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New California Laws Forbid Broad Type I Indemnity Obligations and Require Sharing More Information About Wrap-Up Policies
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May 25, 2009
(This article first appeared in the May 2009 edition of Constructor, published by the Associated General Contractors of California.)
By Peter K. Zweighaft
Howrey LLP
In 2005, the California Legislature amended Civil Code §2782 in an effort to prevent home builders from imposing “Type I” indemnity obligations on subcontractors. Such indemnity obligations typically forced the indemnitor/subcontractor to indemnify the indemnitee/builder for, among other things, the negligence or misconduct of the indemnitee/builder.
Two new pieces of legislation, enacted by the Legislature in the last session and signed into law by the Governor, seek to close perceived loopholes in Civil Code §2782 and to further curb the use of Type I indemnity clauses in residential construction contracts.
Senate Bill 138
Subdivision (c) of §2782 rendered unenforceable any Type I indemnity clause in a residential construction contract that required the subcontractor to indemnify the “builder,” as that term is defined in Civil Code §911, against claims: 1) that arise out of the negligence of the builder; 2) for design defects; or 3) that do not arise out of the subcontractor’s scope of work.
However, because the definition of “builder” in Civil Code §911 excluded a contractor that was “not a partner, member of, subsidiary of, or otherwise similarly affiliated with the builder,” subdivision (c) arguably permitted such non-affiliated contractors to enforce Type I indemnity clauses against their subcontractors. Senate Bill 138 added subdivision (e) to make all Type I indemnity clauses unenforceable in residential construction contracts, even if the contractor is not also the builder or is not affiliated with builder. Subsequently, in Assembly Bill 2738, subdivisions (c) and (e) were combined to the same effect.
Assembly Bill 2738
Residential builders also attempted to circumvent the rules against Type I indemnity clauses by requiring subcontractors to pay for all defense costs, including those that did not bear any relation to the subcontractors’ scope of work. In theory, the subcontractors’ share of defense costs would be reimbursed upon final resolution of the claim. However, in reality, because most cases settle short of a final resolution, subcontractors could find themselves paying a disproportionately large share of defense costs. Assembly Bill 2738 amended Civil Code §2782 to make a subcontractor’s defense obligation subject to basic comparative fault principles.
Subdivision (d) now provides that a subcontractor owes no defense or indemnity obligation to a builder or general contractor unless that builder or general contractor tenders the claim and all information relevant to it in writing to the subcontractor. Once written tender is made, the subcontractor may either 1) provide a complete defense against all claims alleged to have been caused by the subcontractor but not including claims resulting from the work of any other party, or 2) pay a reasonably allocated share of the builder’s or general contractor’s defense fees on an ongoing basis, subject to reallocation upon final resolution of the claim that is consistent with the comparative fault principles.
The election of either option satisfies the subcontractor’s defense obligation. However, if the subcontractor fails to elect either option, the builder or general contractor may pursue a claim against the subcontractor for compensatory and consequential damages, including attorney fees.
Section 2782 also expressly permits claims for equitable indemnity by the builder, general contractor and subcontractor for claims covered by this section as well as claims for equitable indemnity against suppliers, design professionals or product manufactures. Such claims are based on comparative fault and not on contractual liability allocations.
With the increasing popularity of wrap-up insurance policies, Assembly Bill 2738 also added §2782.9 to the Civil Code. Wrap-up insurance policies typically are taken out by a builder and are designed to cover multiple contractors and subcontractors against risks associated with a construction project. Civil Code §2782.9 prohibits the builder from imposing contractual indemnity obligations on a subcontractor when a residential project is covered by a wrap-up insurance program. But, any party may make equitable indemnity claims for damages if the claims are not covered by the wrap-up policy. The builder or general contractor may require subcontractors or other participants to pay a reasonable share of the self-insured retention or deductible of the wrap-up policy. However, the maximum amount of the each participant’s contribution and the method of collection must be disclosed in the contract with the participant. The contribution must be reasonably limited so a participant may have a financial obligation in the event of a claim allegedly caused by that participant’s work. The contribution may only be collected when the deductible or self-insured retention is incurred by the builder or general contractor and only in an amount that is reasonable and proportionate to the claim. Written notice must be given to collect. Contributions may not exceed the deductible or self-insured retention due. Builders or general contractors can sue to recover unpaid contributions and may recover attorney fees for doing so.
Assembly Bill 2738 also adds §2782.95 to the Civil Code. It mandates disclosures when wrap-up policies are used on private residential construction projects. The owner, builder or general contractor that obtained the wrap-up policy is required to disclose in the contract documents the total amount or method of calculating any credit or compensation for the policy premium sought from the subcontractor. Policy limits, scope of coverage, policy term and other specified information regarding the coverage must be provided, including a copy of the policy if it is available. If the owner, builder or general contractor that obtained the wrap-up policy fails to disclose the amount or method of calculating the premium credit or compensation charged before the participant submits its bid, then the participant is not legally bound by the bid unless the participant has the right to increase the amount of the bid to make up the difference between cost of the wrap-up policy carried in its bid and the actual cost.
Finally, Assembly Bill 2738 adds §2782.96 to the Civil Code. It mandates disclosures when wrap-up insurance policies are used on public works or any project other than residential construction. The owner, builder or general contractor that obtained the wrap-up policy must disclose in bid documents the amount or method of calculating any credit or compensation for the policy premium. The contract documents must disclose the policy limits, known exclusions and the length of time that the policy is expected to remain in effect. Those covered by the policy may obtain a copy of it.
Conclusion
Collectively, Senate Bill 138 and Assembly Bill 2738 attempt to restrict the use of Type 1 indemnity clauses in residential construction projects by using basic comparative fault principles to provide that the project participants pay only for damages they caused.
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For more information about the issues covered in this report, please contact Peter K. Zweighaft in our Los Angeles office at 213-892-1996 or at zweighaftp@howrey.com or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
©2009 Howrey LLP
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