Keep an Eye on sb 474 in California: Sweeping Edits will Eliminate Traditional Indemnity Rights and Obligations, as well as AIE's in Commercial Construction Contracts
Indemnity and additional insurance provisions in commercial construction contracts may no longer be an “arm’s-length” negotiation in California. Dramatic changes are proposed in sb 474 (2011). We most recently saw this type of legislative intrusion directing contract language in the residential construction context with the significant modifications of Civil Code section 2728 a few years ago. The current proposed legislation likewise dramatically changes the traditional model of commercial construction contracts and risk-shifting amongst the parties for California projects, and it applies broadly to all commercial construction contracts, including public contracts.
The language of the present text of sb 474 would – effective for any contract executed on or after 1-1-2012 – bar the usual risk allocation in the indemnity provisions and requirements for additional insured endorsements in developer to general contractor/lower tiers, and from the general contractor to any lower-tier subcontractor/vendor. It is significant to note that the new language would eliminate the application of section 2782.5 (developer and general contractor negotiations on risk allocation) after 1-1-2012 through proposed section 2782(2). While the prohibition would not apply to “amendments” to contracts existing prior to 1-1-2012, it would apply to virtually all commercial construction contracts after that date with few exceptions, including all “design construction, alteration, renovation, repair or maintenance” arising out of a wide variety of construction activities. These activities encompass work in the green and alternative energy realms as well, where risk allocation is sensitive due to the inherent emerging nature of the technology involved in the project. Under the proposed statute, however, any provision between the parties written in conflict with the law would be void as against public policy and unenforceable.
In substance: no blanket indemnity provisions allocating the risk (historically called a Type I provision in California) would be valid. Only provisions that narrow the indemnity/contribution to the harm caused by the fault of the indemnifying party would be permitted. Importantly, the proposed statute would also prohibit the common requirement of AIE coverage in favor of the developer/general contractor to the extent such requirements seek coverage for the scope of the prohibited indemnity.
Furthermore, if the property on which the construction is performed is in California, this law would apply regardless of any choice-of-law provision or place of execution of the contract.
The proposed language impacts developers and general contractors in very practical ways. Naturally, all contracts and subcontracts, as well as all insurance provisions, will have to be modified if this legislation passes. Insurance policy requirements, scope of coverage and risk management considerations will have to be re-evaluated in light of the elimination of historic requirements. Once a claim is made, however, the real result will be that the developer/general contractor will bear the full burden of responding to and defending the claims when they arise. No longer will a simple tender under a Type I be effective to bring everyone closer to the table for an early resolution. And there will be no tenders to all AIE insurers requesting a full defense and indemnity under their policies with an expectation of a cooperative defense. Instead, we should expect that the developer/general contractors and their insurers will be primary and first have to front the defense expenses for any claims and suits until it is – if it is – proven that the actual fault or violation was caused by the indemnifying party. Typically, this means that there will be rare recovery through early resolution without much litigation firsthand. The apparent goal of this litigation is to finger-point and shift the blame to other parties to avoid indemnification and contribution to the requesting party, along with the fee reimbursement obligations. Even then the catch-22 may be what recovery will or can be had on the cross-claims that seek indemnity and contribution without a final factual finding of the indemnitor’s liability, which naturally leads to more litigation (the costs of which “chase” may not be recoverable without adequate contract language). While claims of “fairness” abound in the promotion of the proposed text, we know from experience that this type of language generates litigation and an existing problem is made worse. These problems will be exponential if there are burning limits policies on the projects as well as limited insurance resources.
The Increasing Importance of Performance Bonds
There are now 25 states in the U.S. that hold that construction defects are not an “occurrence” and are therefore not covered under commercial general liability policies insuring contractors. Couple this troubling statistic with the ever increasing number of policy exclusions and limitations, and we begin to realize that in many situations the contractor’s insurance policy is inadequate (or non-existent) protection against defects.
The importance of performance bonds as security to pay for construction defects is therefore growing. While some sureties who sell the bonds will tell you that bonds merely guarantee completion, and do not insure against latent defects, the language of the typical bond defies this position.
Bonds plainly state that they guarantee each and every obligation of the contractor under the contract. Those obligations usually include the duty to perform work according to the plans and specifications, the standard of care, and without defect or nonconformity. This author has not seen a bond that attempts to carve out construction defects from its coverage. And bonds do not have the host of exclusions or limited coverage grants that plague the value of insurance policies. By the same token, bonds are not perfect and owners should consider the following to get the most protection from a bond:
First, the bond duration should extend at least as long as the warranty period (typically one year from completion but sometimes longer) and for as many years thereafter as possible, up to the statute of repose period in the state in which the project is located. Because construction defects often appear years after completion, the bond duration is critical. You may pay more for a bond with a longer duration, but if the bond is needed, you should be paying less for the unreliable insurance carried by the contractor.
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Oregon Supreme Court Declines to Reconsider Abraham Decision
In March of this year, the Oregon Supreme Court issued its opinion in Abraham v. T. Henry Construction, Inc. Unhappy with one aspect of the opinion, the Abrahams promptly filed a petition for reconsideration. Last week, the Oregon Supreme Court denied the Abrahams’ petition. While it was making its way through the appellate courts, Abraham provoked considerable interest from lawyers and construction industry groups alike because of its potential to change Oregon law.
Abraham involved construction defect claims by the Abrahams, homeowners, against their contractors. The central issue in Abraham was whether the Abrahams could recover in negligence for damage to their home even though there was a contract between the Abrahams and their contractors. This was a significant issue for the Abrahams: If their negligence claims were barred, they could not recover because the statute of limitations had expired on their breach of contract claims. The Supreme Court concluded that, in the absence of contract language limiting the Abrahams’ right to assert negligence claims, their allegations of property damage stated a claim for negligence. This meant that the Abrahams’ case against their contractors could move forward.
Still, the Oregon Supreme Court did not stop there. The Court went on to state that that negligence claims arising out of the construction of a house must be brought within two years from the date on which the plaintiff discovers or should have discovered the injury. While a two-year statute of limitations is generally assumed to be the applicable period for negligence claims, at least one recent case (Waxman v. Waxman & Associates) has, for some lawyers, cast doubt on that assumption. Indeed, those same lawyers have contended that rather than two years from discovery, the applicable limitations period for negligence claims is six years from the date of the injury. This apparent conflict has, in some cases, allowed lawyers to argue one of two potentially applicable statutes of limitations, depending on which party they represent and when it appears the injury occurred or was discovered.
By filing their petition for reconsideration, the Abrahams sought to have the Oregon Supreme Court modify its opinion and omit the reference to a two-year statute of limitations for negligence claims. The Abrahams argued that, among other things, they did not ask the Oregon Supreme Court to decide any statute of limitations issues. While it is true that the Court’s reference to a two-year statute of limitation was not essential to the holding in Abraham, it certainly indicates how the Oregon Supreme Court might rule. As a result, Abraham provides some measure of guidance on the issue of which statute of limitations should apply in construction defect cases. However, because Abraham did not decide any statute of limitations issues, it is likely that the two-year versus six-year dispute will continue until Oregon’s appellate courts address it directly.
