Morgan Miller Blair

Assembly Bill 758 (AB 758) was signed into law by the Governor on September 29, 2005. 

AB 758 is of significant interest to residential builders and contractors performing residential construction in California, as it materially alters the scope of indemnity that builders may require from subcontractors.  Starting January 1, 2006, California Civil Code Section 2782 is amended so that a builder may no longer require subcontractors to defend and indemnify the builder against all claims except those arising from the builder’s sole negligence or willful misconduct.  Instead, amended Section 2782 will permit indemnification (and corresponding defense obligations) only to the extent of the subcontractor’s negligence.

Depending on one’s perspective, AB 758 is either a much needed tonic addressing the ills that construction defect litigation has caused subcontractors, or is a snake oil that will make the patient more sick. Amended Section 758 contains a number of ambiguities and leaves many questions unanswered.  Consequently, as to which view is correct, the doctor is out.

The following is a summary of the scope, substance, and potential impacts of AB 758 (the full text of the amendment to Section 2782 is at the end of this article).

Amendment to California Civil Code Section 2782(c) & (d):

Scope of Amendment:

Work affected: Residential construction.¹
Effective date: Contracts and amendments entered into after January 1, 2006.
Who is affected: “Builders” (as defined in Section 911 of the Civil Code²) and “subcontractors” who contract with one another.
Who is not affected: AB 758 does not apply to contracts between general contractors and builders, or contracts between subcontractors and general contractors who are not affiliated with a builder.

Substance of Amendment:

Indemnity for liability for construction defect claims (including the cost to defend) is unenforceable to the extent the claims arise out of, pertain to, or relate to the negligence of the builder or the builder's agents or contractors, or for defects in design, or to the extent the claims do not arise out of, pertain to, or relate to the written scope of work.

Limitations:

Joint Defense Agreements permitted: A builder and subcontractor may agree on the “timing or immediacy of the defense and provisions for reimbursement of defense fees and costs, so long as that agreement, upon final resolution of the claims, does not waive or modify” the protection of AB 758.

Insurer’s defense obligations not altered: AB 758 does not affect the obligations of an insurance carrier under Presley Homes, Inc. v.  American States Insurance Company (2001) 90 Cal.App.4th 571, which holds that an insurer who owes an additional insured builder a duty to defend any claim asserted in an action has a duty to defend the additional insured builder against the entire action (not just the covered claims).

Title 7/SB 800 obligations not altered: AB 758 does not affect the builder or subcontractor's obligations pursuant to Title 7/SB 800 (commencing with Civil Code Section 910).

Other: 

The protections of AB 758 may not be waived or modified by written agreement.

Comments and Issues: 

It will be some time before the impacts of AB 758 are fully realized.  Some likely immediate impacts, however, are obvious:

• The substance of the indemnity obligation that can be required is “equitable indemnity” or “comparative fault indemnity” with attorney’s fees and defense obligations only for the proportional share of the defense.
• While providing subcontractors with significant new rights, AB 758 does not provide any new rights to builders.  While some proponents of AB 758 view the codification of the right to enter an agreement regarding the “timing or immediacy of the defense and provisions for reimbursement of defense fees and costs” as a benefit to builders, builders had this right before passage of AB 758.
• There will likely be debate over the term “subcontractor.”  A subcontract is a secondary contract to perform a portion of the scope of work of a larger prime or general contract.  If a builder enters a contract directly with a roofer, and the roofer’s work is not a portion of the roofing work covered by a prime or general contract, then the roofer is not a subcontractor.  Under a literal reading of amended Section 2782, the roofer would not be entitled to AB 758’s protection.
• If a builder hires a non-affiliated general contractor, AB 758 may not apply.
• To increase protection, builders should develop broader written work descriptions for subcontractors.
• Builders should consider contracting for upcoming projects prior to January 1, 2006.
• Builders should revise their subcontracts, particularly indemnity provisions, for subcontracts to be executed after January 1, 2006.
• After January 1, 2006, the practice of issuing “work orders” or “work amendments” to master subcontracts should be closely scrutinized.  Indemnity related to the work covered by those work orders or work amendments will be subject to the amended Section 2782.  It remains to be seen whether AB 758 could then affect other scope of work issued under the master subcontract.
• The scope of the agreements that parties can enter regarding the “timing or immediacy of the defense and provisions for reimbursement of defense fees and costs” is uncertain.  A joint defense agreement entered into after a claim has arisen is permitted, so long as it contains procedures for re-allocation “upon final resolution of the claim.”  But can the original contract allocate the defense obligations before the claim has arisen?  In any event, a builder will want to enter a “builder defense agreement,” rather than a joint defense agreement, to avoid the possibility of becoming responsible for a share of the subcontractor’s defense costs.
• It is unclear what rights the parties may have for allocation of responsibility when the “final resolution of the claim” is by settlement.  Presumably, settlement would include the parties' binding agreement on allocation, otherwise the settlement would be ineffective to finally resolve the matter.  The question then is whether AB 758 will encourage or discourage settlement?
• Whether a builder will be able to enforce a contractual right to recover fees incurred to secure a subcontractor’s participation in the defense and indemnity of the builder is yet to be determined.  If those fees are recoverable, then arguably the contractual provision providing for such recovery will create a mutual right to recover attorney’s fees in favor of the subcontractor (under California’s mutual attorney fee statute, Civil Code Section 1717).
• Although AB 758 does not affect an insurance carrier’s obligations to pay for a defense of claims, this may be false consolation given difficulty subcontractors currently have obtaining insurance in California. 
• The role that wrap/OCIP insurance programs will play in either alleviating or exacerbating AB 758’s shift of risk to builders, and whether there will be an insurance market shift, is uncertain.  The insurance benefits that Title 7/SB 800 promised to deliver have not materialized (and many believe that the market has worsened for builders since its passage). 

Conclusion

The passage of AB 758 raises as many questions as it answers, and builders are faced with numerous decisions in the wake of its passage.  Like the last major legislative change burgeoned by the continuing impacts of residential defect litigation in California (Title 7/SB 800) it will undoubtedly be some time before the true impact of AB 758 is understood.  In the meantime, sophisticated legal counsel can assist builders in navigating the new landscape, and maximizing the risk management tools that remain available under AB 758.

AB 758:
CC 2782(c) & (d):

 (c) For all construction contracts, and amendments thereto, entered into after January 1, 2006, for residential construction, as used in Title 7 (commencing with Section 895) of Part 2 of Division 2, all provisions, clauses, covenants, and  agreements contained in, collateral to, or affecting any such construction  contract, and  amendments thereto, that purport to indemnify, including the cost to defend, the builder, as defined in Section 911, by a subcontractor against liability for claims of construction defects are unenforceable to the extent the claims arise out of, pertain to, or relate to  the negligence of the builder or the builder's other agents, other servants, or other independent contractors who are directly responsible to the builder, or for defects in design furnished by those persons, or to the extent the claims do not arise out of, pertain to, or relate to the scope of work in the written agreement between the parties. This section shall not be waived or modified by contractual agreement, act, or omission of the parties. Contractual provisions, clauses, covenants, or agreements not expressly prohibited herein are reserved to the agreement of the parties.

(d) Subdivision (c) does not prohibit a subcontractor and builder from mutually agreeing to the timing or immediacy of the defense and provisions for reimbursement of defense fees and costs, so long as that agreement, upon final resolution of the claims, does not waive or modify the provisions of subdivision (c).  Subdivision (c) shall not affect the obligations of an insurance carrier under the holding of Presley Homes, Inc. v.  American States Insurance Company (2001) 90 Cal.App.4th 571. Subdivision (c) shall not affect the builder's or subcontractor's obligations pursuant to Chapter 4 (commencing with Section 910) of Title 7 of Part 2 of Division 2.

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¹Residential construction has the meaning used in Title 7 of Part 2 of Division 2 of the Civil Code, which applies to original construction intended to be sold as an individual dwelling unit.

²Section 911 defines builders as a builder, developer, general contractor, contractor, or original seller in the business of selling residential units to the public, or in the business of building, developing, or constructing residential units for public purchase, for the property at issue; but does not include any entity or individual whose involvement with a residential unit is limited to his or her capacity as general contractor or contractor and who is not a partner, member of, subsidiary of, or otherwise similarly affiliated with the builder.

This Update is produced and copyrighted by Morgan Miller Blair. Any use or reproduction of the article or its contents without Morgan Miller Blair's prior express written consent is strictly prohibited. This published material constitutes neither legal advice nor exhaustive legal study. Applicability to any particular situation is dependent on a fact-by-fact analysis.
© 2005 Morgan Miller Blair. All Rights Reserved.

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