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.

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