Contractual Risk Transfer
|May 24, 2012|
Previously published on May 22, 2012
Bodily injury and property damage claims against companies in the construction industry are as prevalent as reinforced masonry is to buildings. Not only are contractors faced with liability for their own negligence, they may also be legally responsible for the negligent acts of others with whom they contract.
The duty to defend and indemnify seems to be expanding every day. Within the insurance context, there are two accepted forms to transfer risk: (1) express indemnity; and (2) the issuance of an additional insured endorsement. This article addresses the duty to defend and the transfer of the risk as it relates to express indemnity and additional insured coverage within California.
A few years ago it was believed that the duty to defend under express indemnity was being limited. Since the fairly recent ruling in the pivotal case of Crawford v. Weather Shield Mfg., Inc. (2008) 44 Cal.4th 541 there has been a recognized shift in the transference of risk in both property damage and personal injury cases by the use of contractual provisions. Specifically, in Crawford, the California Supreme Court held that a subcontractor (indemnitor) owed a duty to defend a general contractor (indemnitee) in a lawsuit against the general contractor that alleged a covered claim under a subcontract agreement where the duties to defend and indemnify were separately identified in the agreement. In essence, the California Supreme Court clarified existing law regarding certain duties under contracts between parties to pay for the liabilities, costs and defense fees of other parties. In legal terms: defense and indemnity obligations.
According to the California Supreme Court, a subcontractor has an immediate contractual obligation to defend, from the outset, any lawsuit against the developer and/or general contractor, alleging damage or loss arising from the subcontractor’s role, even if the subcontractor is later absolved of liability. In other words, to the extent that the developer/general contractor is required to defend claims made by plaintiffs, a subcontractor who signs a contract with an express indemnity provision in favor of the developer/builder will owe an immediate obligation to defend those claims.
It should be noted, however, that according to a footnote contained within the Crawford opinion, the Court stated that it did not intend to suggest that the duty would continue even if all claims potentially subject to the contractual indemnity obligation were eliminated or if the subcontractor conclusively established the claims were not among those “embraced by the indemnity” provision in the contract. Based upon the comments of the Court, there appears to be an argument that if the evidence shows no potential for coverage under the subcontract agreement, the impact of the Crawford decision may be negated. In other words, if the evidence shows that the claims being made by plaintiff do not implicate the work of the subcontractor and thus, arguably, are not covered under the express indemnity provision, the subcontractor may not owe a duty to defend.
In addition, with regard to construction contracts, California Civil Code section 2782(a) expressly provides that indemnity provisions which purport to indemnify a party against liability for damages arising from its sole negligence or willful misconduct are void and unenforceable. The purpose of Civil Code section 2782(a) is to ensure that one party would not, even by specific contractual language, require indemnity for damages sustained as a result of its sole or willful misconduct. (See Gonzales v. R.J. Novick Construction Co. (1978) 20 Cal.3d 798, 809) It should be noted, however, that this section does not prevent indemnity where there is negligence on both the general contractor and subcontractor.
As an important note, the Crawford Court stated that indemnity provisions may be specifically tailored based on the needs of the parties. Crawford affirms that parties are free to contract to allocate their respective risks.
With regard to potential insurance implications arising from contractual indemnity provisions, it should be noted that an indemnity agreement does not make one party an “insured” on the other party’s insurance policy. (See Alex Robertson Construction Co. v. Imperial Casualty & Indemnity Co. (1992) 8 Cal.App.4th 337). However, if the insurance policy provides contractual liability coverage, an insurance policy may ultimately respond and pay defense costs and any indemnity owed under the contract as “damages”. (See Golden Eagle Insurance Co. v. Insurance Co. of the West (2002) 99 Cal.App.4th 837. However, pursuant to Golden Eagle, an indemnification provision in a contract does not bind the insurance carrier to defend. In other words, the insurance carrier is not a party to the contract and owes no direct duty defend based on the indemnification provision alone.
However, some changes to the contractual liability landscape may apply as a result of California Senate Bill 474. The new law will become effective January 1, 2013 and provides that construction agreements with a subcontractor that attempt to indemnify a general contractor, construction manager, public entity or other subcontractor for liability claims (including the costs to defend) will be unenforceable to the extent of willful misconduct or if the general contractor, construction manager, etc. is actively negligent.
The effect of SB 474 remains to be seen. This new law may conflict with Crawford. Crawford indicates that the duty to defend begins immediately but SB 474 references both defense and indemnity obligations. It may be possible to argue that the defense obligation does not arise until a determination is made as to the extent of the indemnitee’s negligence.
Another form of risk transfer is the Additional Insured Endorsement (AI). The additional insured endorsement arguably provides an even stronger and more direct transfer of risk than that of the indemnity provision. In essence, additional insured endorsements obligate another’s insurer to defend and indemnify even if the additional insured’s liability is the sole cause of damage.
An additional insured endorsement can be limited by its specific terms or can broadly extend to the named insured’s contracts with its customers where it expressly covers anyone who the named insured has agreed in writing to insure. But the terms of an express indemnification provision in the named insured’s contract has no bearing on the scope of coverage under an additional insured endorsement.
Given the relationship created between the additional insured and the insurer, when an insurer chooses not to use clearly limiting language, but instead grants coverage for liability arising out of the “named insured’s work”, the additional insured is covered without regard to whether the injury or damage was caused by the fault of the named or the additional insured.
Fortunately, as common sense would dictate, pursuant to Patent Scaffolding Co. v. Williams Simpson Construction Co. (1967) 256 Cal.App.2d 506, 509, an additional insured obligation trumps and fully satisfies any additional contractual obligation to defend. In other words, a developer who successfully tenders its defense to a subcontractor’s insurance carrier pursuant to a valid additional insured endorsement, does not also have a continued claim against the subcontractor for those same fees and costs pursuant to an express indemnity provision. The developer is not entitled to a double recovery.
Case law in this area continues to evolve and as both contractual indemnity provisions and designations of third parties as additional insureds under an insurance policy are grounds for a third party’s tender, they are separate and distinct and thus, require separate analysis.
The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
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