When is a Type 1 Indemnity Not a Type 1 Indemnity?
When it favors a Developer with Strict Liability.
Heppler v. J.M. Peters Company, et. al. (1999) 73 Cal. App. 4th 1265 (August 4, 1999)
In a case of major significance to homebuilders, the Fourth District Court of Appeals in Heppler has strictly limited the scope of indemnity protection afforded a developer in what had been previously upheld as a typical type 1 indemnity agreement. If a strictly liable party, such as a developer, seeks indemnity for liability other than that based on the fault of the subcontractor, the language of the agreement must now specifically spell out that exposure.
HOLDINGS:
Homeowner's, as assignee's of the developer, J.M. Peters, contractual indemnity rights, had to prove negligence in order to recover against the subcontractors as they had only agreed to be liable for the consequences of their own negligence.
Good faith settlement determination had no preclusive effect on contractual indemnity claims.
An assignee has attorney's fees exposure when the contract contains an attorney's fees clause and the other party is the prevailing party.
BACKGROUND:
The 1997 case of Continental Heller Corp. v. Amtech Mechanical Services Inc. (1997) 53 Cal.App.4th 500, represented the culmination of a gradual expansion of indemnity cases, both in California and across the nation. The judicial branch had long sent the message that the allocation of risk, subject to certain statutory limitations (California Civil Code § 2782, for instance, prohibits indemnification for liability arising out of one's sole negligence or willful misconduct) was a proper subject of the agreement of the parties.
As a result, developers and others, left exposed to strict liability for defective work actually performed by others, began broadening their indemnification provisions to reflect these risks. Counsel began specifically crafting indemnity language to apply to any and all acts and omissions resulting in liability other than that statutorily prohibited. These indemnity agreements included the obligation to defend any and all such claims, and was often supported by additional insured endorsements with similar "arising out of your work" language.
The Second District Court of Appeal in Continental Heller held that Amtech's agreement to indemnify the builder against claims "arising out of or in any way connected with the subcontractor's performance of work," was triggered regardless of whether or not the subcontractor was at fault in creating the liability. The Continental Heller court specifically noted that the language used by the parties failed to require that the loss arise out of the subcontractor's negligence or for any other fault-based reason; and that if the parties had so intended such a basis to trigger the application of the indemnity, they could have easily so provided. The Continental Heller Court held the agreement commercially reasonable, and the negotiations within arms-length, because Amtech (a large plumbing subcontractor, who purchased and installed the defective valve) was in a better position to allocate this particular loss.
This public policy analysis formed the basis of the Heppler decision.
SUMMARY OF DECISION:
The homeowners of a subdivision built by J.M. Peters, amongst others, sued asserting liability for implied warranty, negligence, nuisance and strict liability alleging defects in their roofs, foundations and soils. J.M. Peters tendered its defense to a number of subcontractors based on their indemnity rights under the subcontracts. The subcontractors refused or failed to respond. J.M. Peters then settles with the homeowners and assigns its rights under said indemnity agreements to the plaintiffs. The settlement was allocated between the roofing, structural and soils claims and found in good faith within the meaning of CCP §877.6.
The homeowner's proceeded to trial against the subcontractor's on these indemnity agreements. In a pretrial ruling, Judge Robert May of San Diego Superior Court, found that plaintiff's would have to prove negligence to trigger the indemnity obligations under the contracts. The case proceeded up on appeal for this and other reasons.
The Court of Appeal eschewed a strict or mechanical application of the indemnity agreement, and citing to Rossmoor Sanitation Inc., v. Pylon, Inc. (1975) 13 Cal.3d 622, 633, instead focused on the nature of the damage, the language of the contract as well as the facts of the case. With indemnity language virtually identical to that used in Continental Heller, the Court held that the "arising out of or connected to" language still required some element of "fault" on behalf of the subcontractor indemnitor.
Although noting the freedom of the parties to allocate these risks, the Court held that the language had to be sufficiently specific and unequivocal in evidencing this intent. The Court found that the above-stated language did not evidence a mutual understanding that the subcontractor would indemnify the builder regardless of whether or not the subcontractor was negligent. The Court based its determination on an analysis of the scope of work and the respective bargaining power of the parties. Here, the Court found that the subcontractors performed limited scopes of work; they had little (if any) control over the work of others; and little (if any) ability to spread the risk of loss. The court held that the agreements had to be read in a manner that rendered them reasonable and capable of being put into effect pursuant to California Civil Code § 1643.
The Court then went into an analysis of strict liability1 and noted that the application of Continental Heller to these facts would have the effect of transferring strict liability to the subcontractors without specific contractual language unambiguously manifesting this intent. It then noted that such an allocation of risk would seriously impact the subcontracting industry and the home-buying public.
The Heppler Court sought to distinguish Continental Heller in the following ways:
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The indemnity provision in Continental Heller included language that it would "apply to any acts or omissions, willful misconduct or negligent conduct, whether active or passive, on the part of the subcontractor" and that such left no doubt that the parties intended the indemnity to apply irrespective of whether or not the loss arose from Amtech's negligence or other reason;
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The agreement was not commercially unreasonable because Amtech was large sophisticated company, positioned to control its work, and able to pass on the risks of defective materials arising out of or otherwise connected with its work; and
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The liability did in fact arise out of work that Amtech had control over and the best ability to pass on such costs.
COMMENTARY:
In both Continental Heller, and Heppler the developer and subcontractors were without fault (or at least no finding of fault existed). The court in each case, however, came to a different conclusion: one found a duty to indemnify and the other did not. A reading of Continental Heller led many an indemnitee to believe (and I think correctly so) that the indemnitor's "fault" was not necessary to trigger an obligation under the clause. This was significant as most indemnity agreements seek to secure a defense as well as indemnity. The Heppler decision will bring only delay and further uncertainty to these issues as indemnitors will now want to see some evidence of negligence before they honor their contractual obligations.
The J.M. Peters subcontract contained a fairly standard "Type 1" indemnity provision, that the court found inadequate to shift liability other than that founded upon the subcontractor's fault. The Court, nonetheless, left open the ability of the parties to so allocate the risk, with specific unambiguous language. The Heppler trap for any contracting party will revolve around the "unequal bargaining power" of the respective parties, their ability to control the work of others and/or pass on the risk of loss to those who are best able to handle it.
We have crafted various provisions to overcome these "public policy" considerations, and would welcome the opportunity to review and revise your subcontracts in light of this authority.
For a discussion of other implications of the Heppler decision, contact:
Ira James Harris, Esq. at 925-258-5100 or by e-mail at ira@iraharris.com.
These materials should not be considered as, or as a substitute for, legal advice and they are not intended to nor do they create an attorney-client relationship. Because the materials included here are general, they may not apply to your individual legal or factual situation. You should not take (or refrain from taking) any action based on the information you obtain from this document without first obtaining professional counsel and you should not send us confidential information without first speaking to one of our attorneys and receiving explicit authorization to do so.
1 Subcontractors have no exposure to strict liability pursuant to La Jolla Village Homeowners" Association v. Superior Court (1989) 212 Cal.App.3d 1131.
