Kent Holland, Esq.
ConstructionRisk Counsel, PLLC
After a contractor settled a construction defect claim with the project owner, it sought indemnity from its subcontractor for the costs incurred in rectifying the construction. The subcontractor successfully argued in a lower appellate court that no “claim” had been made by the owner that would trigger the indemnity obligation, and that even if the indemnity obligation had been triggered, the statute of limitations for enforcing the indemnity had elapsed. The Supreme Court of Michigan, reversed and held that the owner’s demand that the prime contractor correct the defective work constituted a “claim,” and there was no dispute that the prime suffered loss as a result of correcting the work when its subcontractor refused to do so. The court found that the subcontractor “twice breached the contract: first when it failed to install the roof system in accordance with the relevant plans and specifications, and then later when it refused to indemnify [the Prime] for the corrective work required to remedy its nonconforming installation.” The statute of limitations was held to run from the date the sub breached its indemnity obligation. The decision explains in some detail the broad meaning of the word “claim” and also the broad duties included in the indemnity obligations. Miller-Davis Company v. Ahrens Construction, Inc., 848 N.W. 2d 95 (Mich. 2014).
In this case the subcontract in question incorporated by reference the AIA A 201 prime contract, and a written guarantee of the subcontractor’s work on the YMCA Natatorium. It obligated the Sub to “bear costs of correcting such rejected Work… and to correct at its expense any work ‘found to be not in accordance with the Contract Documents within one year of Substantial Completion.’” After the project achieved substantial completion, the YMCA experienced excessive condensation in the natatorium due to certain construction defects including inch-wide caps in roof insulation, and many gaps and tears in the vapor barrier.
The prime contractor notified the sub that the roof system was not installed in accordance with the plans and specifications. It declared the sub in default, and demanded that it devise a corrective action plan and perform the necessary repairs. When the subcontractor failed to do the rework, it was default terminated. The prime then entered into an agreement with the YMCA to perform the corrective work. After completing that work, it sought to recover its costs from the subcontractor and its bonding company for breach of contract, and it sought indemnification and bond collection.
The Indemnification Clause
In determining whether the trial court was correct in finding the Sub liable to the Prime for over $348,000 under the indemnity agreement, the Supreme Court first explained the workings of the indemnity clause of the contract and emphasized that the state law provides contracting parties broad discretion in negotiating the scope of indemnity clauses. The only legal restriction, said the court, “is the prohibition on indemnification against the ‘sole negligence’ of the contractor, which is not at issue here.”
The language of the clause provided in relevant part as follows:
“You [subcontractor] agree to defend, hold harmless and indemnify [prime contractor] … from and against all claims, damages, losses, demands, liens, payments, suits, actions, recoveries, judgments and expenses including attorney’s fees, interest, sanctions and court costs which are made, brought, or recovered against [prime contractor], by reason of or resulting from, but not limited to, any injury, damage, loss, or occurrence arising out of or resulting from the performance or execution of this Purchase Order and caused, in whole or in party, by any act, omission, fault, negligence, or breach of the conditions of this Purchase Order by the Subcontractor….” (emphasis by court).
The question for the court was whether the “all” in the above-quoted language included the amounts that the prime contractor incurred in costs for the corrective work that the owner demanded by performed. The related question was whether the demand for corrective action constituted a “claim” within the meaning of the indemnity clause.
With regard to the word “all,” the court quoted from earlier case law, that, “there cannot be any broader classification than the word ‘all.’ In its ordinary and natural meaning, the word ‘all’ leaves no room for exceptions.”
With regard to whether the requirement to perform corrective work constituted a claim within the context of the indemnity agreement the court first pointed out that even without getting to the question of whether it was a “claim,” the indemnity clause also required indemnity for “damages, losses, demands,” or “expenses,” resulting from “any act, omission, fault, negligence, or breach” by the subcontractor.
The court also cited AIA A201, Section 4.3.1, which was incorporated into the subcontract, and defines a claim as “a demand or assertion by one of the parties seeking, as a matter of right, … relief with respect to the terms of the Contract,” as well as “other disputes and matters in question … arising out of or relating to the Contract.”
The court concluded that a straight forward reading of the negotiated Agreement for Corrective Work confirmed that the YMCA possessed a claim or demand against the prime contractor that was resolved at the contractor’s expense by this settlement agreement.
The court further concluded, “The indemnity provisions do not require Sherman Lake YMCA to prove liability or initiative a lawsuit or arbitration proceeding against [prime contractor] to seek indemnification from [subcontractor] for the corrective work it performed under the Agreement….”
Having determined that the subcontractor breached its contractual duty to indemnity the prime contractor, the court then rejected the subcontractor’s argument that the suit against it should be dismissed based on the running of the statute of limitations from the date that the original work was completed. Instead, the court concluded that the relevant breach of contract in this case was not the breach of the defective work, but rather the subsequent breach when the subcontractor refused to honor its obligations under the indemnity agreement.
Several lessons are learned from this case. It is important to carefully read and understand the significance of the wording of indemnity clauses, and to negotiate narrower obligations if that is what is intended. The clause in this case was as broad as could be legally permitted. It covered all damages even if they were caused in part by the indemnified party. It covered first and third party claims. It was not limited to wrongful acts or negligence of the subcontractor. The explanation of what constitutes a “claim” is also quite important. It is not uncommon for a party to receive a demand to take corrective action to repair damages from defective work without its client filing a formal claim or suit. They merely assert a right to corrective work and the contractor has little choice but to do it. The court recognized that the subcontract indemnification clause in such a situation entitles the prime to recover its corrective action costs from the subcontractor who performed the defective work. Recognizing that the statute of limitations does not begin to run until the subcontractor breaches its indemnity obligation may potentially allow claims to be brought long after substantial completion of the project.
About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report, Vol. 16, No. 9 (November 2014).
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