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 Risk of Builders Risk
Contractors and owners obtain builders risk policies to protect themselves from risks associated with construction. But a lack of care in understanding and negotiating the provision of the construction agreement governing the builders-risk policy and the policy itself may lead the parties to expose themselves to needless and significant liability.
What owners and general contractors should do to protect themselves
If a construction contract requires the owner or the general contractor to obtain a builders risk policy—and it should—then that party should in fact obtain the policy. This may seem painfully obvious, but sometimes parties do not obtain required policies.
Courts have held, unsurprisingly, that a construction contract calling for a builders-risk policy means what it says. If the party whom the contract required to obtain a builders-risk policy does not obtain a policy, that party assumes the risk of loss that ought to have been covered by the policy. So, if a construction agreement requires, say, the owner to obtain a builders-risk policy, the owner should obtain the policy, and the other parties relying upon the policy should confirm the existence of the policy and its terms.
The Builders-Risk Policy Should Allow for the Construction Contract’s Mutual Waiver of Subrogation
Construction contracts frequently include a clause in which the owner and the contractor, both covered by the builders-risk policy, waive their right of subrogation against each other regarding any damages covered by that policy. The owner should not be able to sue the contractor for a loss if the owner has already obtained builders-risk insurance that would make him whole (or vice versa)—the mutual waiver of subrogation prevents the owner or the contractor from recovering twice.
However, if the builders-risk policy itself contains a provision preventing the parties from waiving subrogation, the execution of the construction contract may violate the policy conditions and might prevent recovery under the builders-risk policy.
As the owner and contractor negotiate the construction contract and the builders-risk insuring agreement, they need to pay attention to the provisions in each agreement governing subrogation. Broadly, they need to pay attention to the effect that each agreement has on the other, and should ensure that the builders-risk policy does not prevent the parties from waiving their subrogation rights. Moreover, they need to pay attention to the interaction between a builders-risk policy and any property insurance policy the owner may have (see below). The waiver of subrogation should apply to claims brought under the property policy for a few years after termination of the builders-risk policy.
The Construction Contract Should Specify When and under What Conditions the Owner Can Terminate the Builders-Risk Policy
Builders-risk policies are, as their name suggests, designed to cover risk arising from building. Once the structure is built, though, the builders-risk policy usually terminates. Builders-risk policies also typically terminate on the occurrence of a number of other conditions.
For example, the builders-risk policy may end when the equipment in a plant is first energized, on the theory that once you fire up the plant, it is no longer under construction but is operating as a business and therefore presents different insurable risks.
Once builder-risk insurance terminates, usually the owner’s property insurance kicks in. Property insurance, however, does not usually protect the contractor because the contractor is not a named insured under that policy, and it will not protect against all the events that a builders-risk policy would. If an insurable event occurs that would have been covered by the builders-risk policy after the policy has been terminated, there may be no coverage, possibly causing the parties to argue about whether the policy was properly terminated. If the owner terminates the builders-risk policy without telling the general contractor—and yes, this does happen—the parties will then argue whether the termination actually occurred.
Simply, unexpected termination of a builders-risk policy can ruin your day. The term of a builders-risk policy, then, is a critical point to negotiate and to stick to. Owners should not terminate a builders-risk policy early, and contractors should ask for a provision in the policy requiring the owner to give them notice before termination of the policy so that the contractor can arrange for adequate coverage elsewhere.
New WA Supreme Court Opinion has several Construction law implications
On June 18, 2009 the Washington Supreme Court issued its decision in Cambridge Townhomes, et al. v. Pacific Star Roofing, Inc., et al., 81003-6. The decision touches on several issues of interest to the construction industry in Washington. In particular, the Court clarified the law about when a corporation may be held liable as a successor in interest to a sole proprietorship (generally, where control in the company remains in the same hands, such that the old entity was effectively just wearing a “new hat”). The Court also enforced a broad indemnity provision in a subcontract, rejecting the subcontractor’s argument that its indemnity should be construed to apply only to third party tort claims. Finally, the court had occasion to revisit RCW 4.16.326(1)(g) which went into effect in July 2003 and requires that construction defect claims be filed within six years of substantial completion of construction or termination, whichever is later. The Court had held in 1000 Virginia Ltd. P’ship v. Vertecs Corp., 158 Wn.2d 205 (1994) that this provision did not apply retroactively. In Cambridge Townhomes, the Court clarified that application of the statute of repose turns on the date when the claim accrues, not when it is filed. You can read the entire decision here.
