Inside this Issue

A1 - Subcontractor Owed Prime No Indemnity Obligation and Additional Insured Status Availed Nothing
A2 - Design Professional Owes Duty to Third Party Condominium Unit Purchasers
A3 - Unlicensed Subcontractor Cannot Recover against Contractor Even if Contractor Knew Sub was Unlicensed When Executing the Contract

Article 1

Subcontractor Owed Prime No Indemnity Obligation and Additional Insured Status Availed Nothing

See similar articles: Additional Insured | Anti-Indemnity Statute | duty to defend | Indemnification clause

Although a subcontractor damaged a sewer pipeline during the course of construction, it owed no indemnification duty to the prime contractor for expenses the prime incurred in repairing the pipe. The key reason given by the court was that a jury found that the sub was not negligent, and the Minnesota anti-indemnification statute prohibits indemnification except to the extent damages are caused by the indemnitor’s negligence. Nor did the sub’s insurance carrier owe the prime coverage for the damages as an additional insured. This was because the additional insured endorsement provided coverage only to the extent of vicarious liability of the prime contractor for the subcontractor’s fault. Having determined that the subcontractor was not at fault, the court found no liability resulted to the prime contractor that could be subject to additional insured coverage. Engineering & Construction Innovations, Inc. v. LH Bolduc, 825 NW 2d 695 (Minn. 2013).

The facts considered by the court were as follows: The prime contractor repaired the damaged pipeline and sought reimbursement from Travelers Insurance, the sub’s carrier who had issued an additional insured endorsement for the benefit of the prime. The endorsement named the prime as an additional insured for liability “caused by acts or omissions” of the named insured, subcontractor. Travelers denied coverage. The prime then sued the Sub.

A jury found the Sub was not negligent and awarded the prime zero damages. Following the jury trial the district court granted summary judgment in favor of Travelers and the Sub on breach of contract claims, concluding that Travelers and the Sub had no obligation to reimburse the Prime for damages not caused by negligence of the Sub. This was reversed by an intermediate appellate court but reinstated by the Minnesota Supreme Court.

On the project in question, the project owner hired Frontier Pipeline, Inc as its general contractor involving installation of an underground sewer pipeline. Frontier subcontracted with Engineering and Construction Innovations (ECI) to install a lift station and force main access structures. ECI further subcontracted with Bolduc (referred to throughout his article as “Sub” or “Subcontractor”) to build cofferdams over the pipeline at six locations by driving metal sheeting into the ground to act as walls for the pit during excavation and construction. Per the subcontract, the Sub was to drive the sheets “per ECI location.” Consequently, the Sub was not responsible for determining where to drive the cofferdams.

The Sub’s indemnity clause stated it would defend and indemnify ECI against claims and damages “caused or alleged to have been caused by any act or omission of Sub....” The Sub’s general liability insurance policy from Travelers was endorsed to make ECI an additional insured “If, and only to the extent that, the injury or damage is caused by acts or omissions of you or your subcontractor in the performance of ‘your work’” to which the “written contract requiring insurance” applies. The person or organization does not qualify as an additional insured with respect to the independent acts or omission of such person or organization.

The clause of the contract provided as follows:

“[Bolduc] agrees to protect, indemnify, defend, and hold harmless ECI and Owner, to the fullest extent permitted by law and to the extent of the insurance requirements below, from and against (a) all claims, causes of action, liabilities, obligations, demands, costs, and expenses arising out of injury to any persons or damages to property caused or alleged to have been caused by any act or omission of [Bolduc], its agents, employees or invitees, and (b) all damage, judgments, expenses, and attorney's fees caused by any act or omission of [Bolduc] or anyone who performs work or services in the prosecution of the Subcontract. [Bolduc] shall defend any and all suits brought against ECI or Owner on account of any such liability or claims of liability. [Bolduc] agrees to procure and carry until the completion of the Subcontract, worker's compensation and such other insurance that specifically covers the indemnity obligations under this paragraph, from an insurance carrier which ECI finds financially sound and acceptable, and to name ECI as an additional insured on said policies.

....

[Bolduc] agrees to obtain, maintain and pay for such insurance coverage and endorsements as will insure the indemnity provisions and coverage limits above and to furnish ECI certificates of insurance evidencing the aforementioned coverage.”

No Indemnification Duty Owed by Subcontractor

The Minnesota anti-indemnity statute provides:

“An indemnification agreement contained in, or executed in connection with, a building and construction contract is unenforceable except to the extent that: (1) the underlying injury or damage is attributable to the negligent or otherwise wrongful act or omission, including breach of a specific contractual duty, of the promisor or the promisor's independent contractors, agents, employees, or delegatees[.]”

The court found that “the damage to the pipeline was not due to Bolduc’s negligence, wrongful act, or breach of a specific contractual duty”. The Prime argued that even if the Sub was not negligent, the indemnity clause was not limited to negligent acts, errors and omissions but was broad enough to encompass all acts of the Sub. It argued that in hitting the pipeline, the Sub breached its obligation to perform its work “efficiently, properly and promptly,” and by failing to pay for the repairs, breached its agreement to bear “complete responsibility’ for its work.

The court found that the Prime presented no evidence that the Sub breached the subcontract in performing its work despite having hit the pipeline with the sheeting while installing the sheets. The jury’s finding of no negligence constituted a finding that the Sub was not in breach of its contract. According to the court, “the negligence and breach of contract for performance of work claims both arose out of the same duty; therefore, the jury’s determination on the negligence issue allowed the district court to properly determine that there was no evidence to find Bolduc in breach of its performance of work obligations.”

Because the court found the Sub was “not at fault for the pipeline damage” any obligation to indemnify the Prime that was not accompanied by a coextensive insurance agreement would violate the anti-indemnity statue.

Additional Insured Analysis

The language of the additional insured endorsement provided that ECI is an addition insured under the policy as follows:

“a) Only with respect to liability for ‘bodily injury’, ‘property damage’ or ‘personal injury’; and

b) If, and only to the extent that, the injury or damage is caused by acts or omissions of you or your subcontractor in the performance of ‘your work’ to which the ‘written contract requiring insurance’ applies. The person or organization does not qualify as an additional insured with respect to the independent acts or omissions of [ECI].”

In reviewing this additional insured language, the state Supreme Court stated that the language “caused by the acts or omissions of [Bolduc]” provided coverage to ECI as an additional insured “only in instances of ECI’s vicarious liability for Bolduc’s negligent acts or omissions.” Therefore, unless ECI had liability for property damage it would not be entitled to coverage. And the court found it had no such vicarious liability, since a jury had found the Subcontractor itself not negligent. Consequently, Travelers owed ECI no duty under the policy. Even if the indemnity agreement were deemed to have created contractual liability, the court held that the policy would not cover it since the contractual liability exclusion of the policy bars coverage arising out of indemnity clauses except to the extent of tort liability assumed by the indemnitor.

The court reasoned that tort liability is defined under the policy as “a liability that would be imposed by law in the absence of any contract or agreement” and, therefore, “damages resulting from other contractual liabilities –including ECI’s possible assumption of liability in its contract with Frontier for Bolduc’s breach of the subcontract—are plainly excluded from coverage under the policy.”

Comment: The reasoning of the court in this decision, particularly with regard to equating “acts and omissions” with “negligence” is not necessarily followed in other jurisdictions. The court itself acknowledged that other courts have found additional insured provisions similar to the one here to be ambiguous and therefore to be interpreted against the insurance company to, therefore, provide coverage to the additional insured. One lesson to be learned from this decision is the importance of understanding how the applicable anti-indemnity statutes will be interpreted and applied to the language of an indemnification clause.

If it is known the court is going to limit indemnification provisions that contain what appears to be broad language such as “acts and omissions” so that it applies only to “negligent acts,” perhaps an indemnitee such as a subcontractor need not worry quite so much about agreeing to what we normally consider onerous language. On the other hand, do you really want to litigate through trial, intermediate appellate court and state Supreme Court to find out what the clause means? Why not just use plain English to restrict the indemnification to damages to the extent caused by the indemnitee’s negligence and avoid all the uncertainty and litigation?

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. 15, No. 5 (May 2013).

Article 2

Design Professional Owes Duty to Third Party Condominium Unit Purchasers

See similar articles: Economic Loss | Residential liability | Risk Allocation | Third Party Beneficiaries

A design professional has been held to owe a third party condominium unit purchaser a duty of care in the performance of its professional services for the developer despite language in the design professional contract stating otherwise. The court relied on both the common law as well as California Civil Code section 1368.3 (a) for the proposition that if a design professional performs its services negligently, it will be liable for damages to the ultimate purchasers of residential property. Beacon Residential Community Association v. Skidmore, Owings and Merrill, 3211 Cal.App.4^th 1301 (2012). In reaching its decision, the court acknowledged that the “rule of liability may negatively impact the cost of housing” and that “Liability concerns may also limit the willingness of design professional to undertake large residential construction projects at all.”

[Author’s comment] It’s good to see the court’s candid observation about the negative impact on housing and the willingness of design professionals to undertake residential construction projects. Particularly with regard to condominium projects, it may seem like the almost-inevitable claims by the condo association and unit purchasers would make these projects too risky for designers and their insurance carriers. I sometimes compare it to insuring a burning building. How do you price professional services when you know there is nothing you can do by contract to limit who can file a claim, when a claim can be filed, or to otherwise limit liability. And how can an insurance carrier underwrite insurance for services on these projects when it is almost a sure thing that claims will be filed against the insured design professional? Risk Management 101 admonishes us to wisely select our clients and projects, and then to appropriately allocate and reduce risk. Good luck with that when choosing to design condominium projects in California.

Duty of Care to Future Residents

Skidmore, Owings & Merrill LLP (SOM) and HKS Architects provided architectural and engineering services, as well as construction administration and construction management for the Beacon Residential Condominiums. The homeowners’ association that manages the Project sued them and others for alleged construction defects. The theory of the association complaint was that the design professionals had a duty of care to the association and future residents when designing the project and that their professional negligence caused the project to violate residential construction standards established in state Senate Bill No. 800.

One of the key defects alleged is “solar heat gain,” whereby the plaintiffs alleged that “the condominium units are rendered uninhabitable, unhealthy, and unsafe during certain periods due to excessively high temperatures.” The plaintiff further avers that the solar heat gain resulted from the designer’s approval “of the substitution of less expensive, and ultimately nonfunctional, windows,” as well as a design lacking adequate ventilation within the residential units.

The trial court dismissed the complaint against the designers because it found they owed no duty of care to the association or its members and could therefore not be liable. The court concluded that that the association had to show that the designers had “control” in the construction process and assumed a role beyond that of providing design recommendations to the owner. No allegations of such control were made. Moreover, the trial court found that “Even if [the designers] initiated the substitutions, changes, and other elements of design that [the association] alleges to be the caused of serious defects, so long as the final decision rested with the owner, there is no duty by [the designers] to the future condominum owners….” [Author’s Note: The reasoning of the trial court is consistent with court decisions in many (probably the majority) of states. The subsequent reasoning of the appellate court is not followed in as many states].

In reversing the trial court, the California Court of Appeal applied a series of balancing factors for rendering a determination of whether in a specific case the defendant will be held liable to a third person with whom it is not in privity of contract. As explained by the court, the factors to be considered include “the extent to which the transaction was intended to affect the plaintiff, the foreseeability of harm to him, the degree of certainty that the plaintiff suffered injury, the closeness of the connection between the defendant's conduct and the injury suffered, the moral blame attached to the defendant's conduct, and the policy of preventing future harm.” (Citing Biakanja v. Irving, 49 Cal.2d 647.)

In a devastating rejection of the parties’ contractual intent with regard to avoiding any responsibly to third party beneficiaries, the court stated the following:

“In this case, Respondents attempted to limit their liability by providing in the HKS contract with the developer that: ‘Except as set forth in this section 12.1, or as expressly agreed in writing by Architect and Owner, no person other than the parties or their successors and assigns shall be a third-party beneficiary of the obligation contained in the Agreement or have the right to enforce any of its provisions. It is understood that (i) Owner reserves the right to sell portions of the Project to one or more condominium associations or purchasers during or after the conclusion of the Project; (ii) Architect is solely responsible to Owner and not to such condominium associations or purchasers for performance or Architect's obligations under this Agreement; and (iii) no such condominium association or purchaser shall be a third-party beneficiary or third-party obligee with respect to the Architect's obligations under this Agreement.’ This intended limitation, however, only serves to emphasize the fact that Respondents were more than well aware that future homeowners would necessarily be affected by the work that they performed. And, in any event, liability to foreseeable residential purchasers is determined by the scope of the duty of professional care, not whether those purchasers are, or are not, third party beneficiaries under contract. While a duty of care arising from contract may perhaps be contractually limited, a duty of care imposed by law cannot simply be disclaimed.”

Having found the contract language to be ineffectual at eliminating third party rights, the court reviewed the Biakanja factors described above and found nothing in those factors that would preclude imposition of liability upon the design professionals of residential construction for alleged negligence in the rendition of professional services.

Next, the court said that a purchaser of residential housing “is certainly more fairly characterized as a ‘consumer’ and residential housing as a ‘product,’ and numerous cases have done so.” As a result, said the court, “While the individuals and entities participating in the development process may have the ability to privately order allocation of liability among themselves by contract or through structuring of insurance overage, the buyer does not.”

The court concluded that even if the design professionals had not been found subject to liability under common law, they would nevertheless be subject to suit by the homeowners pursuant to statutory law. As explained by the court,

“The plain language of Senate Bill No. 800 provides that a design professional who “as the result of a negligent act or omission” causes, in whole or in part, a violation of the standards set forth in section 896 for residential housing may be liable to the ultimate purchasers for damages. The legislative history confirms the legislature's intent. In construing a statute, our general goal must always be to effectuate the legislative intent. To the extent that a Biakanja/ Bily policy analysis is not otherwise dispositive of the scope of duty owed by design professionals to a homeowner/buyer, Senate Bill No. 800 is.”

Based on this reasoning, the court reversed the trial court. The case will now proceed to trial for a jury to determine whether the design professionals breached the duty of care that the appellate court concluded they owed to the plaintiffs.

Comment

This case is just one more example of the difficult legal climate in California for design professionals. When contrasted with decisions in other states, we see how important a role legislative and judicial philosophy plays in the outcome.

Article 3

Unlicensed Subcontractor Cannot Recover against Contractor Even if Contractor Knew Sub was Unlicensed When Executing the Contract

See similar articles: In Pari Delicto | License | Licensing

Where a subcontractor lacked a contractor’s license, the Supreme Court of Florida held that pursuant to state statute the contract was unenforceable by the unlicensed contractor. This meant that the prime contractor could not be liable to the Sub for breach of contract. The Subcontractor argued that the prime contractor was equally at fault for entering into the contract while knowing the Sub was not licensed, and that that the common law defense of in pari delicto should be applied to prohibit the Prime from refusing to honor the contract. That defense refers to “the principle that a plaintiff who has participated in wrongdoing may not recover damages resulting form the wrongdoing.” That defense theory was rejected by the court because even if the plaintiff and defendant were both wrongdoers, the court stated the defense only applies if the parties participated in the same wrongdoing and with comparatively equal fault. Here, the wrongdoing of the Sub was paramount. In reaching that conclusion, the court cited the state statute that imposed substantial penalties on an unlicensed contractor – including forfeiting the rights or remedies of enforcement of the contract. Although the state could impose a $5,000 fine on the Prime for having hired an unlicensed contractor, the potential penalties on the unlicensed Sub are far more extreme, including a $10,000 fine and a first-degree misdemeanor for the first offense, and a third-degree felony for a second offense. For these reasons, the court held the in pari delicto defense was not available to the unlicensed Subcontractor. Earth Trades Inc. v. T & G Corp., 2013 WL 264440 (Fla. 2013).

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ConstructionRisk.com Report (May2013)