Death of “Type 1” Indemnity in California Construction
For many years the prevalence of the “Type 1” indemnity clause has been the subject of fierce debate within the construction industry. Subcontractors have complained that they are saddled with indemnity obligations that require them to indemnify contractors from construction-related claims for which these subcontractors are truly not responsible. In defense, contractors have argued that they must be entitled to the freedom to set contractual terms to best protect themselves and they point out that subcontractors are certainly free to negotiate better terms or turn down work.
After many years of debate and small legislative inroads in prohibiting Type 1 indemnity in residential projects and where it concerns the “sole negligence”, “willful misconduct” or the “design defects” of others, the California legislature has finally spoken broadly and definitively on the issue of Type 1 indemnity clauses in construction contracts. Under new Civil Code section 2782, beginning with contracts entered into on or after January 1, 2013, broad “Type 1” indemnity clauses shall be void and unenforceable in the context of both private and public construction projects in California. Civil Code section 2782 now makes it clear that subcontractors can no longer be required to indemnify against another’s active negligence in connection with construction contracts, whether public or private. Specifically, note the following:
What the New Indemnity Law Does Do:
- No Shifting Public Owner Active Negligence to Subcontractors: Under prior law, indemnity provisions in public works contracts were unenforceable when the provision purported to shift liability for the active negligence of a public entity to the contractor. Under the new law, this same protection is extended to subcontractors. Contract provisions where the contractor purports to shift the liability for the public entity’s active negligence to subcontractors are no longer enforceable. Civil Code section 2782(b)(2).
- No Shifting of Private Owner Active Negligence: The same protections noted above are also extended to Private Construction Projects. Under the new law, except as to a homeowner performing a project on a single family dwelling, owners of Private Projects cannot enforce contract provisions which purport to relieve the private owner for its own active negligence or shift liability for such active negligence to contractors or subcontractors. Civil Code section 2782(c).
- No Shifting of Contractor Active Negligence: The new provisions noted above apply specifically to the active negligence of both the public and private owner. New Civil Code section 2782 also prohibits the shifting of liability for the active negligence of general contractors or construction managers to subcontractors or the shifting the liability for the active negligence of one subcontractor to another subcontractor. This includes a prohibition of requiring subcontractors to indemnify contractors for claims that “do not arise out of the scope of work of the subcontractor pursuant to the construction contract”. Civil Code section 2782.05(a).
- Changes to Defense Obligations: As to the obligation to provide a legal “defense” to construction claims, the customary past practice was for construction contracts to require subcontractors to secure legal counsel immediately on receipt of a claim that falls under the indemnity clause. Under the new law such provisions are unenforceable. Instead, a subcontractor will have no defense and indemnity obligation unless the contractor first provides a written tender of the claim that follows the requirements of the new statute. These requirements include providing specific information provided by the original claimant relating to that part of the claim caused by the subcontractor’s work. In addition, contractors can no longer require that subcontractors be required to pay for the defense of those parts of the overall claim that do not relate to the subcontractor’s actual work on the project. Civil Code section 2782.05(a), (e).
- No “Choice of Law” Option: The new law prohibits efforts to incorporate into construction contract “choice of law” clauses which attempt to apply the laws of other states to avoid the above provisions. Civil Code section 2782.05(c), (d).
What the New Indemnity Law Does NOT Do:
- No Impact on “Wrap” Insurance Policies or Surety Agreements: The new law does not apply to obligations set forth under the terms of “Wrap” insurance policies or indemnity agreements required by sureties.
- No Relief for Design Professionals: The new law does not apply to contracts with design professionals.
- No Relief on Immediate Defense Obligation of Direct Contractors: The new law does not relieve the direct or “prime” contractor from any contractual obligation to provide a complete and immediate legal defense to owners for claims brought by third parties relating to the work of contractor and subcontractors on a project. This is despite the fact that the new law does not always allow a contractor to pass such obligations on to subcontractors.
- No Change in “Additional Insured” Obligations: The new law does not prohibit contractual provisions that require subcontractors to name contractors and/or owners as “additional insureds” under insurance policies required under the terms of the contract. Nor does the new law change the obligation of an insurer to provide an immediate defense to claims if required by the terms of the contract.
Problems on the Horizon:
- “Active” vs. “Passive” Negligence: While owners and contractors are now prohibited from passing liability for “active negligence” to lower tier contractors and subcontractors, they are not prohibited from passing down their liability for “passive negligence”. The distinction between active and passive negligence is not entirely clear or subject to ready determination and in most circumstances must be decided on a case by case basis at considerable expense to both contractor and subcontractor.
- Cumbersome Claims Procedure Under Civil Code Section 2782.05: The new law provides a claims procedure for contractors making indemnity and defense demands on subcontractors. Contractors now must be very specific in describing the claims, including providing “a written statement regarding how the reasonable allocated share of fees and costs was determined”. Subcontractors may defend using their own counsel or by paying “no more than a reasonable allocated share of the general contractor’s … defense fees and costs”. How this will work in practice and what challenges might be posed as contractors and subcontractors attempt to apply these laws and procedures remains to be seen.
- Impact on Insurance Rates: The prevailing view seems to be that insurance rates for general contractors will increase and insurance rates for subcontractors will decrease as a result of the law. Most speculate that the increase or decrease will be slight. We shall see.
In Conclusion: With the advent of the new law, owners, contractors and subcontractors alike should review their written contracts and their “indemnity and defense” clauses in particular to insure that they maintain all protections available to them under the new law. They should insure that lower tier contractors and subcontractors provide adequate insurance and additional insured certificates are provided and maintained. As to those contractual indemnity and defense clauses containing terms which are clearly prohibited under the new law, the clauses should be amended so that they comply with the law to the greatest extent possible, lest the entire indemnity clause be stricken by a court as unenforceable.
Article written by William L. Porter, Esq. in 2013. Mr. Porter is a principal in The Porter Law Group, Inc. in Sacramento, California. He can be reached by phone at (916) 381-7868.