Will Your Indemnity Clauses be Unenforceable on January 1, 2013?

by Allen Matkins

Amendments to California’s construction indemnity statutes will go into effect on January 1, 2013. Your commercial construction contracts may need to be modified or other strategies may need to be implemented or your indemnity clauses may be held void and unenforceable.

We are available to revise your commercial construction indemnity clauses or to restructure your risk management strategies to help keep your indemnity clauses and insurance coverage enforceable.

The following is a review of some of the key indemnity amendments as they apply to private owners of commercial real estate. Also included are strategies for utilizing some of the exceptions to these amendments. Please note that amendments impacting public projects or residential projects are not discussed in this legal alert; however, we are ready to assist you with indemnity and risk management strategies involving those types of projects as well.

New Restrictions on Indemnities for Owners from GC’s.

For construction contracts or modifications (i) entered into after January 1, 2013, (ii) concerning a private owner of real estate and (iii) where the owner is not acting as a contractor or supplier, the new amendments state that an indemnity is unenforceable if it relieves the owner from liability to the extent of the owner’s “active negligence” and imposes the liability on a contractor, subcontractor or supplier. The impact of this new amendment is that owners will need to obtain insurance to cover risks associated with their active negligence, which risks many owners previously passed on to their general contractor (GC) and subcontractors.

Arguably, the statute provides a way around this amendment if the owner acts as the GC or supplier for the project. Usually, when the owner enters into multiple-prime contracts or owner/builder contracts the owner acts as the GC and enters into contracts directly with the subcontractors for a project.

This amendment does not change the obligations of a contractor’s insurance carrier to accept the tender of defense and pay the owner’s and contractor’s construction defect defense costs (without any reimbursement from owner) where the contractor has agreed in the construction contract to defend the owner against claims.

New Restrictions on Indemnities for GC’s from Subcontractors.

Construction contracts or contract modifications (i) entered into after January 1, 2013, (ii) whereby a subcontractor agrees to “insure or indemnify, including cost to defend,” a GC, CM or another subcontractor, the new amendments state that the subcontractor’s insurance or indemnity is:

(a) void to the extent claims arise out of the “active negligence or willful misconduct” of the GC, CM, another subcontractor or their independent contractors;

(b) void for “defects in design furnished” to the subcontractor by the GC, CM or other subcontractor or their independent contractors; or

(c) void to the extent the claims do not arise out of the subcontractor’s scope of work.

This amendment does not prohibit the subcontractor, GC or CM from agreeing upon the timing or immediacy of the defense of a tendered claim and reimbursement of defense fees and costs.

The impact of this new amendment is that contractors will need to obtain insurance to cover their active negligence, defects in design provided to subcontractors and any self performed work that is outside the subcontractor’s scope of work. Further, since contractors will no longer be able to pass along these risks to their subcontractors, they will likely pass these risks along to the owner and refuse to sign indemnities with owners that do not carve out these risks as well.

There appear to be more than 13 exceptions to the applicability of this new contractor amendment. The exceptions that may apply to a private project include (a) using multiple-prime contracts, (b) using wrap-up insurance programs, (c) using causes of action for breach of contract or breach of warranty that are independent of indemnity obligations, (d) entering into contacts with design professionals, (e) requiring insurance covering the acts or omissions of the indemnitor, including additional insurance endorsements covering acts or omissions during ongoing and completed operations, and (f) requiring (1) owner and contractor protective liability insurance, (2) contractor all-risk insurance, and (3) owner all-risk insurance.

Some of the Old Rules Still Apply to Indemnities.

California law still provides that in construction contracts, one party can indemnify, defend and hold harmless the other party even if the other party is at fault except for the other party’s sole negligence or willful misconduct. However, the conservative construction lawyer should carefully read these older provisions in conjunction with the new amendments. There is an argument to be made that an owner that enters into multi-prime contracts is exempt from the owner and contractor amendments and can arguably use the old rules to draft the indemnity clause since the old rules remain in the indemnity statute. However, if a court or trier of fact decides that the multi-prime exemption and the old rules do not apply, then the parties may attempt to rely on equitable indemnity which arguably would provide comparative fault standards that will require each party to bear their own liabilities and rely on their own insurance to respond to claims which is where the amendments seem to be leading the parties anyway.

This area of the law has become increasingly more complex thanks to these new amendments. We stand ready to revise your indemnity agreements and help restructure your risk management to cope with these new provisions.

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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