On October 9, 2011, California Governor Jerry Brown signed Senate Bill 474 into law, which significantly impacts commercial and public construction contracts in California. SB 474 amended California Civil Code Sections 2782 and 2783 and, most notably, added Section 2782.05 to the California Civil Code.
Civil Code § 2782.05 provides three specific provisions that will directly impact a general contractor's and a public entity's contractual rights in commercial or public construction contracts executed on or after January 1, 2013, as follows:
1) Civil Code § 2782.05 will prohibit the use of Type I indemnity agreements by general contractors, construction managers and public entities;
2) Civil Code § 2782.05 will require that California law be applied to all commercial and public construction contracts regardless of choice of law provisions that might otherwise apply; and
3) Civil Code § 2782.05 will prohibit additional insured endorsement coverage for the prohibited Type I indemnity.
TYPE I INDEMNITY PROHIBITED
Civil Code § 2782.05 dramatically changes the traditional model of commercial contracts, freedom of contract and risk-shifting among the parties to construction contracts in California, and it applies broadly to all private, public, and commercial contracts. The introductory language, setting forth the Legislative intent behind the statute, states as follows:
"The Legislature finds and declares that it is in the best interests of this state and its citizens and consumers to ensure that every construction business in the state is responsible for losses that it, as a business, may cause."
The pertinent language of the new code section (Civil Code § 2782.05) states:
". . .agreements contained in, collateral to, or affecting any construction contract and amendments thereto entered into on or after January 1, 2013, that purport to insure or indemnify, including the cost to defend, a general contractor, construction manager, or other subcontractor. . .are void and unenforceable to the extent the claims arise out of, pertain to, or relate to the active negligence or willful misconduct of that general contractor..." (Emphasis added.)
This statute seeks to apply comparative fault principles to construction contracts in an effort make all parties responsible for their own conduct. This will result in a significant impact upon a general contractor's burden of proof and ability to support a claim for defense and indemnification. Under traditional Type I indemnity provisions, the indemnity provision would require the subcontractor to defend and indemnify the general contractor for not only the subcontractor's own negligence, but also for the general contractor's negligence. Civil Code § 2782.05 will now limit the subcontractor's defense and indemnity obligations to its proportionate share of fault. For example, if a general contractor can only establish that a given subcontractor was 1% at fault for damages related to a given claim, the subcontractor is only obligated to fund 1% of the general contractor's defense and indemnification. Moreover, if the general contractor is found to have been actively negligent, it will be precluded from receiving any defense or indemnification.
Through Civil Code § 2782.05, the Legislature has extended the reach of California Civil Code § 2782, which similarly precluded the use of Type I indemnity provisions in residential construction contracts. Civil Code § 2782.05 was crafted in direct response to heavy lobbying from subcontractor groups after the California Supreme Court's recent decision in Crawford v. Weather Shield Mfg., Inc. (2008) 44 Cal.4th 541, where the high court held that a subcontractor had a duty to defend a general contractor from the outset of the litigation pursuant to a Type I indemnity agreement, regardless of whether it is ultimately determined that the subcontractor is negligent.
The silver lining in Civil Code § 2782.05 for general contractors is that the prohibition on Type I indemnity applies only to the general contractor's "active negligence" and leaves open the door for general contractors to retain the right to defense and indemnification for the general contractor's "passive negligence".
The law also expressly states that it has no impact on a general contractor's right to equitable indemnity.
THE DISTINCTION BETWEEN "ACTIVE" AND "PASSIVE" NEGLIGENCE
Given the language used in Civil Code § 2782.05, understanding the distinctions between "active" and "passive" negligence is essential to evaluating future liability exposure for all construction contracts starting January 1, 2013. The Supreme Court of California has described the distinction as follows:
"Passive negligence is found in mere nonfeasance, such as the failure to discover a dangerous condition or to perform a duty imposed by law. Active negligence, on the other hand, is found if an indemnitee has personally participated in an affirmative act of negligence, was connected with negligent acts or omissions by knowledge or acquiescence, or has failed to perform a precise duty which the indemnitee had agreed to perform. 'The crux of the inquiry is to determine whether there is participation in some manner by the person seeking indemnity in the conduct or omission which caused the injury beyond the mere failure to perform a duty imposed upon him by law.'" Rossmoor Sanitation, Inc. v. Pylon, Inc. (1975) 13 Cal. 3d 622, 629.
This concept is more easily explained by way of example. In Rossmoor, an owner of real property (Rossmoor) employed a contractor (Pylon) to construct a sewage pump station and sewer lines. Pylon agreed to indemnify Rossmoor against all claims for damages arising out of the work and for attorney's fees and costs which might be incurred in the event of suit. According to the construction plan, two parallel trenches were to be dug for the installation of sewer pipes. Shortly after the excavation of both trenches, two Pylon employees entered the trench to work. Although shoring material was available, the employees proceeded into the trench without shoring it because it was easier and faster than waiting for supports to be installed. Unfortunately, the trench caved in, killing one worker and injuring another. The surviving worker and the heirs of the deceased worker brought suit against Rossmoor (the owner) for personal injury and wrongful death and recovered a sizable verdict. Rossmoor then sought indemnity from Pylon for the amount of the judgment. A significant issue raised at trial was whether Rossmoor, the party seeking indemnification, was actively or passively negligent.
Pylon, the contractor, argued that Rossmoor was actively negligent because Rossmoor hired the party who prepared the excavation plans, participated in preparing the plans, had numerous safety personnel present at the project, and should have known that the existence of parallel trenches created an unsafe condition. Rossmoor countered that it was not actively negligent because it was Pylon's failure to shore the trench in violation of state safety laws which was the cause of the accident, and at most, it was only passively negligent. Ultimately, the Court agreed with Rossmoor and concluded that the contractor was actively negligent, while the Rossmoor was only passively negligent. As a result, Pylon owed Rossmoor indemnity.
The Supreme Court of California, in discussing the active vs. passive dichotomy, noted the following case examples:
"Passive negligence has been found or assumed from [a party's] failure to discover a defective condition created by others (Markley v. Beagle, 66 Cal. 2d 951(1967)), failure to exercise a right to inspect certain work and specify changes (Muth v. Urricelqui, 251 Cal.App.2d 901 (1967)), and failure to exercise a supervisory right to order removal of defective material (Safeway Stores, Inc. v. Massachusetts Bonding & Ins. Co., 202 Cal.App.2d 99 (1962)). Active negligence [on the other hand] has been found in [cases where a party participated in] digging a hole which later caused an injury (Morgan v. Stubblefield, 6 Cal. 3d 606 (1972)), knowingly suppl[ied] a scaffold which did not meet the requirements of a safety order (id.), creat[ed] a perilous condition that resulted in an explosion (Burlingame Motor Co. v. Peninsula Activities, Inc., 15 Cal. App. 3d 656 (1971)), and fail[ed] to install safety nets in violation of a contract[ual provision] (MacDonald & Kruse, Inc. v. San Jose Steel Co., 29 Cal. App. 3d 413 (1972))." Rossmoor, 13 Cal. 3d at 630.
Although the question of whether a party's negligence is "active" or "passive" is ordinarily a question of fact for a jury, understanding and evaluating the distinction as early as possible will be critical for all parties going forward in understanding their potential risk exposure and setting the stage for law and motion to address the issue.
CALIFORNIA LAW WILL BE APPLIED
Civil Code § 2782.05 provides that if the property on which the construction is performed is located in California, then California law will apply regardless of any choice-of-law provision or place of execution of the contract. This type of choice-of-law mandate is similarly provided in multiple states and seeks to preclude a party with superior bargaining power from selecting the law of the state most favorable to its position. In essence, if you want to participate in construction in California, you must be bound by its laws.
While the Legislature addressed the choice-of-law issue, Civil Code § 2782.05 is silent with respect to forum selection. Therefore, while Civil Code § 2782.05 may require the application of California law, it appears the parties are free to negotiate the location of the forum.
ADDITIONAL INSURED COVERAGE IS LIMITED TO PROPORTION OF FAULT
Civil Code § 2782.05 precludes full defense and indemnity from any additional insured carrier. Alternatively, the additional insured carrier's defense obligations will likely be limited to the named insured's actual fault. The question remains, however, if the fault must be proven before the defense obligation is triggered. We will likely see a great deal of litigation on the coverage front with this new law.
THE IMPACT OF CALIFORNIA CIVIL CODE § 2782.05
California Civil Code § 2782.05 reflects the nationwide trend in construction contracts for all parties to bear responsibility for their own fault. These so-called "Anti-Indemnity Statutes" like section 2782.05 exist in a majority of states and many of these statutes have been passed in recent years. While the typical anti-indemnity statute bars a general contractor from recovery of defense and indemnification for "any fault" of the general contractor, California's anti-indemnity statute still allows for defense and indemnification for passive negligence. Consequently, it is expected that the legal battles to come from Civil Code § 2782.05 will focus sharply on the conduct of the general contractor and a determination whether the general contractor was actively or passively negligent.
While subcontractor groups are applauding the enactment of Civil Code § 2782.05, general contractors are lamenting Governor Brown's passage of the statute. General contractors who seek to retain their defense and indemnity obligation will then attempt to be only "passively" involved in construction projects, to "passively" supervise the work of their subcontractors, and to generally take a "passive" approach to the management of construction projects, to the detriment of all parties, the fear being that if the general contractor becomes too actively involved, it risks losing all defense and indemnification rights.
The impact of Civil Code § 2782.05 will be felt across California and throughout all commercial and public construction. While design professionals had previously secured a similar ban (Civil Code § 2782.8), subcontractors now have the same protections. Inevitably, the enactment of Civil Code § 2782.05 will expose general contractors to more risk, liability and costs, which will increase the overall cost of construction in California. General contractors will now be forced to redraft their defense and indemnity provisions to comply with Civil Code § 2782.05. As was done after the passage of Civil Code § 2782, the attorneys at Wood, Smith, Henning & Berman LLP are currently assisting clients with the preparation of contracts that comply with this new legislation.