SAN DIEGO-Amendments to California's laws governing construction indemnities, passed as Senate Bill 474 and signed into law on Oct. 9, 2011, took effect on Jan. 1, 2013. The impact on contracts for certain types of construction is significant; risk-shifting agreements that were enforceable if entered into before Jan. 1, 2013, may now be void and unenforceable if entered into after January 1. 

The new laws heighten the emphasis on determining fault for claims concerning construction, and may also have unintended effects on the obligation to provide a defense, which can be just as important as the obligation to indemnify for the underlying liability.

Allocation of the risk of a claim if something goes wrong is a key consideration for property owners, contractors, and subcontractors entering into agreements for construction services. The party bearing the risk for possible claims of injury or property damage caused by the construction that could be raised by a third party or subsequent purchaser of the property is often determined by contractual indemnity provisions, by which one party agrees to assume responsibility for such claims.  Parties typically seek to shift the risk of these claims "downstream."  Typically, the owner of the property on which construction occurs will want direct contractors to protect it from claims by indemnifying it, and the direct contractors will want their subcontractors to indemnify them.

The legislature has limited the extent to which a party may require another to take responsibility for claims against it.  Under previously existing law, property owners and contractors could not be indemnified for claims arising from their sole negligence or willful misconduct. (Cal. Civil Code, § 2782(a).) However, property owners and contractors could enter into contracts requiring that others indemnify them for claims even if the owners or contractors were partially at fault for those claims. 

The new law now extends the limitation on indemnity, making contractual provisions indemnifying an owner or general contractor for its active negligence unenforceable. (Cal. Civil Code, § 2782(c).) A similar limitation for residential construction was already on the books for contracts entered beginning in 2009 (Cal. Civil Code, § 2782(d), but this limitation now applies to all construction, including public works. 

The new law also makes clear that this limitation on the scope of an indemnity provision extends to all levels of contracting; the limitation applies not only to a property owner or builder, but also to general contractors, construction managers, and any upstream subcontractor seeking to shift risk downstream.  (Cal. Civil Code, § 2782.05.)  Finally, the new law expands the definition of the "construction contracts" to which the limitation applies to specifically encompass utilities, including water, sewer, gas, and electric lines.  (Cal. Civil Code, § 2783.)

Proponents of the amendments argue that the new law furthers the end of fairness by making each party responsible for its own fault, and protecting smaller subcontractors with less negotiating power from having the risk of others foisted upon them.  Opponents argue that contract pricing and insurance premiums already accounted for the downstream shifting of risk.  Under either view, the amendments may now result in increased litigation expenses, as owners, contractors, and subcontractors may have further incentive to fight about who is at fault for any given claim.

The new laws also further complicate the duty to provide a defense to a party that is sued.  The cost of a lawsuit over a construction claim, including attorneys' fees and the fees of construction experts who must be hired to evaluate the claim, can be substantial.  An agreement to provide indemnity "embraces the cost of defense" of a claim or action, and the person providing the indemnity is obligated, on the request of the person being indemnified, to defend the claim or action.  (Cal. Civil Code, § 2778, subds. (3) and (4).)  In this way, the indemnity provision shifts not only the obligation to pay for the underlying claim, but also to pay for the expense of defending any lawsuit about the claim.

Existing law requires that a contractor (or subcontractor or engineer) provide an immediate defense if a claim is tendered to it under an indemnity provision, so long as the claim falls within the scope of the provision.  (Crawford v. Weather Shield Mfg., Inc., 44 Cal. 4th 541 (2008); UDC-Universal Development, L.P. v. CH2M Hill, 181 Cal. App. 4th 10 (2010).)  Often, indemnity language provides that the claim falls within the provision if the claim arises from or is in any way connected to the work of the party providing the indemnity.  The defense must be provided immediately, even if the party giving the indemnity is able to later prove that it was not at fault or that the claim is not connected to its work (though that determination should cut off the obligation to continue providing a defense).  As directed by the California Supreme Court in Crawford, the duty to provide a defense applies before the lawsuit has been decided and before it is known if an indemnity is actually owed, so this duty cannot depend on the outcome of the litigation.

It remains to be seen how the courts will interpret the impact of the new indemnity laws on the obligation to provide a defense.  Those owing the indemnity may seek to place at least partial fault for the claim on the party to be indemnified, and then argue that the agreement to provide a defense, to the extent it is included in the indemnity, is unenforceable.

Just as prior to the amendments to the law, the specific language of the indemnity provision remains critical to determining the applicability of the indemnity and the duty to provide a defense.  Provisions may be narrowly tailored to limit the scope of the indemnity provided, or to alter the timing of the duty to provide a defense or to entirely exclude it.  With greater limitations on what is allowable now in effect, parties seeking to protect themselves in the event of claims or lawsuits need to pursue alternative strategies for minimizing their risk.

Charles L. Pernicka is a senior counsel in Allen Matkins' San Diego office. The views expressed in this column are the author's own.