Hot Rods, LLC, v. Northrop Grumman Systems Corporation
November 6, 2015
WHY THIS CASE IS IMPORTANT
Indemnity clauses are a standard provision in nearly all consumer and commercial contracts. How the courts interpret the language of an indemnity clause will either substantially limit or broaden a party's liability and exposure. This case is important to anyone who is drafting or litigating indemnification provisions in a contract and demonstrates how important every word in an indemnity provision is when claims eventually arise.
An indemnity provision which includes coverage for "any claims" will include not only third party claims, but also first party claims between the parties to the contract (e.g., claims by the indemnitee against the indemnitor for the indemnitee's losses.) While indemnity provisions typically apply to third party claims, this general rule does not apply if the parties' contract encompasses direct or first party claims. Thus, whether an indemnity provision covers first party claims will depend upon the language of the provision itself.
Northrop owned property in Anaheim, California, which it utilized to manufacture floor beams for Boeing. The manufacturing facility closed its doors in the mid-1990's. In 1995, Northrop sought closure of the site from the Regional Water Quality Control Board (the Board).
In mid-1995, Northrop began discussing a deal with Dan Welden to sell the property. On December 1, 1995, Northrop executed a purchase and sale agreement, for $3.5 million, selling the property to Welden and his wife. At some point thereafter, Welden and his wife assigned their rights to Hot Rods, LLC, which they owned in its entirety.
Section 16.2 of the purchase and sale agreement specifically stated as follows:
"With respect to the Seller's ownership and/or operation of the Real Property including the acts and omissions of Seller's employees, agents or contractors before or after the Closing, Seller hereby agrees to indemnify, defend by legal counsel selected and retained by Seller, and reasonably approved by Buyer, and hold the Buyer and the Buyer's lenders…harmless from and against any claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses including, without limitation, reasonable environmental consulting fees and reasonable attorney fees arising out of (a) any Environmental Action(s) and/or Remediation involving an environmental condition or liability involving the Real Property caused by an act or omission of Seller and its employees, agents and contractors before or after the Closing; (b) any personal injury (including wrongful death) or property damage (real or personal) arising out of Hazardous Materials used, handled, generated, transported, disposed, or released by Seller and its employees, agents and contractors at the Real Property before or after the Closing. This Environmental Indemnity is in addition to any rights or remedies of Buyer and Seller under section 3.3."
In November 1996, Northrop removed an underground storage tank discovered on the property at Hot Rods' request through a letter specifically demanding Northrop "comply with its environmental indemnification obligations."
In November 2003, the Board issued a Cleanup and Abatement Order requiring Northrop to remediate the groundwater located at the property; the Board subsequently approved Northrop's plan to do so. While work was being done on the property to effectuate the remediation, Welden complained he was subject to substantial inconvenience as a result of the remediation. He claimed there were wells, odors, parking spots taken up by the equipment, blocked access, and pollution generated by equipment, among other things. At some point, evacuation was required for several days because damage to the building occurred.
While Northrop reimbursed Hot Rods on approximately thirty (30) separate occasions for expenses related to the environment between 1995 and 2008, a dispute arose between the two parties when Hot Rods claimed loss of rental payments due to Hot Rods' tenants delaying a lease as a result of the remediation occurring at the property.
Hot Rods filed a complaint against Northrop in April 2009, which it amended in June 2011. Pursuant to the Purchase and Sale agreement, Northrop and Hot Rods stipulated to have a referee hear the case. Northrop contended that the above indemnity provision applies solely to third party claims, and did not give Hot Rods the right to sue for its own first party damages under an indemnity theory. In contrast, Hot Rods argued the indemnity provision applied to both third party and direct claims by Hot Rods because the provision covered "any claims".
The referee issued a statement of decision in favor of Hot Rods, awarding it over $3 million. The court entered judgment in January 2014 pursuant to the referee's decision. Northrop appealed this decision.
The Court of Appeal began by noting that, while indemnity provisions typically refer to third party claims, indemnity provisions can include direct claims if the parties intended it to based on the language in the contract. Therefore, this is a matter of basic contractual interpretation.
The Court also expressly disavowed Northrop's claim that for an indemnity clause to encompass direct claims in addition to third party claims, the clause must have express language stating such; the Court instead emphasized that the intent of the indemnity provision and the agreement as a whole controls.
In its interpretation of the Northrop-Hot Rods contract, the Court first addressed the actual language of the indemnity provision. It stated that this particular indemnity provision was quite broad, emphasizing that it included "any claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses including, without limitation, reasonable environmental consulting fees and reasonable attorney fees." The Court then went on to note that the contract itself defined "Claim" to include "a claim or demand by any Person" and defined "Person" as "any person, employee, individual, corporation, unincorporated association, partnership, trust, federal, state, or local government agency, authority or other private or public entity." The Court reasoned because the Northrop-Hot Rods contract defined "Claim" and "Person" so broadly, the contract's indemnity provision covered third party claims as well as first party claims.
Additionally, the Court explained that it does not make sense for the indemnity provision to cover only third party claims because if that were the case, the words "damages, costs, losses" would be duplicative; it noted that courts interpret contracts to avoid surplus language and that these specific words suggest the provision was not limited to third party claims. Finally, the Court pointed out there was no language limiting the liability to third party claims in the indemnification provision.
Thus, in light of the overall intent of the agreement and the terms of the indemnity provision itself, the Court found that the indemnity provision in the Northrop-Hot Rods agreement covered both first and third party claims.
Because the Court addressed indemnity clauses broadly, this case extends far beyond the environmental concerns that gave rise to the underlying claim. While drafting clear and specific indemnity language has always been vital to protect a client's interests, this case emphasizes the need to have broad and express language in such clauses. Certainly, the best practice is to expressly include both direct and third party claim language in an indemnity provision to avoid having the battle in the first place.