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Governor signs AB 758 outlawing 'Type 1' indemnity for residential construction defect claims

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On Sept. 29, 2005, Governor Schwarzenegger signed AB 758, which essentially bars enforcement of "Type 1" indemnity provisions in construction contracts entered into after Jan. 1, 2006 for residential construction defect claims.

The bill amends California Civil Code section 2782, rendering unenforceable indemnity provisions that require a subcontractor to indemnify a builder to the extent such provisions require the subcontractor to defend or indemnify the builder for the negligence of the builder or other contractors hired by the builder.

AB 758 outlaws Type 1 indemnity for residential construction defect claims by modifying Civil Code section 2782, which formerly prohibited indemnity provisions requiring subcontractors to indemnify builders for the sole negligence or willful liability of the builder or its other agents, or for defects in the design furnished by the builder.

The new law applies only to residential construction contracts and amendments entered into after Jan. 1, 2006. Contracts signed in 2005, even if not performed until 2006, are exempt from the new rules.

Under new Civil Code section 2782(c), indemnity clauses in construction contracts are unenforceable in construction defect claims to the extent that they require indemnity or defense costs for the negligence of the builder or the builder's other subcontractors.

This essentially wipes out Type 1 indemnity for residential construction defect claims, under which subcontractors would be liable for the builder's concurrent negligence, as well as for the negligence of other missing or uninsured subcontractors.

New section 2782(c) will apply only to residential construction projects, not to commercial projects. Section 2782(a) remains in place to apply to all other construction contracts. Only a few minor grammatical changes were made to the language of section 2782(a), making it very likely that the courts will uphold that Type 1 indemnity provisions in commercial projects.

The new statute applies only to construction defect claims. It does not, for example, apply to delay claims, B&P Code section 17200 claims, or other business damage claims. It also does not apply to personal injury claims. These exceptions may lead to application of different rules within the same case. For instance, mold claims typically involve both construction defect allegations and claims of personal injuries arising from mold exposure.

The new statute will limit indemnity only as to the defect aspect of such a lawsuit, not the personal injury claims in the same case. Builders should therefore consider having separate indemnity provisions for construction defects, and other indemnity provisions for other construction risks. Type 1 indemnity provisions remain enforceable except as to residential defect claims.

Section 2782(d) does contain some good news for builders.

First, it statutorily endorses the Presley decision on additional insured endorsements.

Second, section 2782(d) allows builders and subcontractors to agree to provisions for immediate 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)."

This provision allows a builder to require immediate defense reimbursement from involved subcontractors, so long as there is a provision for equitable reimbursement at the end of the case.

The new indemnity statute will also impact the growing trend of wrap-up insurance policies, OCIPs, and CCIPs. As an example, many such plans require subcontractors to reimburse the builder for the self-insured retention under the wrap policy, sometimes under mechanical formulae that have no direct relationship to the relative responsibility of the parties for the claims raised.

If interpreted as an indemnity obligation, such provisions may run afoul of the new statute. Subcontract and wrap-up provisions may require substantial fine-tuning to best accommodate the risk transfer issues raised by AB 758.

Residential developers and builders are encouraged to re-evaluate indemnity provisions in their subcontractor contracts. A developer is not prevented from seeking a Type I indemnity from a subcontractor for liability arising out of workers' compensation or bodily injury claims.

In addition, a developer may enter into defense cost reimbursement agreements if, upon final resolution of the claim, the agreement does not violate the proscribed indemnity.

Commencing on Jan. 1, a subcontractor can only be required to indemnify a builder for construction defects relating to the subcontractor's scope of work and performance under the construction contract, but not for any negligence of the builder and defects in design or construction that do not arise out of the scope of the subcontractor's work

Epstine is an account executive in Barney & Barney's Construction Practice. For more information call (858) 587-7182 or e-mail petere@barneyandbarney.com. This is not intended to serve as legal, tax or financial advice. You should consult with your qualified legal, tax, or financial adviser.

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