California’s Long-Awaited Indemnity Compromise—AB 758
With the recent passage of Assembly Bill 758 (AB 758) in the California Assembly, it appears that California may be headed toward resolution of the growing controversy over indemnity that has been so divisive between builders and trade contractors. As a compromise bill, AB758 reunites the builders and trade contractors in their common mission of building quality homes and minimizing construction defect litigation and litigation expense.
Under the current mechanics of contractual indemnity, trade contractors have long complained that they have been expected to defend more than their own defective work, and were required to indemnify a builder for the builder's own actions. And builders have often had to stand alone at the party, defending against the construction defect claims while simultaneously pressing claims against the trade contractors in order to trigger an indemnity obligation—effectively proving the case for the plaintiffs. This inherent conflict has lead to a bitter dispute between the very parties that should be united in defending against the construction defect claims.
AB 758 attempts to redefine the underpinnings of contractual indemnity in residential construction contracts. It is intended to eliminate those instances in which subcontractors have been held responsible for problems not arising from their work. In exchange, responsible subcontractors can be required by contract to promptly step up and defend claims.
Under AB 758, any provision in a residential construction contract entered into after January 1, 2006 that requires a trade contractor to indemnify (including the cost to defend) a builder against liability for construction defect or other property damage claims is unenforceable to the extent the claims arise from the negligence of the builder or the builder's other independent contractors or to the extent the claims do not arise out of or relate to the trade contractor's written scope of work. AB758 further expressly permits builders and trade contractors to separately negotiate the timing and immediacy of the trade contractor's defense obligation.
From the trade contractor's perspective, AB 758 limits the trade contractor's indemnity duty to those claims arising out of the trade contractor's negligence. No doubt there will be much discussion as to whether AB 758 eliminates Type 1 and 2 indemnity agreements. However, the time has come for this industry to stop focusing on the "type" of indemnity agreement (a practice disfavored by the judiciary) and, instead, concentrate its attention on the fact that a trade contractor's indemnity duty will only be to the extent of their negligence.
From the builder's perspective, AB 758 gives them the opportunity to require an immediate defense from the trade subcontractors involved in the construction defect allegations. Further, it expressly allows builders to enter into joint defense agreements with trade contractors initially broader than the trade contractors' respective fault so long as the joint defense agreement provides for subsequent reallocation based upon fault upon final resolution of the claim including reimbursement for overpaid defense fees and costs. AB 758 is presently pending in the Senate's Judiciary Committee. It is largely expected to pass with little modification and to be signed into law by California Governor Arnold Schwarzenegger. Although AB 758 will dramatically affect the construction and insurance industry in California, it also presents many opportunities. Builders should take advantage of the defense component of the bill and negotiate the scope and timing of the subcontractors’ defense obligation within the subcontracts themselves, including an immediate duty to defend. AB 758 should also encourage builders to partner with their trade contractors in developing joint defense agreements enabling the parties to be united in the defense against construction defect actions. It will also motivate builders to accurately track and monitor the provision of additional insured endorsements for the statute of limitations and to selectively screen for financial viability and stability those subcontractors with whom it chooses to partner.
In addition, we may see many more builders move into wrap-ups as an even better way of ensuring adequate protection from loss without having to worry about "orphan shares" or a trade contractor's ability to obtain additional insured coverage for the entire statute of limitations. It should also be seen as an opportunity for greater availability and affordability of trade contractor general liability policies, which will be good for both trade contractors, builders and builders' general liability carriers.
With the recent passage of Assembly Bill 758 (AB 758) in the California Assembly, it appears that California may be headed toward resolution of the growing controversy over indemnity that has been so divisive between builders and trade contractors. As a compromise bill, AB758 reunites the builders and trade contractors in their common mission of building quality homes and minimizing construction defect litigation and litigation expense.
Under the current mechanics of contractual indemnity, trade contractors have long complained that they have been expected to defend more than their own defective work, and were required to indemnify a builder for the builder's own actions. And builders have often had to stand alone at the party, defending against the construction defect claims while simultaneously pressing claims against the trade contractors in order to trigger an indemnity obligation—effectively proving the case for the plaintiffs. This inherent conflict has lead to a bitter dispute between the very parties that should be united in defending against the construction defect claims.
AB 758 attempts to redefine the underpinnings of contractual indemnity in residential construction contracts. It is intended to eliminate those instances in which subcontractors have been held responsible for problems not arising from their work. In exchange, responsible subcontractors can be required by contract to promptly step up and defend claims.
Under AB 758, any provision in a residential construction contract entered into after January 1, 2006 that requires a trade contractor to indemnify (including the cost to defend) a builder against liability for construction defect or other property damage claims is unenforceable to the extent the claims arise from the negligence of the builder or the builder's other independent contractors or to the extent the claims do not arise out of or relate to the trade contractor's written scope of work. AB758 further expressly permits builders and trade contractors to separately negotiate the timing and immediacy of the trade contractor's defense obligation.
From the trade contractor's perspective, AB 758 limits the trade contractor's indemnity duty to those claims arising out of the trade contractor's negligence. No doubt there will be much discussion as to whether AB 758 eliminates Type 1 and 2 indemnity agreements. However, the time has come for this industry to stop focusing on the "type" of indemnity agreement (a practice disfavored by the judiciary) and, instead, concentrate its attention on the fact that a trade contractor's indemnity duty will only be to the extent of their negligence.
From the builder's perspective, AB 758 gives them the opportunity to require an immediate defense from the trade subcontractors involved in the construction defect allegations. Further, it expressly allows builders to enter into joint defense agreements with trade contractors initially broader than the trade contractors' respective fault so long as the joint defense agreement provides for subsequent reallocation based upon fault upon final resolution of the claim including reimbursement for overpaid defense fees and costs. AB 758 is presently pending in the Senate's Judiciary Committee. It is largely expected to pass with little modification and to be signed into law by California Governor Arnold Schwarzenegger. Although AB 758 will dramatically affect the construction and insurance industry in California, it also presents many opportunities. Builders should take advantage of the defense component of the bill and negotiate the scope and timing of the subcontractors’ defense obligation within the subcontracts themselves, including an immediate duty to defend. AB 758 should also encourage builders to partner with their trade contractors in developing joint defense agreements enabling the parties to be united in the defense against construction defect actions. It will also motivate builders to accurately track and monitor the provision of additional insured endorsements for the statute of limitations and to selectively screen for financial viability and stability those subcontractors with whom it chooses to partner.
In addition, we may see many more builders move into wrap-ups as an even better way of ensuring adequate protection from loss without having to worry about "orphan shares" or a trade contractor's ability to obtain additional insured coverage for the entire statute of limitations. It should also be seen as an opportunity for greater availability and affordability of trade contractor general liability policies, which will be good for both trade contractors, builders and builders' general liability carriers.