August 20, 2019 Construction Law 101

Indemnity vs. Duty to Defend: Know the Differences and Potential Critical Variations in State Law

Sean McChristian, Porter Hedges LLP, Houston, TX, Division 1 (Litigation & Dispute Resolution)

Defense and indemnity clauses are routine devices used in construction contracts to shift responsibility for potential risks from one project participant to another. The terms defend and indemnify often appear in the same clause, but they are each typically understood to impose different obligations. However, even if the term defend does not appear in the indemnity clause, in some jurisdictions a defense may still be owed. It is therefore critical for construction attorneys to understand: (1) the difference between the duty to indemnify and the duty to defend and (2) that in some jurisdictions, an indemnity obligation automatically carries with it the duty to defend regardless of whether the duty to defend is expressly stated.

The consequences of failing to appreciate the distinct requirements of the duty to defend or to recognize that a duty to defend exists can be severe and unpleasant. The risks of misunderstanding the distinction between indemnity and the duty to defend and whether a duty to defend may be invoked are compounded by variations in controlling statutes and case law from state to state. The risk is obviously greater when dealing with the law of an unfamiliar jurisdiction.

The term indemnify is generally interpreted as imposing an obligation on one party (the indemnitor) to pay or compensate the other party (the indemnitee) for certain legal liabilities or losses, but that obligation does not typically arise until the end of a case when the indemnitee has had a judgment entered against it for damages or has made payments or suffered actual loss. The term defend, on the other hand, usually imposes an independent duty to either actively defend or fund the defense of any claim brought against the indemnitee that falls within the scope of the indemnification provision. The duty to defend is a promise to render, or fund, the service of providing a defense on the indemnitee’s behalf—a duty that usually arises as soon as a claim is made against the indemnitee and may continue until the claim has been resolved.

Because indemnity and defense provisions are so common, one of the first steps many construction lawyers take when presented with a new claim is to send a demand for defense and indemnity to all parties that may possibly owe one of these duties to the client. This means that construction lawyers are often on the receiving end of these demands. Too often, though, construction practitioners only do half the analysis required to evaluate and respond to such a demand, choosing to focus primarily on the indemnity demand without fully evaluating the demand for a defense. But this is a dangerous approach because the two duties are typically considered to be separate and independent, and in each state there generally is a unique body of case law that has developed around each and the analysis as to whether each duty exists will be different.  Consequently, when presented with a demand for a defense it is essential to go beyond general principles and to consider the governing law for the contract when evaluating whether the duty to defend has been triggered.

If the Contract Does Not Say Defend Is a Defense Owed? Maybe.

Under the common law of most states, an indemnitor generally has no duty to defend unless the contract specifically requires that a defense be provided. Thus, if the governing indemnity provision does not expressly require the indemnitor to both defend and indemnify the indemnitee with respect to certain claims, many parties will reflexively deny a tender of defense. However, some states impose a statutory obligation on all indemnitors to provide a defense, while others read an implied duty to defend into every indemnification agreement unless the contract specifically negates that right.

For example, in California, Montana, Oklahoma, and South Dakota, unless a contrary intention appears in the contract of indemnity, the indemnitor is bound, on request of the indemnitee, to defend actions or proceedings brought against the indemnitee in respect to the matters embraced by the indemnity.[1] Consequently, before denying a tender of defense based solely on the lack of the word “defense” in an indemnity provision, it is prudent to determine whether the controlling state law imposes a defense obligation on your client.

Is the Duty to Defend Analysis the Same As in an Insurance Context?

Most jurisdictions agree that in the insurance context, the duty to defend is triggered if any part of the claim against the insured is arguably within the scope of protection afforded by the policy. Thus, in determining whether an insurer has a duty to defend, the allegations in the underlying complaint must be compared to the relevant coverage provisions of the insurance contract, and the duty to defend will exist as long as the allegations of the underlying complaint are potentially within the scope of coverage, even if the allegations are groundless, false, or fraudulent. Moreover, when determining an insurer’s duty to defend, the allegations in the pleadings should be construed liberally and all doubts regarding the duty to defend should be resolved in favor of the insured. But that is in the insurance context. What about a defense and indemnity provision in a construction contract?

In many jurisdictions, there is no difference between the duty to defend that arises from a private indemnity contract and the duty to defend that is imposed on a liability insurer. The law governing an insurer’s duty to defend is wholesale imported into the non-insurance indemnity context and private indemnity contracts are interpreted according to the same principles as insurance contracts.[2] This means that when you are analyzing whether the duty to defend has been triggered in one of these jurisdictions, the allegations in the pleadings must be construed liberally and all doubts regarding whether the duty to defend has been triggered should be resolved in favor of the indemnitee. However, in other jurisdictions, indemnity agreements are subject to different rules of interpretation and a contractual indemnitor’s duty to defend is narrower than an insurer’s duty to defend.[3]

In those jurisdictions that recognize a distinction between a contractual indemnitor's duty to defend and an insurer's duty to defend, the difference in treatment is typically justified on public policy grounds. The purpose of an insurance contract is to distribute risk of loss across a large group. These contracts are usually not negotiated, thus any ambiguities are construed in favor of the insured. By contrast, an indemnity clause contained in a non-insurance contract is construed against coverage, because the agreement creates duties that differ or extend beyond those established by general principles of law. Such clauses are typically collateral or incidental to a contract that has a principal purpose other than risk shifting. In light of these differences, some courts will not automatically apply insurance rules to the duty to defend in a non-insurance contract. Therefore, in order to properly analyze whether the duty to defend has been triggered in any particular case, you should always confirm whether the governing law weighs in favor or against finding that the duty to defend has been triggered.

Is the Duty to Defend Voided by an Anti-Indemnity Statute?

The vast majority of states have enacted some form of anti-indemnity legislation for construction contracts. A few state statutes specifically refer to agreements that require a party to defend another party with respect to certain claims as being void and unenforceable. However, most statutes do not specifically address the duty to defend and instead only refer to agreements that require a party to indemnify or hold another party harmless with respect to certain losses. In these jurisdictions, the courts have frequently been called upon to determine whether the anti-indemnity statute applies with equal force to both defense and indemnity obligations. In some states, courts have focused on the concept that the duty to defend is distinct from the duty to indemnify and have held that it is possible for the duty to defend to survive even if an indemnity agreement is struck down as violating an anti-indemnity statute.

For example, Massachusetts courts have explicitly made this determination and found that even if an indemnity provision does not comply with the Massachusetts anti-indemnity statue, it does not follow that there is automatically no duty to defend because the duty to defend is “independent of and broader than the duty to indemnify” and the imposition of a duty to defend is not constrained by the Massachusetts anti-indemnity statue because the statute does not refer to the duty to defend.[4] Other state courts, though, have ruled to the contrary, finding that there can be no duty to defend if the underlying indemnity provision is voided by an anti-indemnity statue.[5] This means that further research may be required in some jurisdictions to determine whether an anti-indemnity statute that does not use the term defend may nonetheless be used as a basis for denying a tender of defense.

Stay Vigilant.

These are just a few of the jurisdictional quirks to consider when presented with a tender of defense. There are certainly others that should be considered as well. For example, different states have different formulations as to how the damages associated with a breach of the duty to defend are calculated, and some states presume that the fees and costs incurred after the breach were reasonable and place the burden on the breaching party to rebut that presumption.

It is important to carefully consider every demand for a defense and to ensure that you are properly conducting your analysis regarding whether to accept or deny the demand based on the unique contours of the governing law.

Endnotes

1. Cal. Civ. Code § 2778(4); Mont. Code Ann. § 28-11-316; Okla. Stat. Ann. tit. 15, § 427(4); S.D. Codified Laws § 56-3-11.
2. Shaughnessy v. KC Rainbow Dev. Co., LLC, 2010 WL 157486, at *5 (D. Haw. Jan. 15, 2010) (“Under Hawai‘i law, private indemnity contracts are interpreted according to the same principles as insurance contracts.”); English v. BGP Int’l, Inc., 174 S.W.3d 366, 372 n.6 (Tex. App.—Houston [14th Dist.] 2005, no pet.) (“[W]e find little reason why the principles regarding an insurer’s duty to defend should not apply with equal force to an indemnitor’s contractual promise to defend its indemnitee.”); Westlake Vinyls, Inc. v. Goodrich Corp., 518 F.Supp.2d 918, 936 (W.D. Ky. 2007) (Under Ohio law, “[a]n indemnitor’s duty to defend under an indemnity contract is subject to the same standard as an insurer’s duty to defend under an insurance contract.”).
3. Chevron U.S.A., Inc. v. Murphy Expl. & Prod. Co., 151 S.W.3d 306, 310 (Ark. 2004); JNJ Found. Specialists, Inc. v. D.R. Horton, Inc., 717 S.E.2d 219, 228 (Ga. Ct. App. 2011); Blackshare v. Banfield, 857 N.E.2d 743, 746 (Ill. App. Ct. 2006); Martin & Pitz Assoc., Inc. v. Hudson Construction Servs., Inc., 602 N.W.2d 805, 809 (Iowa 1999); Ramos v. Browning Ferris Indus. of South Jersey, Inc., 510 A.2d 1152, 1159 (N. J. 1986); Linkowski v. General Tire & Rubber Co., 371 N.E.2d 553, 557 (Ohio Ct. App. 1977); Sangermano v. Roger Williams Realty Corp., 22 A.3d 376, 377 (R.I. 2011); see also DaimlerChrysler Corp. v. Wesco Distribution, Inc., 760 N.W.2d 828, 833 (Mich. Ct. App. 2008) (construe against drafter and indemnitee).
4. Herson v. New Boston Garden Corp., 667 N.E.2d 907, 914 (Mass. App. Ct. 1996).
5. Arthur v. State, 377 P.3d 26, 35 (Haw. 2016), as corrected (June 27, 2016); Sunset Presbyterian Church v. Andersen Construction Co., 341 P.3d 192, 199–200 (Or. Ct. App. 2014).