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Construction

Indemnity Agreements Requiring Designers to Indemnify Public Entities for more than their Share of Negligence are Declared Unenforceable

October 2006

On September 25, 2006, Governor Arnold Schwarzenegger signed a new bill that will have significant implications on public works projects starting next year. The bill, Assembly Bill (“AB”) 573, generally provides that in their contracts with design professionals, public entities cannot include certain indemnity provisions which require the design professional to indemnify the public entity for anything other than the design professional's own negligence, recklessness, or willful misconduct.

AB 573, which was authored by Assembly Member Lois Wolk (D – Vacaville), passed unanimously in both the California State Assembly (78-0 vote) and the California State Senate (37-0 vote). Given the unanimous and bi-partisan approval in both the Assembly and the Senate, it is certainly not surprising that Governor Schwarzenegger signed the bill into law.

Sponsored by the Consulting Engineers and Land Surveyors of California (CELSOC), AB 573 provides that: "[f]or all contracts, and amendments thereto, entered into on or after January 1, 2007, with a public agency for design professional services, all provisions, clauses, covenants, and agreements contained in, collateral to, or affecting any such contract, and amendments thereto, that purport to indemnify, including the cost to defend, the public agency by a design professional against liability for claims against the public agency, are unenforceable, except for claims that arise out of, pertain to, or relate to the negligence, recklessness, or willful misconduct of the design professional." The bill defines "design professional" to include licensed architects, registered professional engineers, licensed professional land surveyors and landscape architects, all as defined under current law. The bill defines public agency as "any county, city, city and county, district, school district, public authority, municipal corporation, or other political subdivision, joint powers authority, or public corporation in the state" except for the State of California.

This bill constitutes a resounding victory for design professionals in California by offering them a layer of statutory protection within the contracts that public entities often require design professionals sign in order to do the highly coveted business with that entity. In the past these agreements have often contained non-negotiable indemnity provisions requiring the architect or engineer to indemnify the public entity for damages arising out of the public entity's negligence (often called “Type I” indemnity.) Indemnity provisions (or “hold harmless” clauses) are provisions in contracts in which one party to the contract (the “indemnitor” or “promisor”) agrees to pay the damages and costs incurred by the other party to the contract (the “indemnitee” or “promissee”) as a result of the indemnitee being held liable to, or having to defend against, a claim filed by a third party. “Type I” indemnity provisions require that the design professional defend and indemnify the public entity for not only anything arising out of the design professional's work, but also for the active or passive negligence of the public entity itself. “Type II” indemnity provisions in favor of public entities are similar to “Type I” clauses except they do not apply to the active negligence of the public entity. Under AB 573 both types of indemnity are unenforceable on public projects.

Representatives of local government entities opposed AB 573, arguing that the bill would limit the flexibility of public agencies to negotiate design service contracts to reflect the particular risks of the engagement. They also argued that the safeguards presently in place, requiring the public entity to disclose all indemnity and hold harmless provisions in requests for proposals and invitations to bid, already provide sufficient advance notice to design professionals such that the transfer of risk can be included in the bids and proposals. Lastly, public entities argued that AB 573 will increase defense costs, burden taxpayers, and result in more protracted litigation involving the public entity. The Legislature, in its unanimous approval of AB 573, found these arguments unavailing.

AB 573 continues a California legislative trend towards the elimination of “Type I” indemnity agreements. AB 573 protects those with less bargaining power and the historically smaller players in the construction industry from signing contracts which expand that party's litigation exposure beyond its proportional share of liability. A similar bill, AB 758 by Assembly Member Ron Calderon (D – Montebello), was enacted last year that provides similar protections to subcontractors vis-à-vis home builders. AB 758 declares unenforceable those indemnification agreements in residential construction contracts between builders and subcontractors that purport to make subcontractors liable for the negligent acts of others. As a result, parties to a residential construction defect dispute are held legally and financially responsible only for their own respective fault. In other words, AB 758 mandates that a builder cannot contractually require a subcontractor to assume the builder's share of liability, and all parties are ultimately liable for their own work.

Under the current law (before AB 573 takes effect), whenever a public entity finds itself in litigation where the issues even remotely implicate the design of a particular building or structure, the public entity has the option of tendering the defense of the claim to its design professionals pursuant to the “Type I” indemnity provision in the public entity/design professional contract. These provisions allow the public indemnity to be defended and indemnified if the claims and damages alleged arose out of the design professional's work on the project. A finding of negligence by the design professional is not a prerequisite. Many indemnity provisions are so comprehensive and all encompassing, they can make the design professional responsible for any liability connected with the performance of the contract even if they did nothing wrong.

AB 573 certainly offers a level of risk avoidance that architects and engineers have traditionally not enjoyed on public works projects. Public entities are capable of offering a large volume of work to design firms and they consequently enjoy a significant amount of bargaining power. Historically, if a design professional has been unwilling to offer the substantial defense and indemnity rights typically contained in the standard design contract offered by some public entities, then the public entity would not have a difficult time finding a design professional that would agree to sign the contract.

One factor which played a significant part in the genesis of AB 573 is the current insurance climate in California. Insurance companies are taking steps to ensure that coverage is not afforded for extra-contractual risks that may exceed liability, and premiums are high and still on the rise. As a result, professional liability carriers have taken a harder line by challenging coverage for its design professional insureds that contractually agree to more liability than that proximately resulting from their actual negligence. Design professionals have thus found that any damages they are found liable for at trial above and beyond that caused by their negligence may not be covered under their professional liability policies.

For example, if a plaintiff prevails in a $1 million lawsuit against a public entity and its retained architect, and the jury finds that each is responsible for 50% of the total, then under traditional principals of comparative fault each party would be responsible for $500,000. If the architect signed a design contract with the public entity that provided Type I indemnity, however, the architect would be responsible for more than just the damages arising out of its own negligent work. It would also be contractually responsible for any damages arising out of the public entity's active or passive negligence. The public entity would try to pass its $500,000 share down to the architect pursuant to the indemnity provision. If the public entity is successful in passing liability down this way, the architect may find itself in a position where it is required to pay the public entity's allocated damages, and this amount is not covered by insurance. Accordingly, design professionals should be mindful of the fact that professional liability insurance policies generally will not cover a design professional's liability beyond the designer's own negligence or willful misconduct, thus leaving the design professional to make up the balance of an adverse judgment.

In AB 573, the California Legislature and Governor Schwarzenegger have unanimously acted to soften the blow of construction litigation upon design professionals in their dealings with public entities. Unless the design professional is liable for negligence, recklessness, or willful misconduct, then the indemnity provision running in favor of the public entity is not enforceable. Please note that this bill only applies to contracts and amendments entered into on or after January 1, 2007. Those contracts and contract amendments entered into on or before December 31, 2006 will still have enforceable indemnity provisions notwithstanding AB 573.

As design professionals close their books for 2006 and consider new projects for the upcoming year, they should take a second look at any agreements that have indemnity provisions running in favor of public entities. These agreements should offer indemnity rights to public entities only arising out of the design professional's negligence, recklessness, or willful misconduct. Public entities may also attempt to compensate for the new law by expanding the scope of an architect's or engineer's construction administration responsibilities in order to provide a stronger basis for indemnity arising out of negligent acts or omissions of the design professional.

As for public entities, this bill should cause them to undergo a more rigorous effort in connection with the selection of architects and engineers to design the public entity's projects. Public entities should become more proactive and devote more resources toward ensuring that they have the right design professionals for the job during the initial qualification-based selection phase, during which time proposals from designers are considered. More time, research, and investigation into designer credentials will be necessary because public entities will have a more difficult time managing risks and passing liability down to those with whom they are in contract. Gordon & Rees' construction attorneys are experienced in all types of contract review on behalf of designers, public entities, and all construction participants, and we are available to assist in this regard.

If you are interested in receiving more information on AB 573, counseling on your existing contracts, or advice on any other aspect of construction law, please contact Ernie Isola or any other attorney in the Construction Practice Group at Gordon & Rees LLP. 

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