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By: Thelen Reid & Priest LLP

A new law effective in 2006 limits the scope of indemnity clauses in subcontracts on residential construction projects in California. The law is important for developers, contractors and subcontractors who are involved, even on an occasional basis, in the residential construction industry. Because the terms of the indemnity clause are something negotiated in almost every significant prime contract or subcontract, it is important to understand the terms and impact of the new statute.

Assembly Bill 758 amended Civil Code §2782, in particular Subsections (c) and (d), so as to provide:

(c) For all construction contracts, and amendments thereto, entered into after January 1, 2006, for residential construction, as used in Title 7 (commencing with Section 895) of Part 2 of Division 2, all provisions, clauses, covenants, and agreements contained in, collateral to, or affecting any such construction, contract, and amendments thereto, that purport to indemnify, including the cost to defend, the builder, as defined in Section 911, by a subcontractor against liability for claims of construction defects are unenforceable to the extent the claims arise out of, pertain to, or relate to the negligence of the builder or the builder’s other agents, other servants, or other independent contractors who are directly responsible to the builder, or for defects in design furnished by those persons, or to the extent the claims do not arise out of, pertain to, or relate to the scope of work in the written agreement between the parties. This section shall not be waived or modified by contractual agreement, act, or omission of the parties. Contractual provisions, clauses, covenants, or agreements not expressly prohibited herein are reserved to the agreement of the parties.

(d) Subdivision (c) does not prohibit a subcontractor and builder from mutually agreeing to the timing or immediacy of the defense and provisions for reimbursement of defense fees and costs, so long as that agreement, upon final resolution of the claims, does not waive or modify the provisions of subdivision (c). Subdivision (c) shall not affect the obligations of an insurance carrier under the holding of Presley Homes, Inc. v. American States Insurance Company (2001) 90 Cal.App.4th 571. Subdivision (c) shall not affect the builder’s or subcontractor’s obligations pursuant to Chapter 4 (commencing with Section 910) of Title 7 of Part 2 of Division 2.

It is important to analyze what the new statute does and does not do. First, the statute applies to residential construction only, as defined in Civil Code §§895, et. seq. Thus, it does not apply to commercial contracts, condominium conversions or apartment construction. Second, it only applies to contracts entered into after January 1, 2006. Third, the statute is limited to claims for construction defects.

The statute is clear that all contractual provisions purporting to require a subcontractor to indemnify a builder or the builder’s other independent contractors are unenforceable to the extent that the claims arise out of the negligence of parties performing other work on the project.

The intent of this new language apparently is to prevent enforcement of indemnity clauses that require the subcontractor to indemnify the “builder” for negligent acts of the builder or third parties. It appears to have achieved this purpose. But it does not appear to change the rule that a subcontractor may be required to indemnify a builder (or contractor) for all claims “arising out of” the subcontractor’s work. Such clauses can require a subcontractor to indemnify a contractor even when the subcontractor was not negligent. See, Centex Golden Construction Co. v. Dale Tile Co., 78 Cal. App. 4th 992 (2000).

The “builder” as defined in Civil Code §911 is the party who is in the business of selling the residential units. Any contracts between such a builder and a subcontractor technically would not be “subcontracts” (which require a prime contractor). However, the statute appears intended to capture subcontracts when a developer also is acting as general contractor and contracting directly with “subcontractors.”

The limitation in the statute applies when a subcontractor enters into a subcontract with a prime contractor that contains an indemnity provision for claims against the owner. Even if the subcontract’s indemnity clause requires the subcontractor to indemnify the owner and general contractor, the indemnity obligations to the owner are limited by §2782.

An unsettled issue is whether prime contractors who do not qualify as “builders” under §911 still can impose broad indemnity obligations on subcontractors on residential construction projects. For example, assume a prime contract between an owner and a general contractor, and a subcontract between the general contractor and a subcontractor, and assume the owner is sued for construction defects. The owner will sue the contractor for indemnity, and the contractor will sue the subcontractor for indemnity. Will a broad indemnity clause in the subcontract still allow the contractor to be indemnified by the subcontractor for the contractor’s negligence or the negligence of other subcontractors?

Another issue is whether it is necessary for “builders” to amend the indemnity clauses in their form subcontracts for residential construction projects. It may be that the effect of the statute is to modify the subcontract clause. Since the statute is limited to construction defects, it makes sense to continue to use a broad indemnity clause in subcontracts so as to allow for broad indemnity for claims for personal injury or wrongful death.

General contractors on residential construction projects now need to be careful about broad indemnity clauses in prime contracts because they may not be able to pass those broad indemnity obligations down stream to their subcontractors.

General contractors faced with an owner who is demanding an overly broad indemnity clause on a residential construction project may consider proposing instead to use a form of indemnity clause that contains broad indemnity provisions but that then recites the language in §2782 (c) to limit the indemnity obligations for construction defects.

About the Author: This article first appeared in the Thelen Reid & Priest newsletter posted at ConstructionWebLinks on April 3, 2006.  For further information, contact Paul Berning, Esq.,attorney with the San Francisco office of Thelen Reid & Priest, LLP.  His address is 101 Second Street , Suite 1800 , San Francisco , CA 94105-3606 .  He may be reached at  415-369-7229 or at pwberning@thelenreid.com.  This article is reprinted in the May/June 2006 ConstructionRisk.com Report with permission.