utah Anti-Indemnity Legislation
Concerned that an indemnitee who knows that another party is ultimately responsible for the indemnitee’s negligence may not act as carefully as it would if it bore responsibility for its own actions, many state legislatures have passed anti-indemnity laws. Utah is one such state. Under Utah construction law, an indemnitor can contract to indemnify an indemnitee only to the extent of the indemnitor’s negligence; i.e. a subcontractor cannot be required to indemnify its general contractor in the event the general is solely or partially negligent. U.C.A. 13-8-1. Additionally, Utah law prohibits contractual limitations of liability arising out of services of architects, engineers, land surveyors or other design professionals. U.C.A. 13-8-2 states that an agreement between a contractor and subcontractor may not limit the owner’s or the design professional’s liability to the subcontractor arising out of the design professional’s services. This prohibition does not apply if the design professional was retained under a design-build or turn-key agreement.
Alternatives to Indemnity Provisions
Such restrictions on indemnification agreements are becoming increasingly common throughout the United States, causing parties to construction contracts to look for alternative techniques to allocate risk. Two principal methods are contractual liability insurance and additional insured coverage.
Contractual Liability Insurance. One potential way to circumvent anti-indemnity laws is to require an indemnitor to procure liability coverage for an “insured contract”. The idea is that an agreement to procure insurance is distinct from an agreement to indemnify. Under this method, an indemnitor essentially assumes an indemnitee’s tort liability by obtaining liability insurance, but the indemnitee does not become an insured party, nor does the indemnitee obtain independent rights under the indemnitor’s policy.
Additional Insured Coverage. Going one step further in shifting risk from the indemnitee, parties to a construction contract can agree that the indemnitor will name the indemnitee as an additional insured on the indemnitor’s CGL insurance policy. Through an endorsement, an additional insured obtains independent rights to and direct claims against the indemnitor’s policy. And unlike plain contractual liability insurance, additional insured coverage means the indemnitee’s defense costs are not constrained by the policy’s coverage limits.
A reading of the precise language in Utah’s anti-indemnity statute might have suggested that Utah law prohibits construction contracts providing for contractual liability insurance or additional insured coverage: U.C.A 13-8-1 invalidates indemnification provisions in construction contracts and defines an indemnification provision as “an agreement… requiring the promisor to insure, to hold harmless, indemnify, or defend the promisee or others against liability…” (emphasis added). However, in 2001 the Utah Court of Appeals in Meadow Valley Contractors, Inc. v. Transcon. Ins. Co., 27 P.3d 594 (Utah Ct. App. 2001) found that a clause in a construction contract that required a subcontractor to procure liability insurance and name the general contractor was not an “indemnification provision” and therefore, did not violate U.C.A. 13-8-1. “[T]he plain meaning of the statute voids only agreements requiring one party in a construction contract to personally insure against liability stemming from the other party’s negligence” Id. at 598.
Although Utah law prohibits indemnitors from indemnifying an indemnitee for the indemnitee’s own negligence—sole or partial—indemnitees’ tool belts are not altogether emptied. Parties to construction contracts are not prevented from including provisions for contractual liability insurance and additional insured coverage in order to construct the desired distribution of a project’s risk.