Posted on 07.16.15
Understanding contribution and indemnification in multiparty construction defect litigation
Source: http://www.lexology.com, July 14, 2015
By: thomas J. Madigan, Pepper Hamilton LLP
This article was originally published in the June 2015 issue of ConsensusDocs Construction Law Newsletter.
The scenario is familiar to every contractor and supplier ever dragged into a lawsuit: The owner’s complaint against the general contractor contains a laundry list of problems with the building — the roof leaks, the EIFS is cracking, the masonry is spalling, the windows and doors leak, the HVAC system does not properly cool and/or heat the building, the fire suppression system does not meet code, etc., etc., etc. The general contractor then joins every subcontractor and supplier involved in construction, claiming they are liable to the general contractor for whatever it may be found liable to the owner. The subcontractors join sub-subcontractors and suppliers, each alleging that, to the extent there is a problem, it is the responsibility of the newly joined party. Finally, everyone cross-claims against each other, alleging that, to the extent any is liable, all are liable.
These claims are often pleaded as a matter of course and without any real thought as to whether there is an actual legal basis for indemnification or contribution. They are simply asserted as if the rights to indemnification and contribution are inherent and automatic. Are they? When do claims for indemnity or contribution actually apply, and, at the end of the day, how is the question of who owes what to whom actually decided?
Indemnification
Indemnification is the right of one party to collect from another the damages it owes to a third party. There are two distinct recognized legal bases for indemnification — contractual and equitable (also often referred to as “common law” indemnification). A right to contractual indemnification, as its name implies, is created by contract. As is the case with any contract claim, the scope of the obligation is strictly defined by the terms of the contract. Although indemnification clauses are generally enforceable, they are subject to certain limitations and defenses. For example, in virtually all states, an agreement that purports to indemnify for intentional conduct is void as a matter of public policy.1 Similarly, agreements to indemnify a party against its own negligence are prohibited in many states and disfavored in most. Even where enforceable, a clause that purports to indemnify a party for its own fault is enforceable only where the language is explicit that it extends to the indemnitee’s own failure to perform.2 General language that indemnifies against “all liability” may or may not be sufficient.3 Thus, depending on the specific language of the indemnification clause and the state in which the project is located, a contractor’s independent breach of its own contractual obligations may bar any claim for indemnification against its subcontractors.
Contractual indemnification is, at least theoretically, a matter of negotiation. As such, its contours and limitations are a matter of mutual agreement. In contrast, equitable (or common law) indemnification is created by operation of law. The purpose of equitable indemnification is to shift liability from one who is only passively liable to the party who was actively at fault. Equitable indemnification is available to one who is liable by operation of law for the acts of another but is otherwise without fault. The most common example is the supplier of a defective product. As a seller, the supplier is liable to the purchaser. However, the supplier is almost universally entitled to indemnification from the manufacturer, who is considered to be ultimately responsible for any defect in the design or manufacture of the product.
A party seeking equitable indemnification must prove that it is entirely without fault and that the party from whom it seeks indemnification is legally responsible for the damages claimed. Equitable indemnity is an all-or-nothing proposition, both damage and fault-wise.4 In determining whether a party is entitled to indemnity, courts do not weigh the relative fault of the parties to determine which is “more responsible.” If both parties are at fault, to any degree, recovery for common law indemnity is precluded.5
The second element — that the party from whom indemnification is sought is liable for the damages claimed — would seem self-evident but often is not. The legal rights and obligations of each of the various parties performing work and supplying materials to a construction project are determined by their respective contracts. Ideally, those rights and obligations should line up, and all of the parties should be performing to the same criteria. By the same token, in the event of a failure of performance, the remedies available to and from each party in the chain of performance should be the same. Many times, however, whether due to inattentive contracting or divergent bargaining power, the parties’ respective obligations, rights and remedies do not align. When this happens, a higher-tier contractor may find that it faces liability for failing to meet a contractual obligation it has undertaken that is not owed to it by a lower-tier subcontractor or supplier. The fact that the lower-tier contractor or supplier may be “at fault” in the sense that it did not provide the level of performance required for the contractor to meet its upstream obligations is insufficient to create a right to indemnification. If the contractor obligated itself to do or provide more than it required of its subcontractor, it is caught in the middle — liable for not meeting its performance obligations, but unable to recover from those whose work or materials are at issue.
Contribution
Unlike indemnity, contribution is a principal of liability sharing. Despite the indiscriminate manner in which it is sometimes pleaded, it does not come into play simply because there are multiple defendants, however. In most states, the law of contribution is codified through the enactment of some version of the Uniform Contribution Among Joint Tortfeasors Act.6 “Joint tortfeasors” are two or more persons who are jointly and severally liable in tort for the same injury to persons or property.7When two or more parties are jointly and severally liable, each is independently liable for the full extent of the injuries stemming from their actions. In such circumstances, the party to whom they are found liable may collect the entire judgment from either defendant. Contribution is the means by which the paying defendant holds the other defendant(s) responsible for its/their fair share.
The concepts of joint and several liability and contribution do not apply in most construction defect cases, however, as the gist of the action doctrine and economic loss rule preclude holding the various subcontractors liable as joint tortfeasors. The gist of the action doctrine precludes parties from recasting breach of contract claims as negligence claims. When the parties’ obligations are defined by contract — as is virtually always the case in construction cases — contract, rather than tort law, defines their respective rights and obligations. The economic loss rule similarly bars a claim for negligence when the only losses incurred are “economic” in nature, which includes the cost to repair or replace defective work. In the absence of personal injury or property damage, the rights and obligations of the parties are determined by contract, not tort, law.
In the absence of joint and several liability, and without rights of contribution, damages cannot be apportioned among subcontractors by percentage of fault or similar concepts of shared responsibility. Even though the contractor is liable for the collective work of all its subcontractors, each individual subcontractor is liable only for its portion of the work. Thus, the contractor seeking to recover from its subcontractors must present evidence of each subcontractor’s breach of its contract and the damages attributable thereto. This means specifically identifying which portions of the work failed to conform to the applicable contract requirements, the subcontractor responsible for performing that work and the cost to repair the deficient work.
The scenario is familiar to every contractor and supplier ever dragged into a lawsuit: The owner’s complaint against the general contractor contains a laundry list of problems with the building — the roof leaks, the EIFS is cracking, the masonry is spalling, the windows and doors leak, the HVAC system does not properly cool and/or heat the building, the fire suppression system does not meet code, etc., etc., etc. The general contractor then joins every subcontractor and supplier involved in construction, claiming they are liable to the general contractor for whatever it may be found liable to the owner. The subcontractors join sub-subcontractors and suppliers, each alleging that, to the extent there is a problem, it is the responsibility of the newly joined party. Finally, everyone cross-claims against each other, alleging that, to the extent any is liable, all are liable.
These claims are often pleaded as a matter of course and without any real thought as to whether there is an actual legal basis for indemnification or contribution. They are simply asserted as if the rights to indemnification and contribution are inherent and automatic. Are they? When do claims for indemnity or contribution actually apply, and, at the end of the day, how is the question of who owes what to whom actually decided?
Indemnification
Indemnification is the right of one party to collect from another the damages it owes to a third party. There are two distinct recognized legal bases for indemnification — contractual and equitable (also often referred to as “common law” indemnification). A right to contractual indemnification, as its name implies, is created by contract. As is the case with any contract claim, the scope of the obligation is strictly defined by the terms of the contract. Although indemnification clauses are generally enforceable, they are subject to certain limitations and defenses. For example, in virtually all states, an agreement that purports to indemnify for intentional conduct is void as a matter of public policy.1 Similarly, agreements to indemnify a party against its own negligence are prohibited in many states and disfavored in most. Even where enforceable, a clause that purports to indemnify a party for its own fault is enforceable only where the language is explicit that it extends to the indemnitee’s own failure to perform.2 General language that indemnifies against “all liability” may or may not be sufficient.3 Thus, depending on the specific language of the indemnification clause and the state in which the project is located, a contractor’s independent breach of its own contractual obligations may bar any claim for indemnification against its subcontractors.
Contractual indemnification is, at least theoretically, a matter of negotiation. As such, its contours and limitations are a matter of mutual agreement. In contrast, equitable (or common law) indemnification is created by operation of law. The purpose of equitable indemnification is to shift liability from one who is only passively liable to the party who was actively at fault. Equitable indemnification is available to one who is liable by operation of law for the acts of another but is otherwise without fault. The most common example is the supplier of a defective product. As a seller, the supplier is liable to the purchaser. However, the supplier is almost universally entitled to indemnification from the manufacturer, who is considered to be ultimately responsible for any defect in the design or manufacture of the product.
A party seeking equitable indemnification must prove that it is entirely without fault and that the party from whom it seeks indemnification is legally responsible for the damages claimed. Equitable indemnity is an all-or-nothing proposition, both damage and fault-wise.4 In determining whether a party is entitled to indemnity, courts do not weigh the relative fault of the parties to determine which is “more responsible.” If both parties are at fault, to any degree, recovery for common law indemnity is precluded.5
The second element — that the party from whom indemnification is sought is liable for the damages claimed — would seem self-evident but often is not. The legal rights and obligations of each of the various parties performing work and supplying materials to a construction project are determined by their respective contracts. Ideally, those rights and obligations should line up, and all of the parties should be performing to the same criteria. By the same token, in the event of a failure of performance, the remedies available to and from each party in the chain of performance should be the same. Many times, however, whether due to inattentive contracting or divergent bargaining power, the parties’ respective obligations, rights and remedies do not align. When this happens, a higher-tier contractor may find that it faces liability for failing to meet a contractual obligation it has undertaken that is not owed to it by a lower-tier subcontractor or supplier. The fact that the lower-tier contractor or supplier may be “at fault” in the sense that it did not provide the level of performance required for the contractor to meet its upstream obligations is insufficient to create a right to indemnification. If the contractor obligated itself to do or provide more than it required of its subcontractor, it is caught in the middle — liable for not meeting its performance obligations, but unable to recover from those whose work or materials are at issue.
Contribution
Unlike indemnity, contribution is a principal of liability sharing. Despite the indiscriminate manner in which it is sometimes pleaded, it does not come into play simply because there are multiple defendants, however. In most states, the law of contribution is codified through the enactment of some version of the Uniform Contribution Among Joint Tortfeasors Act.6 “Joint tortfeasors” are two or more persons who are jointly and severally liable in tort for the same injury to persons or property.7When two or more parties are jointly and severally liable, each is independently liable for the full extent of the injuries stemming from their actions. In such circumstances, the party to whom they are found liable may collect the entire judgment from either defendant. Contribution is the means by which the paying defendant holds the other defendant(s) responsible for its/their fair share.
The concepts of joint and several liability and contribution do not apply in most construction defect cases, however, as the gist of the action doctrine and economic loss rule preclude holding the various subcontractors liable as joint tortfeasors. The gist of the action doctrine precludes parties from recasting breach of contract claims as negligence claims. When the parties’ obligations are defined by contract — as is virtually always the case in construction cases — contract, rather than tort law, defines their respective rights and obligations. The economic loss rule similarly bars a claim for negligence when the only losses incurred are “economic” in nature, which includes the cost to repair or replace defective work. In the absence of personal injury or property damage, the rights and obligations of the parties are determined by contract, not tort, law.
In the absence of joint and several liability, and without rights of contribution, damages cannot be apportioned among subcontractors by percentage of fault or similar concepts of shared responsibility. Even though the contractor is liable for the collective work of all its subcontractors, each individual subcontractor is liable only for its portion of the work. Thus, the contractor seeking to recover from its subcontractors must present evidence of each subcontractor’s breach of its contract and the damages attributable thereto. This means specifically identifying which portions of the work failed to conform to the applicable contract requirements, the subcontractor responsible for performing that work and the cost to repair the deficient work.
