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October 2011

California Senate Bill 474: A Fair Allocation of Construction Risk or a Formula for Increased Litigation?

The California Legislature and Governor Brown recently approved California Senate Bill 474, which generally provides that in all construction contracts for private commercial projects entered into on or after January 1, 2013, any indemnity obligations (including the cost to defend) arising out of the active negligence or willful misconduct of the indemnified party are void and unenforceable.  

This new law will dramatically affect risk allocations in construction projects, and also lead to a likely increase in insurance-related litigation and associated costs. Under current practice, California developers and general contractors typically use what is referred to as a "Type I" indemnity provision in construction contracts.  "Type I" indemnity allows one party (usually owners, developers, and general contractors) to require the other party (typically subcontractors) to indemnify them for their own active negligence or fault.  Although some legislative changes have been made to ameliorate the effects of Type I agreements in the context of residential construction, SB 474 extends these protections to commercial projects.   

SB 474's other important aspects include the following:

  • If the property on which the construction is performed is located in California, then California law would apply regardless if the parties have a contrary choice of law provision in their contract. 
  • SB 474 does not apply to design professionals. 
  • SB 474 has no effect on additional insured obligations, i.e., contractual provisions requiring a party to obtain additional insured endorsements covering the party's acts or omissions during ongoing and/or completed operations. 
  • SB 474 expands the definition of "construction contract" to include agreements for renovations and such subjects as utility, water, sewer, oil, and gas lines.
  • SB 474 does not apply to Owner Controlled Insurance Programs (often called OCIPS or WRAPs) 
  • Prior to SB 474, California law prohibited indemnity provisions requiring a "contractor" to indemnify a public agency for its own active negligence.  SB 474 amends this law to clarify "contractor" to include "contractor, subcontractor, or supplier of goods and services".
  • A new section (c) is added to Civil Code Section 2782 providing that in construction contracts with owners of privately owned real property to be improved, in which the owner is not also acting as a contractor or supplier, there can be no indemnity provision relieving the owner from his active negligence. However this does not apply to a homeowner performing an improvement on a single family dwelling.  

"Type II" indemnity agreements, which allow a party to be indemnified for another party's passive, as opposed to active, negligence are still legal and enforceable.  Passive negligence can include a failure to discover a dangerous condition or a failure by a general contractor to identify a subcontractor's defective work, among other things.    

The Effects of SB 474

General Contractors/Developers:  General contractors and developers are adversely impacted since the new law eliminates an effective risk control tool. A likely result will be increased insurance premiums for general contractors and developers.  Language in existing model contracts containing the Type I indemnity language will also have to be modified, and general contractors must be diligent in obtaining all subcontractors insurance information prior to the project's commencement. 

SB 474 proponents assert it adds fairness by making each party responsible for its own negligence.  Opponents, i.e., owners, developers, and general contractors, claim it will lead to increased litigation.  They argue parties will expend more resources to determine actual liability instead of having a predetermined contractual obligation regardless of fault, resulting in additional discovery, depositions, etc.  OCIPs (and other forms of WRAP insurance) will likely increase because developers and general contractors will be precluded from shifting all the risk on to subcontractors and their insurance carriers.    

Subcontractors:  The law's primary purpose was to equitably shift the risk from the subcontractor trades towards the higher tier construction participants.  Proponents argued that "Type I" indemnity placed the majority of the burden of liability and defense costs on the subcontractor.   Although in theory subcontractors have been free to negotiate contracts without "Type I" indemnity provisions, in reality they have been unable to do so given the superior bargaining power of the developer/general contractor, especially in today's economic environment.  The intended result of SB 474 is that the cost of subcontractors' insurance will likely decrease.  

The effect of SB 474 on defense obligations between construction participants remains to be seen.  This new law may conflict with the recent Crawford and UDC decisions, which require a contractor or design professional to provide an immediate defense if a tender is made under a clause requiring them to "defend" another.  Since SB 474 speaks to not only indemnity obligations but also "the cost to defend," an argument can be made that the defense obligation does not arise until a determination is made whether the general contractor was "actively negligent."  On the other hand, SB 474 does not specifically mention the Crawford/UDC line of cases, so it is unclear whether the California Legislature meant to abrogate these cases and their language concerning an immediate defense obligation.

Design Professionals:  SB 474 does not apply to design professionals.  However, design professionals have been advocating for expanding the laws protecting them from defense and indemnity obligations.  While SB 474 only addresses Type I indemnity for contractors, subcontractors, and material suppliers, it may pave the way for similar legislation affecting design professionals. 

California is the seventeenth state to eliminate Type I indemnity provisions in construction contracts.  To read the full text of this statute, please click here.




Ernest M. Isola