• What Is the Impact on an Insurer's Limit of Liability Where the Named Insured Has a Duty to Defend an Indemnitee?
  • August 29, 2008
  • Law Firm: McCormick, Barstow, Sheppard, Wayte & Carruth LLP - Fresno Office
  • Subcontractor which agreed, pursuant to subcontract, to (1) indemnify general contractor for all claims growing out of the execution of the subcontractor’s work and (2) defend any suit brought against the general contractor "founded upon" a claim for such damage is obligated, upon tender, to defend general contractor

    Crawford v. Weather Shield Mfg., Inc., 44 Cal.4th 541 (2008)

    BACKGROUND FACTS
    JMP was the developer, builder and general contractor of a residential project. Weather Shield contacted with JMP to manufacture and supply wood- framed windows for the project. Weather Shield agreed pursuant to the subcontract to indemnify JMP for claims for damage growing out of the execution of Weather Shield’s work and to defend JMP in any suit founded upon claims for such damage. Owners of finished homes on the project sued JMP, Weather Shield and others, including Darrow, the principal sub-contractor, for construction defects. The complaints included allegations of improper design, manufacture and installation of the windows in the homes causing extensive damage. JMP cross-complained against Weather Shield and other subcontractors, asserting that under the subcontract provisions the subcontractors owed JMP duties of indemnity and defense against the complaints.

    All subcontractors except Weather Shield and Darrow (whose duties included framing the structures and installing windows) settled before trial. The jury returned general verdicts against Darrow and in favor of Weather Shield.

    On the cross-complaint, the trial court ruled that Weather Shield owed no obligation to indemnify since the jury’s verdict had absolved it of liability. However, the trial court further concluded that the subcontract required that Weather Shield provide JMP with a legal defense since the claims concerned the windows supplied by Weather Shield. The Court of Appeal affirmed finding that Weather Shield’s promise to defend suits founded upon claims arising out of Weather Shield’s work contemplated an immediate duty to provide such a defense.

    The California Supreme Court granted review limited to the issue of whether "a contract under which a subcontractor agreed ‘to defend any suit or action’ against a developer ‘founded upon’ any claim ‘growing out of the execution of the work’ require[d] the subcontractor to provide a defense to a suit against the developer even if the subcontractor was not negligent?"

    THE COURT’S RULING
    In addressing the above question, the California Supreme Court first noted that indemnity agreements, although resembling liability insurance policies, are interpreted according to significantly different rules. In the non-insurance context, it is the indemnitee who usually has the superior bargaining power and may use this power to shift financial responsibility for fault. Thus, for example, if an indemnitee attempts to shift responsibility for its own active negligence, the language in the contract must be particularly clear and explicit and will be interpreted against the indemnitee. Furthermore, the Court noted that construction contracts cannot validly require indemnification for the indemnitee’s sole negligence or willful misconduct under Civil Code § 2782. Finally, the Court referred to Civil Code § 2778 which sets forth general rules for interpreting indemnity contracts unless the parties reveal a contrary intention.

    Considering the foregoing, the California Supreme Court agreed with the Court of Appeal that even strictly construing the subcontract in Weather Shield’s favor, the provisions expressly obligated Weather Shield to defend, from the outset, any suit "founded upon" claims alleging damage arising from Weather Shield’s negligence in connection with the project. Thus, the obligation to defend existed even if it was later determined that Weather Shield was not negligent. The Court went on to note that "a contractual promise to ‘defend’ another against specified claims clearly connotes an obligation of active responsibility, from the outset, for the promisee’s defense against such claims." The Court determined that Civil Code § 2778, subd. 4 requires that the indemnitor defend, upon the indemnitee’s request, all claims embraced by the indemnity, unless the agreement provides otherwise. Implicit is the fact that this duty arises immediately upon proper tender and thus before any determination has been made as to whether indemnity will actually be owed. In so holding, the court disapproved of the decision in Regan Roofing Co. v. Superior Court, 24 Cal.App.4th 425 (1994), wherein the court concluded that a subcontractor’s defense duties arise only if the subcontractor becomes liable for indemnity.

    Finally, Weather Shield raised numerous policy concerns which could arise if a subcontractor was forced to defend a residential developer in construction defect suits. However, the Court pointed out that statutes effective January 1, 2006 and January 1, 2008 were adopted to address such concerns and void any term in a residential construction contract which obliges a subcontractor to indemnify other project participants, including the cost to defend, against defect claims to the extent such claims arise out of the negligence of the other entities.

    Since the Court found that a duty to defend existed under the terms of the subcontract and arose upon tender, the decision of the Court of Appeal was affirmed.

    THE EFFECT OF THE COURT’S RULING
    For insurance companies, this decision will impact coverage under contractual liability coverage. Generally, under contractual liability coverage, any payment of defense fees incurred by the general contractor/indemnitee by virtue of an indemnity obligation on the part of the subcontractor/indemnitor would come off of the limits of the policy issued to the subcontractor/indemnitor. (See Alex Robertson Co. v. Imperial Casualty & Indemnity Co., 8 Cal.App.4th 338, 344 (1992).) This is true except in situations where the defense of the general contractor/indemnitee is paid by the insurer of the subcontractor/indemnitor under a supplementary payments provision common in CGL policy forms currently in use. Pursuant to such supplementary payments provisions, the carrier agrees to defend the indemnitee of the insured where the indemnitee is named, along with the named insured, as a party to the suit, provided there is no conflict of interest requiring separate counsel.

    Notably, prior to the Crawford case and under the reasoning of Regan Roofing, a subcontractor/insured ultimately held to be free from negligence liability would not owe the general contractor’s defense fees. In turn, the carrier for the subcontractor would have no obligation to pay those fees. However, under the Court’s ruling in Crawford, the carrier will now be liable for those fees even in the absence of any ultimate determination of negligence liability on the part of the subcontractor/insured, up to the subcontractor/insured’s liability limits. Thus, the ruling could ultimately effect amounts owed by carriers in these situations.

    Of course, where the conditions of the supplementary payments provision are met and activated by a request, by the indemnitee and the insured, that the carrier handle the defense, the ruling in Crawford would not impact the carrier’s obligation to pay defense costs in addition to the limit of liability. However, in light of the Court’s decision in Crawford, it is possible that carriers will see general contractors being less inclined to request a defense from the carrier under a supplementary payments provision as the Crawford decision would allow them to retain their own attorney and get reimbursement from the subcontractor, through the insurer, immediately upon tender. Furthermore, situations may arise where the subcontractor/insured’s liability limits are exhausted prior to any judgment or settlement due to its immediate obligation to defend the general contractor upon tender and the fact that such payments, ultimately owed by the subcontractor/insured’s carriers, would come off of the limits of liability.