United States: Express Indemnification Clauses: Better Safe Than Sorry

It used to be taken for granted that when a claim arose out of a construction project, contractors and subcontractors, and even some suppliers, could point the finger at those who provided labor or materials behind them in the contractual chain. For instance, in a claim by an owner against a contractor for providing defective materials to a project, the contractor would inevitably point the finger at the supplier that actually furnished the materials. To the extent the contractor was liable to the owner, the contractor would simply bring a claim against the supplier for reimbursement. To the extent the contractor seeks to be partially reimbursed from the supplier, the claim is generally called one for "contribution." When the contractor seeks to be fully reimbursed, the claim is referred to as "indemnification." However, the North Carolina Court of Appeals recently set strict limits on when contribution and indemnification claims can be asserted in the construction context.

In light of the ruling, contractors, subcontractors, and even suppliers should, whenever possible, obtain written indemnification agreements any time they will rely on labor or material furnished by another in order to fulfill their own contracts.

In Kaleel Builders, Inc. v. Ashby, 587 S.E.2d 470 (2003), a general contractor on a residential construction project sought to recover contribution and indemnification from its subcontractors, some time after the owner of the project sued the general contractor for defective work in a separate lawsuit. In Kaleel, the contractor alleged the defects were caused by the work of its subcontractors and argued that it should be able to recover contribution or indemnification damages from them. As discussed above, this type of claim by the contractor is very common, almost automatic, in construction cases.

The trial court, however, dismissed the contractor’s claims, finding that no basis existed for them, and the Court of Appeals upheld the ruling. With regard to the claim for indemnification, or reimbursement in full, the court noted that such recovery can only be obtained under certain circumstances. First, indemnification may be obtained when there is an express contract provision for it, in other words, where a supplier, for example, explicitly agrees to reimburse the contractor for any liabilities it may incur as a result of a defect in the supplier’s products. In Kaleel, there was no such contract provision. Second, the court pointed out that indemnification can also be obtained in situations such as an employer-employee relationship. If a company is responsible to a third party solely because of acts of its employee, the company can generally recover from the employee. However, in Kaleel, the court determined that a contractor-subcontractor relationship is not sufficiently similar to an employer-employee relationship to justify indemnification claims.

With regard to the claim for contribution, or partial reimbursement, the Court of Appeals pointed out that such recovery is only authorized by a North Carolina statute dealing with tort claims. Therefore, a contractor, in order to seek contribution, must first allege that its subcontractor acted negligently. A negligence claim, however, implicates a long-standing ruling by the North Carolina Supreme Court, Ports Authority v. Roofing Co., 294 N.C. 73 (1978), which holds that one party cannot generally assert a negligence claim against another if the claim arises out of a contractual relationship between them. The reason for that principle is that the parties’ rights and obligations should be determined by the contract itself, not the law of negligence.

Without its claims for indemnification or contribution, the contractor in Kaleel attempted to fall back on its breach of contract claims against the subcontractors. By those claims, the contractor alleged that, without regard to the owner’s claims, the subcontractors did not fully honor their obligations, causing the contractor to incur damages. These claims were also dismissed, however, because they were not timely filed. Under North Carolina law, a party generally has three years from the breach to assert a breach of contract claim. It must be noted that an indemnification claim, however, can generally be asserted much later, since that action does not even arise until the owner, for example, makes the initial claim against the contractor.

In light of the Court of Appeals’ ruling in Kaleel, any contractor, subcontractor, or supplier would be wise to incorporate an indemnification agreement in the standard terms and conditions it includes in its contracts. However, such an agreement must be carefully drafted in order to comply with North Carolina statutes, which place certain limits on the extent of indemnification clauses in the construction context. If possible, persons or entities seeking to incorporate an indemnification provision should first check with an attorney.

Drafted correctly, an indemnification clause can prevent a contractor, subcontractor, or supplier from bearing all responsibility for defects. Instead, it would ensure that responsibility rests where it actually belongs in a particular situation: on the subcontractor or supplier that provided the defective materials or performed the defective work.