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Court: Poorly Drafted Indemnity Clauses May Still Be ‎Partially Enforceable

Daily Journal of Commerce
August 24, 2015

Overview

One of the most important risk-shifting provisions in a construction agreement also tends to be one of the most confusing: the indemnity provision. While the basic concept of contractual indemnity is simple enough to understand – for example, one party obligates itself to pay for damages incurred by the other party under certain circumstances – it gets more confusing when there are statutes governing its effect. In Oregon, the statute that governs indemnity provisions in construction agreements is ORS 30.140, and its interpretation has been subject to a long history of legal analysis. This article discusses the most recent court decision regarding the purpose and effect of that statute.

Last month, in Montara Owners Association v. La Noue Dev. LLC, the Oregon Supreme Court decided that poorly-drafted indemnity clauses are still partially enforceable if they can be limited so they comply with the indemnity statute. In other words, courts will not disallow an entire indemnity clause simply because part of the indemnity clause is overbroad and impermissible.

In this case, a homeowners association sued a general contractor and developer for damages caused by design and construction defects in a townhome complex. The contractor then sued several of its subcontractors who performed work on the project. Before trial, the contractor settled with the homeowners association and all but three of the subcontractors. It was a dispute with one of those subcontractors that gave rise to the Oregon Supreme Court decision.

The contractor made a claim against the subcontractor seeking to enforce an indemnity provision in the subcontract between the parties. The indemnity clause in question required the subcontractor to indemnify the contractor for multiple horrors, "whether or not caused in part by [contractor], [its] employees or agents, but ‎excepting that caused by the sole negligence of [contractor], [its] employees or ‎agents‎."

The trial court determined that the indemnity provision violated Oregon's indemnity statute, ORS 30.140. The statute has two parts. The first subsection bars overbroad indemnity provisions – those that require one party to indemnify another party for damage "caused in whole or in part by the negligence of the indemnitee." In this case, both the contractor and subcontractor agreed that the indemnity clause was overbroad and violated the first part of the statute.

However, the parties disagreed over the effect of the second subsection of the law. That subsection provides that the statute "does not affect any provision in a construction agreement" that requires indemnity where the injury or damage arises out of the fault of the indemnitor. The contractor argued the second subsection of ORS 30.140 is an exception to the first subsection. The subcontractor took the opposite position and argued that ORS 30.140 sets out two mutually-exclusive categories or construction agreement indemnification provisions – one of which is enforceable, the other of which is unenforceable.

On appeal, the Oregon Court of Appeals reversed the trial court's decision because it agreed with the contractor that ORS 30.140(2) acts as an exception to ORS 30.140(1). In other words, even though an indemnity provision is void under ORS 30.140(1) because it is overly broad, it may still be enforceable and hold the indemnifying party accountable for injuries or damages that result from its own fault.

The subcontractor next asked the Oregon Supreme Court to weigh in. The Court ultimately upheld the Court of Appeals' decision and ruled the indemnity clause at issue to be partially enforceable.

The Court reasoned that, "By including the phrase ‘[e]xcept to the extent provided under subsection (2)" in subsection (1), the Legislature intended that the subsections would overlap rather than be mutually exclusive." The Court decided that unenforceable parts of an indemnity clause can be severed, and the remainder of a given clause can be enforced. The Court also concluded that "the legislature intended that a subcontractor remain liable for the subcontractor's negligence even though subsection (1) protects the subcontractor from having to indemnify a general contractor for the general contractor's negligence."

Oregon courts have now definitively spoken regarding the effect of these two subsections of ORS 30.140: an indemnity provision in a construction agreement that requires both parties to be liable to the other for their own fault will be enforced regardless of whether another part of the indemnity provision attempts to require more. In other words, if you break it, you buy it. But if the other person breaks it, you are not required to pay for it.

What this decision also means is that parties to a construction agreement should pay careful attention to the language in an indemnity provision. Regardless of whether it includes some parts that may be unenforceable, depending on the remainder of the text, the provision may still pass legal scrutiny and obligate your company to indemnify. The best practice is to have your attorney review the indemnity provision so you have a clear understanding of your company's exposure.

As published in Daily Journal of Commerce, July 22, 2015.

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