An Analysis of Indemnity Obligations from a Subcontractor’s Perspective

December 2004

A subcontract agreement between Subcontractor and Contractor contains the following indemnity provisions:

22. INDEMNIFICATION. All work covered by this agreement shall be at the risk of Subcontractor alone. Subcontractor shall indemnify Contractor and hold Contractor harmless against any and all liability, claims, judgments, losses, or demands, of every kind and nature arising directly or indirectly out of the work, or arising from performance by or obligations of Subcontractor herein, or arising from operations conducted by Subcontractor even if such liability, claims, judgments, losses, or demands are caused in part by the active or passive negligence of Contractor. Subcontractor shall not be responsible to indemnify Contractor from any liability, claims, judgments, losses, or demands, which are caused by the sole negligence of Contractor. Subcontractor will make good to and reimburse Contractor for any expenditures or obligations, including reasonable attorneys’ fees, Contractor may make or incur by reason of such matters, and if requested by Contractor, will defend any such suits at the sole cost and expense of Subcontractor. Subcontractor’s obligations to indemnify Contractor as set forth above shall apply completely to all liability, claims, judgments, losses, or demands, including but not limited to, any which rest upon an allegation, or theory, or finding based upon the legal theory of strict liability against Contractor. The contractual right of indemnification provided to Contractor hereunder shall be cumulative to all rights of equitable indemnity to which Contractor may otherwise be entitled; provided, however, that reservation of the right of equitable indemnity shall not apply to reduce or decrease any rights of indemnity provided to Contractor pursuant to the terms of this agreement and this paragraph. Included in this indemnity, but not by was of limitation, is Subcontractor’s obligation to indemnify and hold Contractor harmless against any loss, liability, expenses, or claim based upon any alleged violation or infringement of rights involving patents, copyrights, or trademarks arising from Subcontractor’s work or any materials provided by Subcontractor.

The law is well-settled that the question of whether an Indemnity Agreement covers a given case turns primarily on contractual interpretation, and it is the intent of the parties that is expressed in the Agreement that should control. When the parties knowingly bargain for the protection at issue, the protection should be afforded. This requires an inquiry under the circumstances of the damage or injury in the language of the contract. This necessarily requires a specific analysis of each unique set of facts (Rossmoor Sanitation, Inc. v. Pylon, Inc. (1975) 13 Cal 3d 622, 633).

California courts, when interpreting professional indemnity agreements, generally have employed a three-type analysis, originally set forth in MacDonald & Kruse, Inc. v. San Jose Steel Co. (1972) 29 Cal. App. 3d 413, which focus on the indemnitees’ active or passive negligence. In summary, the MacDonald court concluded that :

1. A “Type I agreement” provides that the indemnitor is to indemnify the indemnitee for, among other things, the negligence of the indemnitee,
2. A “Type II agreement” provides that the indemnitee is indemnified from his own acts of passive negligence, but not his own acts of active negligence,
3. A “Type III agreement” (less common) provides indemnification for liabilities caused by the indemnitor, but does not provide indemnification for liabilities caused by anyone else.

Recently, California courts have moved away from “mechanical application” of the MacDonald & Kruse rule, and instead emphasize basic rules of contractual interpretation (Maryland Casualty Co. v. Bailey & Sons, Inc. (1995) 35 Cal. App. 4th 856, 868). Essentially stated, indemnity agreements are construed under the same rules which govern the interpretation of other contracts (Myers Building Industries, Ltd. v. Interface Technology, Inc. (1993) 13 Cal. App. 4th 949, 969). Accordingly, the contract must be interpreted so as to give effect to the mutual intention of the parties (Civ. Code § 1636). Further, the intention of the parties is to be ascertained from the “clear and explicit” language of the contract (Civ. Code §§ 1638 – 1639). Finally, unless given some special meaning by the contracting parties, the words of an indemnity agreement are to be understood in their “ordinary and popular sense” (Civ. Code § 1644).

Under the early analysis of MacDonald & Kruse or the contract interpretation analysis set forth above, it is clear that the indemnity agreement between Subcontractor and Contractor is a “Type I” agreement as it provides that Contractor, as indemnitee, is to indemnified even if “such liability, claims, judgments, losses, or demands are caused in part by the active or passive negligence of Contractor.

Given the establishment of the Type I indemnity, the critical inquiry is whether or not the indemnity provisions at issue apply absent proof by the developer that subcontractor was at fault. Stated differently, the question to be decided is whether or not the indemnity provisions require the establishment of subcontractor fault (negligence plus causation) as a prerequisite to triggering the contractual obligations to indemnify under the subcontractor agreement.

Unfortunately, the recent leading cases dealing with this critical issue have reached conflicting interpretations and analyses.

The first case to discuss this issue in any detail was Continental Heller v. Amtech Mechanical Services (1997) 53 Cal. App. 4th 500.

In Continental Heller, a general contractor paid a settlement to settle claims against it arising out of an explosion caused by a defective valve installed ten years earlier by the subcontractor Amtech in a refrigeration system in a plant where several employers were injured. Even though Amtech was found not to be at fault for the explosion, the court upheld Amtech’s liability for the payment by Continental Heller based on the indemnity language in the subcontract agreement. Specifically, the agreement provided that the subcontractor would indemnify the general contractor for a loss “which arises out of or is in anyway connected with the performance of work under this subcontract.” The agreement further provided that the subcontractor’s liability for indemnity “shall apply to any acts or omissions, willful misconduct or negligent misconduct whether active or passive, on the part of the Subcontractor.” In determining that the language of the indemnity agreement was “clear and explicit”, the court held that there was no requirement that the indemnity needed to establish the fault of the indemnitor in causing the loss or that the indemnitor’s performance was “substantial” or a “predominating” cause of the loss. (Continental Heller v. Amtech, supra, 53 Cal. App. 4th 506.

A careful review of the Continental Heller decision establishes that the court relied upon two significant criteria for determining liability. First, the court citing the case of E.L. White, Inc. v. City of Huntington Beach (1978) 21 Cal. 3d 497, 507, expressly noted that parties to an indemnity contract enjoy “great freedom of action” in allocating risks, subject to certain limitations of public policy. In the Continental Heller case, the court determined that the contracting parties were two sophisticated entities and that the allocation of risk to the subcontractor was neither unreasonable nor unconscionable. Second, the court interpreted the phrase “act or omission” in the indemnity agreement to be broad enough not to require fault on the part of the subcontractor, but merely an “act” which would trigger the indemnity provisions. Based upon this interpretation and the risk allocation analysis, the court concluded that enforcement of the indemnity provisions of the agreement was reasonable under the circumstances.

Following the Continental Heller decision, the Court of Appeal, 4th Appellate Dist., decided the case of Heppler v. J.M. Peters Co., Inc. (1999) 783 Cal. App. 4th 1265. The Heppler case was the first case to deal with indemnity provisions related to standard “construction defect actions.”

In Heppler, plaintiffs, a certified class of homeowners, had taken an assignment from the developer of its indemnification rights against non-settling subcontractors as part of a global settlement. At trial, the plaintiffs proceeded to attempt to enforce the indemnity language in the subcontract agreements. Specifically, the various subcontract agreements required the subcontractors to agree to indemnify the developer for any claims or liability “arising out or in connection with Subcontractors… performance of the Work and for any breach or default of Subcontractor in the performance of its obligations under this Agreement.” Heppler v. J.M. Peters Co., Inc., supra 73 Cal App. 4th at 1273.

The court affirmed the trial court’s pretrial ruling that required plaintiffs to prove negligence and causation on the part of the subcontractor to trigger each subcontractor’s indemnity obligations. While the court did determine that the indemnity agreements were “Type I” agreements it also held that the indemnity provisions reasonably read, and the “commercial context” in which they arise, did not obligate the subcontractors to indemnify developer for developer’s liability unless such liability was attributable to them because of their negligent conduct. Heppler, supra 73 Cal. App. 4th at 1277. In so determining this issue, the court expressly held the indemnity provisions are to be strictly construed against the indemnitee, and had the parties intended to include on indemnity provision that would apply regardless of the subcontractor’s negligence, they would have had to use specific, unequivocal contractual language to that effect (see Goldman v. Ecco-Phoenix Electrical Corp. (1962) 62 Cal. 2d 40, 44).

Moreover, the court took into consideration the attendant circumstances, i.e., subcontractors performing limited scopes of work that was to be combined with the working materials of numerous others to build mass-produced residences was a factor to be considered.

Simply put, the court concluded that indemnity language contained in the pre-printed subcontracts did not evidence a mutual understanding of the parties that the subcontractor would indemnify the developer even if its work was not negligent. Further, the court asserted that utilization of such indemnity language which would trigger indemnity obligations regardless of the indemnitor’s fault ran afoul of public policy considerations and decisional law which imposed vastly different responsibilities on a developer (strict liability) versus the subcontractor. (La Jolla Village Homeowners Assn. v. Superior Court, (1989) 212 Cal. App. 3d 1131, 1143).

Based on the analysis in the Heppler case, one could argue that the Subcontractor’s indemnity obligations were not triggered until establishment of Subcontractor’s fault, i.e., negligence and causation. Unfortunately, the same court of appeals that decided Heppler subsequently decided Centex Golden Construction Co. v. Dale Tile Co., (2000) 78 Cal. App. 4th 992. In Centex Golden, Centex Golden was the general contractor responsible for construction of a commercial building. Dale Tile Co. was a tile subcontractor on the project. Following completion of the project, the owner made numerous claims against Centex Golden including a claim that the tile work was defective. Centex Golden settled the claims made by the owner and demanded indemnity from the subcontractor whose work had given rise to the claim. Centex Golden filed an indemnity action against Dale Tile in which it sought reimbursement for the monies paid as well as for a portion of the attorneys’ fee it had incurred in defending the owner’s claim. At trial, the jury found Dale Tile had not been negligent. The trial court still found Dale Tile liable for a claim for indemnity.

The court of appeal affirmed the trial court decision and concluded that an agreement by a subcontractor to indemnify a general contract or for any claim made with respect to the work covered by or incidental to their subcontract may require indemnity even if the claim is not meritorious and the subcontractor is not guilty of any negligence.

The underlying indemnity agreement provided that “all work covered by this Agreement done at the site of construction or in preparing or delivering materials or equipment, or any or all of them, to the site shall be at the risk of the subcontractor exclusively.” The Agreement further provided that the subcontractor was to indemnify and hold the contractor harmless from and against “loss, damage or expense, including any if the same resulting from subcontractor’s alleged or actual negligent act or omission, regardless of whether such act or omission is active or passive.” (Centex Golden supra, 78 Cal. App. 4th at 996.

In reaching the determination that the indemnity provisions applied irrespective of the determination of fault of the subcontractor, the court concluded that the language of the agreement left no doubt that the parties intended that the subcontractor should indemnify the general contractor for any reason except for the sole negligence or misconduct of the general contractor. In so deciding, the court based the decision on two distinct interpretations. First, the court determined that the reference to all work “shall be at the risk of the subcontractor exclusively” was an even clearer statement of the subcontractor’s agreement to provide indemnity even in the absence of any fault (Centex Golden supra, 78 Cal. App. 4th at 999).

Second, the court found that reference to the phrase “alleged or actual negligent acts of omission” plainly contemplated more than the narrowed risks of the subcontractor’s own negligence or fault, as the indemnity provided for mere allegations of negligence (Centex Golden supra, 78 Cal. App. 4th at 999).

While the Centex Golden court concluded liability for indemnity existed based on the aforementioned language, it again discussed in great detail the policy ramifications with respect to the nature and extent of the commercial setting in which the contract was executed. In Centex Golden, the court expressly noted that this was not the same as the case in Heppler which involved the builder of a large residential tract which, upon completion would be marketed, but was rather a situation involving a general contractor on a single commercial building. Thus, unlike the mass producers of homes, Centex had no ability to pass on the costs of the defects to other customers, and thus had no liability in tort different from the liability of its subcontractors. (Centex Golden supra, 78 Cal. App. 4th at 1000).

Given the conflicting decisional law on the subject, there is no clear cut resolution to the question of rather or not the Subcontractor’s indemnity is triggered under the Contractor’s subcontract, absent of showing of fault. Unfortunately, like the Centex Golden indemnity agreement, the Subcontractor’s notification provision provides that “all work covered by this agreement shall be at the risk of the subcontractor alone” which the Centex Golden court found to provide the trigger of indemnity.

Further, the Subcontractor’s indemnity additionally states that the Subcontractor is to indemnify Contractor . . . “completely to all liability, claims, judgments, losses or demands, including but not limited to, any which rest upon an allegation, or theory, or finding based upon the legal theory of strict liability against Contractor.” Again, this language is similar to the Centex Golden language regarding “alleged or actual negligence” which triggered indemnity.

Based on a literal reading of the contract, it would seem to be more closely analogous in language to the Centex Golden case than language and discussions set forth in Heppler. However, a key consideration to keep in mind is that this is in fact a construction defect action, and the policy arguments in Centex Golden would not be applicable. Rather, the policy arguments favoring the non-application of the indemnity agreement as stated in Heppler would appear to apply. As such, there is a dichotomy between the decisional law which might allow an argument to be made that the indemnity agreement is not triggered until there has been a finding of fault requiring both negligence and causation, given the attendant commercial circumstances..

As such, depending upon the actual cause of the accident or incident, it is possible that the court could find that the Subcontractor does not owe a duty to indemnify and defend Contractor without a showing that Subcontractor was at fault in causing the Contractor’s loss or that its performance was a “substantial” or “predominating” cause of the loss. While such an argument can be made, we do acknowledge that the indemnity agreement between Contractor and Subcontractor is a strong one which runs in Contractor’s favor, and one would raise a technical argument to offset such indemnity claims.

It is conceivable that a court would take a simplistic view of the analysis, and merely determine that liability for indemnity lies as a result of the agreement requiring indemnity at the “sole risk of the subcontractor”, even for mere “allegations” or theories.

The argument is that Subcontractor never intended to indemnify the developer, regardless of fault, or for mere allegations of negligence. Further, Subcontractor performed only a limited scope of work that was to be combined with the work and materials of numerous others to build mass-produced residences which should trigger a Heppler analysis. Finally, Subcontractor intended the indemnity obligations to arise only if it performed negligently and caused property damage, and such indemnity provisions only apply if Contractor was passively, and not actively negligent.

Please Note: This article is necessarily general in nature and is not a substitute for legal advice with respect to any particular case. Readers should consult with an attorney before taking any action affecting their interests.