Arizona Subcontractor Indemnity Exposure Clarified

The MT Builders decision reminds subcontractors to review construction contracts for land mines that go off when charges of construction defects are made

A November 2008 Arizona Court of Appeals decision (in MT Builders v. Fisher Roofing) provides a guide for writing a narrow indemnity clause that limits the subcontractor’s liability for injuries or defects on a construction job. More important, it reminds subcontractors to have legal and insurance professionals review subcontracts for “land mines” that go off when charges of construction defects are made.

Background. In January 2001, an Arizona condominium association filed a construction defect lawsuit against a number of defendants, including the general contractor (MT Builders), the roofing subcontractor (Fishing Roofing), and other subcontractors.

MT Builders filed a cross-claim against the subcontractors, to force them to indemnify MT against any losses MT may incur in the lawsuit. Its cross-claim was based on the indemnity provision in MT’s standard subcontract agreement that it had used with all of its subs. The “narrow form” indemnity clause provided:

To the fullest extent permitted by law, the Subcontractor shall indemnify and hold harmless the Owner, Architect and the Builder and all their agents and employees from and against all claims, damages, losses and expenses, including but not limited to attorney’s fees and court costs, arising out of or resulting from the performance or non- performance of the Subcontractor’s Work under this Subcontract ... to the extent caused in whole or in part by any negligent act or omission of the Subcontractor or anyone directly or indirectly employed by him or anyone for whose acts he may be liable[.] (Emphasis added)

In late 2002, MT Builders and most of the subcontractors settled the association’s lawsuit for $1.75 million. Three subcontractors, including Fisher Roofing, refused to participate in the settlement, and the association assigned to MT its claims against them. Thus, the lawsuit continued among MT, Fisher and the other holdout subs.

In 2004, MT filed a motion for summary judgment asking that Fisher be ordered to reimburse MT for Fisher’s share of the $1.75 million settlement and for MT’s attorneys’ fees. MT argued that the $240,500 that the association had spent on roof repairs in 2004 was the best evidence of Fisher’s fair share of the damages, and that Fisher had no right to contest MT’s settlement with the association because Fisher had refused to participate.

Fisher countered that deciding the extent of its negligence, if any, required a trial. Fisher argued that:

• MT must prove that Fisher was negligent;

• if MT met that burden, MT must then prove how much damage Fisher’s negligence caused; and

• because of conflicting evidence, Arizona law did not allow the superior court to enter judgment without hearing all of the evidence at trial.

The court granted MT’s motion, awarding summary judgment against Fisher for $240,500, plus $113,000 of MT’s attorneys’ fees.

Appeal and Remand. Fisher appealed the superior court’s decision and found a more receptive audience at the Arizona Court of Appeals. The appellate court held that, given the language of the indemnity clause, the trial court should not have granted summary judgment and that a trial would be required to determine the extent of Fisher’s fault.

The case was remanded, and the trial court was instructed to resolve conflicting testimony as to (a) whether Fisher’s work was negligent, and (b) to what extent its negligence had caused damage, rather than simply accepting the $240,500 figure that the association spent on repairs. The court could not presume that all roof repairs were Fisher’s responsibility if, for example, there was evidence that the HVAC sub had damaged the roof. In short, MT was entitled to indemnity only “to the extent” of Fisher’s fault, and it was MT’s burden to prove the degree of Fisher’s fault.

In addition, the trial court was instructed to require MT:

• as a prerequisite for obtaining indemnity from Fisher, to prove that its overall settlement was reasonable and prudent, given the risk of exposure at trial and the strength of the available defenses; and

• to show how much of the settlement amount was attributable to Fisher’s fault and that its settlement of the Fisher claims also met the “reasonable and prudent” test.

On the last point, the court noted, “Even if the overall settlement reached by MT Builders with the Association was reasonable and prudent under the circumstances, to obtain indemnity from Fisher, MT Builders was required to show that its settlement of the Fisher-based claims met this test.”

Lessons Learned. For Arizona subcontractors, the MT Builders decision provides detailed instruction on how a trial court must treat a carefully written, narrow form indemnity clause. The decision holds that the words “to the extent caused by the negligent act of the subcontractor” can significantly reduce a subcontractor’s exposure.

In addition, MT Builders may turn out to influence “additional-insured” endorsements required by form subcontracts. Since November 2008, when the decision was issued, some liability insurers have begun to write the same type of “to the extent of” language into additional-insured endorsements to restrict the insurer’s liability to the extent of subcontractor negligence only. (See your insurance agent for more information.)

MT Builders provides new, useful instruction in crafting an indemnity clause and should remind all contractors and subcontractors to understand the indemnity provisions of their contracts and to be sure that their insurance covers their exposure.

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