Courts Wrestle With Indemnity Clauses

By Frederick B. Simpson and James A. Edwards

A recent Court of Appeals ruling has raised two intriguing issues. The first is whether the phrase “to the extent permitted b law” saves a contract provision that exceeds the permissible limits set by law. The second is whether New York recognizes the incongruous doctrine of “partial contractual indemnity.” The Court invited both questions in Itri Brick v. Aetna[i].

Itri laid to rest one of the more troubling issues for tort practitioners by construing General Obligations Law §5-322.1 as “voiding” agreements that purport to indemnity negligent owners or general contractors for their own negligence. Though the statute declares that such agreements are “against public policy” hence “void and unenforceable” the Court of appeals, consonant with a prior holding in Brown v. Two Exchange Plaza[ii], rules implicitly that such unlimited indemnity agreements are actually “voidable”. The offensive language must be coupled with active negligence by the owner or general contractor (the indemnitees) to “void” the agreement.

Simply stated, the Itri rule is that unlimited contractual indemnity agreements are unenforceable by negligent indemnitees. Following Itri, litigation has centered on the two issues noted at the outset: what language is needed to save an indemnity agreement and what are the implications for litigation over a well-crafted agreement?

Defense attorneys know the dance. At construction sites, owners and general contractors require subcontractors to indemnity or hold them harmless for accidents causing injury or damage. GOL §5-322.1 was enacted to prevent these agreements from requiring subcontractors to hold owners and general contractors harmless for their own negligence.

The public policy underpinnings of this law are obvious: such agreements removed incentive from owners and general contractors to run safe job sites. Due to some unfortunate and inartful legislative drafting, the courts of the state were entirely and internally inconsistent in interpreting this statute. Itri, as the final word, was to put this confusion to rest. Or so we thought.

These seemingly innocuous distinctions have consequence beyond academic pursuit. They mask important insurance implications. In instances where the indemnitor is the employer and the indemnity provision is deemed unlimited, the general liability carrier (which insures the contractual indemnity claim) can go on holiday and leave the workers’ compensation carrier (which insures contribution claims under its Employer’s Liability coverage) alone to pay the entire judgment. Hence, Burgeoning litigation has ensued on these issues perceived as unanswered in Itri, driven by parties with a real financial stake.

‘Extent Permitted’

The sufficiency of the limiting language did not appear a fertile area for litigation, but appearances can deceive. Many indemnity agreements commence with the phrase “to the extent permitted by law” and go on to require full indemnity. To most, this language appeared to remove the indemnity clause from the prohibition of GOL §5-322.1. Somewhat surprisingly, the issue has spawned conflicting results.

This conflict is particularly surprising since the Court of Appeals in Itri shed light on this very issue. In noting that the agreements under review in Itri were unlimited, the Court observed:

The agreements [under review] contemplate full indemnification, even in cases where the general contractor is found to be negligent, and contain no language limiting the subcontractor’s obligation to that permitted by law or to the subcontractor’s negligence. (Emphasis added)

This sentence implies that indemnity agreements can pass muster in two ways: by including the “to the extent permitted by law” modifier “or” (the Court phrased this in the disjunctive) by limiting the subcontractor’s obligation to its own negligence.

Significant here is the Court’s specific reference that the agreements under review did not contain language limiting the indemnitor’s obligation “to that permitted by law.” Presumptively, if the provision began with this phrase it would not violate the statute.

Some courts have not read Itri this way.

Two decisions that met the issue head-on came to opposite conclusions. In the unreported Supreme Court decision Bray v. C&D Fireproofing[iii], Justice Howard Miller found that an indemnity provision that contained the phrase “to the extent permitted by law” did not “purport to indemnity [the indemnitee] against its own negligence and is enforceable…”

A few months later in Bright v. Tishman Construction Corp. of New York[iv], District Court Judge Denise Cote found that an indemnity provision that provided indemnity “to the fullest extent permitted by laws” was “ an insufficient limitation on the indemnification provision to remove the contract from the proscriptive scope of GOL §5-322.1.” Judge Cote found that the Bray decision was “not to the contrary and requires no different result.”

The only difference apparent between the two limiting phrases in Bray and Bright was the inconsequential adjective “fullest.” Hardly the stuff of a bright line distinction.

Judge Cote held that “the saving language must indicate with sufficient clarity that the indemnification does not run to the negligent conduct of the indemnitee.” This interpretation would appear to be beyond what the Court of Appeals required in Itri.

The battle lines for future litigation are thus emerging: does insertion of the phrase at the beginning of an unlimited indemnity agreement “to the extent permitted by law” remove it from the proscription of GOL §5-322.1? With such significant coverage implications, this issue will likely reach the Appellate Divisions in the near future. Eventually, some agreements will be found enforceable. That prospect leads to the next issue of contention.

Partial Indemnity

There appeared to be little room to wiggle on whether limited indemnity agreements would be enforced following Itri. The statute did not bar such arrangements so by implication they should be enforceable. Though not specifically decided, the general tenor of the opinion was that the court would enforce such agreements.

There is no public policy or other apparent impediment preventing two sophisticated parties from agreeing to this. The Second Circuit, endeavoring to interpret New York law, had previously enforced such an agreement[v].

Itri provided little insight on this topic. The Court observed curtly:

Whether or not Section 5-322.1 would allow enforcement of a “partial indemnification” agreement is irrelevant here….the question whether a negligent contractor/promisee could enforce an indemnification agreement, notwithstanding Section 5-322.1, so long as the agreement did not purport to indemnify the contractor for its own negligence is not before us.

However, the portion of the opinion cited earlier concerning the “to the extent permitted by law” issue intimated that inclusion of appropriate savings language would render the provision enforceable.

The Appellate Division and Supreme Court decisions following Itri have only tangentially addressed this aspect. These cases have reaffirmed the Brown v. Two Exchange Plaza principle that void agreements are really “voidable” and are enforceable if the indemnitee is free of active negligence[vi]. They have also taken this doctrine one step further in holding that motions made before a liability apportionment are premature[vii].

One case affirmed a grant of contractual indemnity where the agreement did not violate GOL §5-322.1 and the indemnitee was free of negligence[viii]. Similarly, in National Union v. The State Insurance Fund[ix], Justice Barbara R. Kapnick was faced with what appeared to be a “good” indemnity agreement (it had sufficient limiting language) but based enforcement on the indemnitee’s freedom from negligence.

Thus, the doctrine of “partial contractual indemnity” has not been squarely addressed by the Appellate Divisions or trial courts. Due to the insurance concerns lurking behind this litigation, it too will likely receive their attention shortly.

Conclusion

Though these issues appear to be a mere academic exercise (the indemnitor/subcontractor will be responsible under CPLR 1401 contribution theories) coverage implications will not let them die quietly. With the advent of the workers’ Compensation Reform Act of 1996, which makes contractual indemnity claims against employers the only viable theory of recovery (except in instances where the plaintiff suffered a “grave injury”), challenges concerning the specific language of indemnity agreements and their effect will likely continue unabated. Fortunately, the answers to these questions can be found hiding in Itri itself.

This article is reprinted from the November 9, 1998 of the New York Law Journal. © 2003 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.