New California law and uninsured defense obligations

Gavel and law booksCalifornia recently enacted a law that appears to lessen significantly the burden of indemnity provisions in contracts governed by the state’s laws. The goal of the legislation was to remove the immediate duty by design professionals to defend public and private clients. That duty was based on the mere involvement of the design professional on a project even if the design professional had no responsibility for the harm caused to a third party.

The legislation—which applies to contracts entered into after January 1, 2018—states that it limits the “duty to defend” to the comparative fault of the professional. It appears that design firms signing contracts in California will no longer be responsible for all of their clients’ defense costs, unless the design firm is 100% liable for the harm.

Although it is rare that a client attempts to tender its defense to a design firm when a third-party claim arises, that possibility created a significant exposure for design firms. No professional liability insurance policy automatically accepts a tender of defense from the policyholder’s client. Thus, the up-front payment of the client’s attorneys’ fees and other defense costs would be paid from the design firm’s assets. Under the new law, it appears that the defense costs of the client would be paid by the design firm only at the same proportion that fault for the harm to the third party is assigned to the design firm.

The scaling back of the contractual obligations of design firms may not be that clear—the actual language in the bill is ambiguous on providing up-front defense costs so the legislative intent will be need to be examined via future courts. The commentary on the bill states: “It preserves the design professional’s uninsurable first-dollar defense indemnity obligation while no longer exposing them to unlimited liability.” If the stated legislative intent influences the courts applying the law, what appears to be a proportionate responsibility for defense costs might end up being interpreted as an up-front payment that could be reimbursed as a shared expense once the percentage of fault is determined.

Until the law is construed in court, a prudent design firm signing a contract governed by California law should still negotiate into any contractual indemnity obligation an affirmative denial of the defense obligation by agreeing to indemnify “but not defend” the client.

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