by Joseph M. Sweeney, Esq., and Scott A. Mangum, Esq.
Indemnity provisions are often highly contested subcontract provisions since they shift risk from general contractors to subcontractors. While subcontractors may understand the general purpose of indemnity provisions, i.e. that one party (the “indemnitor”) agrees to indemnify and defend another party (the “indemnitee”) from claims, they sometimes do not understand how indemnity provisions are applied to significantly increase their risk on construction projects.
This article discusses indemnity provisions in three parts: 1) how and when indemnity clauses impose a duty on subcontractors to reimburse general contractors or owners for sustained loss and damage which they may not expect; 2) how to negotiate a balanced indemnity provision that limits a subcontractor’s indemnity obligations to claims for their own fault or that may be covered by insurance; and 3) a comparison of California and Texas indemnity laws to illustrate the importance of reviewing the indemnity laws of your state.
What Is Indemnity?
“Indemnity” is “(1) A duty to make good any loss, damage, or liability incurred by another; (2) The right of an injured party to claim reimbursement for its loss, damage, or liability from a person who has such a duty; (3) Reimbursement or compensation for loss, damage, or liability in tort; especially, the right to recover from the party who is primarily liable for reimbursement of expenditures paid to a third party for injuries resulting from a violation of a common law duty.” Black’s Law Dictionary 784 (8th ed. 2004).
Put succinctly, one party agrees to defend another party for any loss relating to a third party’s claim. Indemnity clauses shift risk by requiring the indemnitor to pay damages that have been or might be caused by the indemnitee.
Consider a third party who slips on stairs. The third party may sue the building owner for its injury alleging that the stairway’s design or construction was deficient because the stairs were too tall, too steep, lacked slip protection, or violated building codes. If the owner has an indemnity provision in its contract with the contractor who built the stairs, the owner may look to the contractor, as the indemnitor, to compensate the building owner for damages awarded to the injured third party. Likewise, if the contractor hired a subcontractor to participate in the design or construction of the stairs and included an indemnity provision in the subcontract, the contractor may look to the subcontractor for indemnity relating to the claim, i.e. the subcontractor must compensate the general contractor for money the general contractor pays to the building’s owner.
Onerous Indemnity Provisions
Indemnity provisions are typically more favorable to the indemnitee, for instance, the owner or the general contractor, than to the indemnitor (the subcontractor). Consider this indemnity provision used in many California subcontracts:
AGCC Short Form Standard Subcontract: To the fullest extent permitted by law, Subcontractor shall indemnify and hold harmless Owner and Contract and their agents and employees from claims, demands, causes of action and liabilities of every kind and nature whatsoever arising out of or in connection with Subcontractor’s operations performed under this Agreement. The indemnification shall extend to claims occurring after this Agreement is terminated as well as while it is in force. The indemnity shall apply regardless of any active and/or passive negligent act or omission of Owner or Contractor, or their agents or employees, but Subcontractor shall not be obligated to indemnify any party for claims arising from the sole negligence or willful misconduct of Owner or Contractor or their agents or employees, or arising solely by the designs provided by such parties. The indemnity set forth in this Section shall not be limited by insurance requirements or by any other provision of this Agreement.
This AGCC indemnity provision underscores how indemnity provisions can be onerous to subcontractors. First, it obliges the subcontractor to “indemnify and hold harmless” the indemnitee from “claims, demands, causes of action and liabilities of every kind and nature whatsoever arising out of or in connection with Subcontractor’s operations …” Second, the provision applies regardless of the indemnitee’s passive negligence. Lastly, the indemnity obligation is not limited by insurance, thereby presenting increased risk to the subcontractor in the event of a third-party claim exceeding the amount of the subcontractor’s insurance.
Balanced Indemnity Provisions
While comparative negligence generally applies under the common law, contractual indemnity favors an indemnitee by circumventing the common law and imposing broad and sometimes unfair obligations on the indemnitor. A subcontractor who familiarizes itself with the typical language found in indemnity provisions will be better equipped to negotiate language shifting risk of loss. Specifically, options for protection include limited indemnity for fault or limiting indemnity obligations to insurable claims.
Subcontractors should seek to limit indemnity obligations to areas where they can obtain insurance. Broad indemnity provisions such as the AGCC language above require the indemnitee to indemnify the indemnitor from “claims, demands, causes of action and liabilities of every kind and nature whatsoever arising out of or in connection with Subcontractor’s operations performed under this Agreement.” For subcontractors, the broad scope is troublesome because it is unlimited and the subcontractor likely cannot obtain insurance on such a broad scale.
Subcontractors should propose indemnity provisions such that indemnity obligations are narrowed to insurable risks. For example, a subcontractor may limit claims for personal injury or property damage claims which are insured.
A subcontractor should also seek to limit its indemnity obligations only to third party claims relating solely to its fault. By excluding obligations to indemnify other parties to the contract for their fault (e.g. the building owner), the subcontractor is better able to limit and control risk. The following is a more narrowly tailored indemnity provision that obligates the subcontractor to a more limited scope of indemnity:
The Subcontractor shall indemnify and hold harmless the Owner … from and against claims, damages, losses and expenses … arising out of or resulting from the performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Subcontractor, Subcontractor’s subcontractor, or anyone directly or indirectly employed by or anyone for whose acts they may be liable. Subcontractor’s obligations hereunder shall be limited to the extent of Subcontractor’s insurance.
California and Texas Indemnity Principles
California
Type I indemnity provisions require a party to indemnify another from any claim arising out of or related to the indemnitor’s scope of work, including the negligence of the indemnified party. Only the indemnitee’s sole negligence or willful misconduct cannot be indemnified.
Although California law once permitted Type I indemnity provisions in construction contracts, California Civil Code 2782.05 now generally prohibits them in construction contracts entered into after Jan. 1, 2013, under 2782.05(a)., California construction contracts may not require a subcontractor to indemnify, defend or insure a general contractor, construction manager or other subcontractor for (1) claims of personal injury property damage, or other loss to the extent that the claims relate to the indemnified parties’ active negligence or willful misconduct; (2) claims that arise from any design defects provided by the indemnified parties or (3) claims that do not arise out of the subcontractor’s scope of work set forth in the subcontract. Any contractual provision attempting to waive these limitations is contrary to public policy and unenforceable. Cal. Civ. Code §2782.05(d).
Civil Code 2782.05 does allow several limited exceptions allowing Type I indemnity provisions, including (1) “contracts for residential construction” to the public; (2) “direct contracts with a public agency”; (3) “direct contracts with the owner of privately owned property”; (4) “any wrap up insurance policy or program”; (5) independently existing causes of action for breach of contract or warranty; (6) a subcontractor’s contractual insurance requirements; (7) “indemnity provisions in loan and financing documents”; (8) indemnity provisions in surety bonds; (9) benefits and protections under workers’ compensation and governmental immunity laws; (10) contractual provisions requiring certain construction risk insurance policies; and (11) contracts with “design professionals.” Cal. Civ. Code § 2782.05(b).
Texas
In 2011, the Texas Legislature enacted the Texas Anti-Indemnity Act (codified in Texas Ins. Code sections 151.001 to 151.151) to limit and void certain indemnity provisions in contracts entered into after Jan. 1, 2012.
The Texas Act prohibits in certain classes of construction contracts broad form indemnity (holding indemnitor responsible for any and all liability arising from the specified subject matter) and intermediate form indemnity (requiring indemnitor to indemnify indemnitee for all liability arising from a specific subject matter, even if damage is caused by the indemnitee’s negligence, but expressly excludes the indemnitor’s sole negligence) if the Act applies to the contract at issue.
According to Texas Insurance Code section 151.001, the Anti-Indemnity Statute applies to construction contracts for projects where an indemnitor procures insurance subject to the Act’s Chapter 151 (Consolidated Insurance Program where principal provides multiple kinds of insurance for a single construction project) or Title 10 (states regulations for Texas property and casualty insurance; includes standard commercial general liability and workers’ compensation coverage).
Section 151.105 contains eleven exclusions to the Anti-Indemnity Act: (1) consolidated insurance programs; (2) actions for breach of contract or warranty that exist independently of an indemnity obligation; (3) loan and financing documents other than construction contracts to which lenders are a party; (4) general indemnity agreements required by sureties; (5) workers’ compensation protections and benefits; (6) agreements subject to Texas Civil Practice & Remedies Code Chapter 127; (7) licenses or access agreements with railroad companies; (8) indemnity provisions applying to copyright infringement claims; (9) construction contracts or agreements collateral to or affecting construction contracts pertaining to single-family homes, townhouses, and duplexes; (10) municipality public works projects; (11) joint defense agreements entered into after a claim is made.
Section 151.104 states that any provision or coverage endorsement in a non-exempted construction contract requiring the purchase of additional insured coverage under an insurance policy with a scope of coverage to cover the other party’s own negligence is void and unenforceable to the extent that it requires coverage for such negligence.
A comparison of the Texas and California indemnity laws underscores the disparate nature of such laws as among different states, and the importance of carefully reviewing indemnity provisions on a state-by-state basis and with experienced local counsel. Understanding indemnity principles is an important skill for all subcontractors seeking to protect themselves in the event of third-party claims relating to their work or the work of an indemnitee party.
Joseph Sweeney, Esq., and Scott Mangum, Esq., are shareholders with Sweeney, Mason, Wilson & Bosomworth, Los Gatos, Calif. Since 1978, Sweeney has focused on construction and real estate law, both transactional and litigation. He has successfully represented owners, developers, general contractors, subcontractors, material suppliers and design professionals in multiple aspects of construction law issues through negotiations, disputes, mediations, arbitrations and trials. He can be reached at (408) 356-3000 or jsweeney@smwb.com. Mangum assists his clients in a variety of litigation matters, focusing primarily on construction and real estate disputes. He can be reached at (408) 356-3000 or smangum@smwb.com. SMWB would like to thank Brian Carroll for his input regarding this article, specifically relating to Texas law.
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