CASE ALERT—New Arizona Appellate Decision Enforces Narrow Form Indemnity Clause Against General Contractor
On November 13, 2008, the Arizona Court of Appeals issued its decision in MT Builders, LLC v. Fisher Roofing, Inc., interpreting a “narrow form” subcontract indemnity provision which reads, in part as follows: “the [Subcontractor] shall indemnify and hold harmless [General Contractor] ... from and against all claims . . . arising out of [Subcontractor’s] work . . . to the extent caused in whole or in part by any negligent act or omission of the [Subcontractor]...”. The case involved a construction defect lawsuit filed by a condominium association against MT Builders (MTB), the general contractor, and at least nineteen subcontractors, including Fisher Roofing, Inc. MTB tendered defense of the case to its subcontractors and filed cross-claims for indemnity against the subcontractors. The subcontractors declined to defend MTB. Eventually, MTB settled the association's claims. In turn, MTB then settled its claims against all of the subcontractors except Fisher, the roofing subcontractor. The trial court considered competing motions for summary judgment filed by Fisher and MTB, and ruled in MTB’s favor on the indemnity claims, establishing $240,523 as the portion of the settlement attributable to Fisher. The appeals court reversed and issued three rulings that substantially impact owners, developers, contractors and subcontractors relating to indemnity obligations on construction projects.
ENFORCEMENT OF NARROW FORM INDEMNITY CLAUSES
First and foremost, the appellate court interpreted the “narrow form” indemnity clause to mean MTB can recover from Fisher only if MTB proves at trial that its losses and expenses were caused, in whole or in part, by Fisher’s negligence, with the recovery limited to the extent of that causation. In short, a narrow form of indemnity requires a trial to determine whether the indemnifying party (Fisher) is responsible at all and, if so, the indemnified party (MTB) will be entitled to recovery for that portion of the damages incurred in connection with the lawsuit against it.
INDEMNITY FOR SETTLEMENT AMOUNTS PAID
Given that most construction defect cases are settled, the second key ruling in MT Builders was that the appeals court also required MTB to demonstrate that the amount it paid to settle the Fisher-based claims was reasonable and prudent. The court listed a matrix of factors to be considered in deciding reasonableness and prudence, including (1) the association's damages, (2) the merits of the association's liability theories, (3) the merits of MTB’s defense theories, (4) MTB’s relative fault, (5) the risks and expenses of continued litigation, (6) any evidence of bad faith, collusion or fraud, (7) the extent of the association's investigation and preparation of the case, and (8) the interests of other parties. Under MT Builders, therefore, a party seeking indemnity for settlement amounts paid must establish at trial that the settlement was prudent and reasonable using a variety of factors.
NO DUTY TO DEFEND
The third and final important indemnity ruling is that Fisher did not have a duty to defend MTB, upon a tender of defense, because the word “defend” was absent from the narrow form indemnity clause at issue. The court found that the “to the extent” language precluded a duty to defend when the duty is not expressly provided because Fisher did not have an obligation to indemnify at all until a determination was made about the extent of Fisher’s fault. The court also suggested that the “to the extent” language in the indemnity may render even an express defense obligation unenforceable because the defense obligation could only arise after liability is established and that would be too late in the proceedings to be a meaningful defense. Practically speaking, that ruling means reimbursement of defense costs from the indemnifying party under narrow form indemnity clauses will not occur until the indemnifying party’s fault has been determined, with that degree of fault applied proportionally for reimbursement of the indemnified party’s attorneys’ fees, legal costs and other expenses.
LESSONS TO BE LEARNED
Contractors, owners and developers negotiating contracts should be aware that under the MT Builders decision, the practical effects of narrow form indemnity clauses, which limit a party’s indemnity obligations “to the extent” of fault caused by the indemnifying party, will be to require a trial determination of fault as a prerequisite to indemnity from the indemnifying party. Contract negotiators concerned about reducing the potential for litigation triggered to enforce an indemnity may wish to consider alternative, broader forms of indemnification consistent with applicable law. Further, before finalizing a settlement with a claimant, contractors, owners and/or developers who intend to seek indemnity under a narrow form indemnity clause with the requisite “to the extent” language must be careful to address and, perhaps, document during the settlement process the various factors under MT Builders relating to the reasonableness of a settlement. Additionally, MT Builders demonstrates the importance of including appropriate “defense” language in indemnity clauses, and the need to consider how an express defense obligation may be enforced if the indemnifying party’s obligations only arise after its liability is established. Finally, note that this decision relates to an indemnity clause that by its terms provided indemnity for “negligence” based claims only. Whether these principles apply to indemnification for damages resulting from the kinds of claims not addressed in the decision, such as contract breaches, remains to be seen.
Posted by Jeffrey Steffen at 9:04 AM |
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Categories: Construction