By Mark J. Rice, Attorney,
Today’s contractor faces the construction version of Lemony Snicket’s great children’s book, “A series of unfortunate events.” When the contractor gets the permit finaled, notice of completion recorded, and certificate of occupancy, the job is “over”. But is it, really?
Today’s construction contract contains “continuing risk” terms and obligations, centering around insurance for later arising construction defects that under California Statutes, can expose the contractor to sleepless nights for ten years after completion. Ugh. Insurance’s double barrel twins, additional insured certificates and express contract indemnity, can be a great way for a prime contractor or owner to spread unknown post project risks and defect contingencies down to subcontractors. Conversely, prime contractors and subcontractors, and their insurers, may wish to limit the risk they bite off in favor of the owner, especially in grey areas such as design and design-construction interfaces, changes in building codes over time, and high risk areas such as mold, asbestos, and other “consequential damages” that may be able to be excluded by well-tailored language.
Yes, I agree – this can give anyone a headache. So to simplify the general rules of the insurance and indemnity road, here are some pointers and definitions:
· Indemnity Defined. What is indemnity anyway? My favorite definition of indemnity is, you pay for what I break – if you indemnify me. It’s a risk shifting provision in a contract that usually states that one party will “defend, indemnify and hold harmless” the other party for all damages, liabilities, claims and losses “arising out of” either “your work” or – more narrowly – “your negligence”. A broad clause – “arising under” is known in court cases as a “Type One” indemnity clause – meaning, if neither party is at fault, but the claim arguably arises out of one party’s work – even if others may also be to blame – then that party – the indemnitor – protects the other party, hires and pays for the lawyer, settles the claim, pays the judgment, and so forth. Each party in the construction food chain wants other participants to promise “Type One” indemnity to them, and conversely, offer only narrow “negligence only indemnity” to those above them in the food chain. Easier said than done.
· Public Works Specs and “Flow Down” Indemnity.In public works, the indemnity clause will be in the specifications and general conditions that are part of a competitive low bid process – meaning, there is little or no room for the successful low bidder prime contractor to negotiate the indemnity clause. And, the prime contractor will invariably “flow down” that indemnity provision (and other one sided owner specifications) to the prime contractor’s own subcontractors, in the form subcontract.
· Civil Code Section 2782 tries to limit indemnity to fault, sort of. Because of this non-negotiable process of onerous indemnity clauses imposed by public (and at times, private) owners, the California Legislature has seen fit to circumscribe the impact of these clauses by Civil Code Section 2782, which nullifies as void, portions of indemnity clauses that seek to shift design defects, or sole negligence of others onto an indemnitor; and as to private projects, also voids attempts to create indemnity for the owner’s active negligence. Then, as to residential construction, it renders unenforceable efforts to make subcontractors liable for indemnity for the fault of others – creating an “each according to his fault” system in theory on residential construction projects, and those governed by the Right to Repair law, AB 800, and Civil Code Section 895.
· Duty to Defend, and Duty to insure still wide open, pretty much. Still, under Civil Code Section 2782 there are two key exceptions – the duty of defending a claim – hiring and paying for a lawyer and experts – can still be shifted irrespective of fault. And, most importantly, insurance and additional insurance provisions can be the “minnow swallowing the whale” and trump the limits on indemnity, by imposing a duty on the indemnitor to secure insurance in favor of the indemnitor. Enough to make your head spin. And, in a multi-party construction defect case, it’s the lawyers’ full employment act, as everyone argues about who is at fault, who insured who, who must indemnify whom, and what injuries or defects arose out of whose work.
· California Supreme Court as indemnity “traffic cop.” At one point, it was reported that about 25% of California court decisions on appeal involved the “duty to defend” under an express indemnity clause. This resulted in the California Supreme Court taking matters into its own hands in Crawford v. Weathershield (2008) 44 Cal.4th 541, giving trial courts the green light to declare early on, who has to pay whose attorneys fees and defend the other under “Type One” indemnity language. Meaning, if you are the beneficiary of a Type One clause, you have your attorney cite Crawford, file a dispositive motion early on, and then sit on the sidelines while others duke it out in court over a risk or loss that may be shared, but whose legal defense you have successfully moved off your financial plate.
· Additional Insured – carrying the project on your carrier’s back – everything becomes your loss run unless you are careful. Ok, now onto Additional Insurance. Public works owner, and astute private owners, will require that the prime contractor and each subcontractor issue an additional insured certificate naming the owner as an additional insured on that party’s general liability insurance. That basically puts the owner in the position of a beneficiary under the other parties’ insurance. This is a very strong tool, since the penalty for failing to provide an insurance defense or insurance coverage where due is, not just contract liability, but possibly punitive damages if the denial is in found to have been unreasonable – in bad faith. So, the insurance terms tend to trump the nuances of contract indemnity exclusions – meaning, insurance rules the road.
· Subrogation – sounds like a hair product. And, what the heck is subrogation, and why do my AIA forms always want me to waive subrogation? Good question. Subrogation involves an old “Court of Equity” doctrine that if an insurance company (or anyone) paid for a loss suffered by another, that payor “stepped into the shoes” of the victim of the loss, and could assert its rights as its own: “Under the doctrine of subrogation, when an insurer pays money to its insured for a loss caused by a third party, the insurer succeeds to its insured’s rights against the third party in the amount the insurer paid.” The classic example is uninsured motorist coverage – when your car is damages by an uninsured motorist and your auto policy pays to fix your car, the auto policy carrier then goes after the uninsured motorist who hit the car, in subrogation. Same in construction – if your CGL carrier pays the owner for damages caused by an unmarked utility, because your backhoe hit it, and your carrier additionally insured the owner, your carrier may end up suing the utility company or the project designer as the ultimate responsible party for the damage.
· Impact of “Waiver of Subrogation” clauses. With that complexity in mind, in AIA contracts the waiver of subrogation language basically stops the second round of risk shifting after one carrier pays the loss. In practical terms, this usually tends to insulate the architect, since a) the additionally insured owner, insured by the prime contractor’s or subcontractor’s liability insurance, may have some fault, or its designer might; and b) by waiver of subrogation, the insurance carrier paying the bill for a defect (let’s say a leaky roof, and it might because of a lack of a design pitch) won’t be able to double back and sue the design professional, or other parties. For this reason, waiver of subrogation is seldom advisable if you are providing additional insurance to other project participants, since you are just going to make your insurance carrier mad at you, and have a higher loss run when your carrier cannot recoup its paid loss by asserting subrogation rights against the real culprit.
· Big, bad War Story – oops, honey, I cut the fiber optic cable. Good example in practice, by way of war story. Pile driver on public project excludes location and protection of utilities from its subcontract with the prime. Its subcontract says its exclusions control over contrary terms, but it also agrees to provide additional insurance to the prime and owner, and to indemnity them under a Type One. Specs say, Call USA and have the subject utility representative present when potholing. The prime contractor potholes without the utility rep present – and oh, this is the main fiber optic cable between San Jose and Oakland. The owner’s designer first showed a clear conflict between the pile location and the fiber optic duct bank, then when it did more potholing, it did not merge its AutoCad surveys one and two, causing the conflict to “disappear” until – yep – the pile driver started driving the pile. The pile driver senses an obstruction, and tells the prime, who says, its been cleared, proceed. The pile driving foreman is in doubt, calls the office, who advises, bring out the City inspector, who is pulled from his office trailer on site, contacts the prime’s superintendent again, who now livid, tells the pile driver to “drive the #%&*pile.” Pile driver believes his is to do or die and not to wonder why, and drives the pile, pushing the duct bank down with it and snapping 3 miles of fiber optics, leading to a class action from businesses losing phone service, and a huge repair bill from the phone company.
· So, who paid? Yep, in the first instance, the pile driver’s insurance company settled the case, on behalf of the City and prime as additional insureds and at fault, and sought to spread the insurance risk to other insurers of the City also providing additional insurance.
· The moral of this war story: do not ignore the interplay between indemnity, insurance, additional insurance, subrogation, and exclusions from scope. Consult with your insurance broker and insurer’s risk managers, and counsel, to tee up your contract and bid proposal right for your industry’s particular set of risks. Fight for the right terms, so you are not buying into risks you do not control.
· OCIPs. “Owner Controlled Insurance” – OCIPs – are an alternative to this more traditional flow down risk of indemnity and insurance. OCIPs are more common on condo and mass residential subdivision projects where the risk of later defect suits are high, and a combined single project insurance policy insuring all the parties tends to reduce the overall project costs, and the later food fights over insurance and indemnity. If you see an OCIP, get your broker to look at it – OCIP coverages are not all the same, and they may provide less insurance coverage than your existing policy. If so, negotiate. Beware of an OCIP that does not cover you if your employee covered by workers compensation sues the owner, and the owner demands indemnity – your regular CGL policy might not cover either, since if there is an OCIP, you paid premiums to the OCIP for that job, and not to your regular carrier. Just be careful, and do not assume the OCIP is automatically your friend.
Conclusion
Yes, the above is mucho boring. Yes, indemnity clauses read like a manual for typewriter maintenance or computer code. And that is the “gotcha” – someone out there unfriendly perhaps to your interest, created special “mumbo jumbo” language to make you hire oodles of lawyers and insurance professionals to translate back into plain English. I hope this helped; if not, well, just cross out the offending language, and see what happens. It’s just typewriter maintenance.
Mark J Rice can be reached McNeil, Silveira, Rice and Wiley, 55 Professional Center Pkwy. Suite A, San Rafael, CA 94903. Tel: (415) 472-3434. Fax: (415) 472-1298
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