California recently joined a number of other states by enacting legislation limiting the permissible scope of indemnities in commercial construction contracts. California Senate Bill 474, which was signed into law by Governor Brown on October 9, 2011, makes unenforceable certain indemnity provisions in commercial construction contracts entered into on and after January 1, 2013. As a result of this legislation, owners and developers of commercial real estate, and their general contractors, will find their ability to shift construction risk to contractors and subcontractors has been limited.
Until now, it has been common practice for owners and developers of real property to include in their commercial construction contracts “Type I” indemnity provisions that require the general contractor to indemnify and defend the owner against claims, losses, and liabilities arising out of the construction of a project, even if caused in part by the owner’s “active” negligence. Under prior law, the enforceability of such indemnity provisions was limited only when the liability arose solely from the “active” negligence or willful misconduct of the indemnitee [Civil Code Section 2782(a)]. These indemnity obligations are frequently passed through by general contractors to the subcontractors performing the work.
Senate Bill 474 makes unenforceable any provisions of commercial construction contracts that purport to require one party to indemnify the other party against the indemnified party’s “active” negligence, and the legislation applies both to direct contracts between an owner and a general contractor and to subcontracts between the general contractor and subcontractors. Owners may still require general contractors, and general contractors may still require their subcontractors, to indemnify them against claims, losses, and liabilities arising out of the “passive” negligence of the indemnitee.
The primary result of these changes in the law is to shift the risk of liability arising from construction projects from subcontractors to owners and general contractors. This risk is more acute with respect to general contractors, whose active involvement in the construction of a project is generally more likely to generate claims that the general contractor’s conduct constituted “active” negligence that would defeat its claim against a subcontractor for indemnity arising out of claims involving the subcontractor’s work.
Of course, the practical effect of the new law depends largely on the distinction between “active” negligence and “passive” negligence. California cases attempting to characterize this distinction have reached conclusions that are predominantly fact-specific and difficult to categorize neatly, but, generally speaking, “active” negligence occurs where a party’s affirmative conduct breaches a duty of care, in contrast to “passive” negligence, which should be limited to instances of “nonfeasance”, i.e. where a party has failed to perform an act that it had a legal duty to perform. However, without clear guidance from the courts, there is a strong possibility that Senate Bill 474 may foster litigation as owners, contractors, and subcontractors argue about how broadly or narrowly to define “active” versus “passive” negligence while asserting or opposing contractual indemnity obligations.
Importantly, SB 474’s limitation on a general contractor’s ability to require its subcontractors to indemnify the general contractor against claims and liabilities to the extent arising out of the “active” negligence of the general contractor extends to the cost of defending claims as well. As a result, general contractors are now limited in their ability to require subcontractors to defend claims to the extent they are alleged to have been caused by the general contractor’s “active” negligence. Owners, however, do not have a similar restriction, and can require general contractors to provide a defense against claims, even to the extent those claims are alleged to arise out of the “active” negligence of the owner. As a result, general contractors will face greater exposure to the costs of defending against third-party claims, and it seems likely that this exposure will be reflected in increased insurance premiums.
Another important aspect of the law is that it governs all construction projects in California, regardless whether the parties provide in the construction contract that a different law applies. Accordingly, owners and contractors cannot avoid the law’s provisions by choosing to have a different state’s law apply to their construction contract.
If you would like more information about the impact of SB 474, or if you would like to discuss its impact on your business or activities, please contact our office.
* The restrictions discussed in this article apply only to private, commercial construction projects; different rules will apply to residential construction and construction contracts involving public agencies.