The duty to defend: How to avoid this serious risk
One of the most crucial risks for design professionals is deciding to agree to a "duty to defend" clause in a professional services contract. Though the clause may not be invoked often, when it is, the ramifications—namely legal fees and insurance denial—can be severe. To avoid these unnecessary obligations, design professionals should explicitly disclaim a duty to defend clients. An extreme case of what happens to design professionals in California who do not disclaim this, discussed below, serves as an example to design professionals in every state to expressly avoid a contractual duty to defend.
Duty to defend details
A contractual duty to defend is an obligation whereby one party, in this instance, design professionals, agree to defend another party, generally an owner or developer against a covered third-party claim, thus incurring attorney’s fees and costs. This duty arises at the beginning of litigation – upon a client’s request that its design professional tender a defense to a third party’s claim of the client’s alleged liability. A related, yet different, duty is the duty to indemnify. Indemnification involves one party, an indemnitor, agreeing to save another, an indemnitee, from legal consequence by a third party. It is activated at the end of that underlying litigation, upon an adverse judgment against the indemnitee for money.
Two reasons make it risky for design professionals to sign a contract with a duty to defend clause. One is that the design professional is agreeing to all of the risk to defend his client, regardless of whether the design professional was at fault. In doing so, the design professional is obligated to pay for the client’s legal fees, which can easily exceed the design professional’s liability.
The second reason it is risky for design professionals to agree to a duty to defend concerns insurance. When design professionals must pay for or reimburse an owner/developer’s defense costs, they will likely turn to their insurance carrier under their policy coverage. Insurers, however, will generally deny coverage for duty to defend claims because they typically do not cover claims by third parties where their insureds have not violated the applicable standard of care.
To avoid these unnecessary obligations, design professionals should explicitly disclaim a duty to defend clients.
Design professionals should know that professional liability insurance will not cover contractually assumed liability, unless the design professional would be liable even without a contract. However, professional liability insurance will cover damages related to a design professional failing to conform with the professional standard of care. This is because professional liability insurance is designed to cover damages resulting from a design professional’s own negligence, not for a design professional’s contractual duty to defend another where the former is not found negligent. To guard against such risk, design professionals’ contracts should expressly disclaim a duty to defend. Alternatively, if the architect is required to reimburse a client for its defense costs in proportion to the architect’s negligence, professional liability insurance may cover those costs as damage due to the architect’s negligence.
Extreme case results
A case that illustrates the potentially extreme results of a design professional’s contract explicitly agreeing to defend a client is UDC-Universal Development L.P. v. CH2M Hill, 181 Cal. App. 4th 10 (2010). In that case, CH2M Hill (“CH2M”) agreed to deliver engineering and environmental planning services to developer UDC. That contract obligated CH2M to indemnify UDC from and against any and all claims of any kind and to defend UDC against “any suit, action or demand” brought against UDC “on any claim or demand covered herein.” After design services and construction were complete, UDC’s client, Valle Vista Homeowners Association (“HOA”), sued UDC for property damage resulting from negligent engineering and environmental planning. UDC requested that CH2M abide by the contract to indemnify UDC from any and all claims and defend UDC against any claim brought against it. When CH2M rejected this request, UDC was left to pay its own defense costs.
Case law decided just prior to this lawsuit held that a contractual indemnitor incurs a duty to defend an indemnitee as soon as the indemnitee tenders its defense to the indemnitor, not after determining liability (see Crawford v. Weather Shield Mfg. Inc. (2008) 44 Cal. 4th 541. The trial court in UDC-CH2M applied this holding and decided that CH2M breached its duty to defend UDC and was liable for reimbursing UDC’s defense costs. The appellate court upheld the trial court’s decision, finding that CH2M incurred a duty to defend UDC when UDC’s cross-complaint alleged that CH2M’s deficient performance caused the HOA’s damages.
The UDC-CH2M case demonstrates that even when a design professional is not found to have acted negligently, if it has agreed to the duty to defend its client, it is still required to defend and pay attorney’s fees for a client sued by a third party.
Although the UDC-CH2M decision affected design professionals practicing only in California, it should serve as a reason for design professionals throughout the country to expressly disclaim any duty to defend a client. This way, designers do not assume risk for liability and defense costs, especially on claims for which they are not found negligent.
California and the duty to defend
While a duty to defend is a national concern, California has been of particular interest recently because it has a statute that implies the duty to defend in any agreement to indemnity. Since 1872, California Civil Code section 2778 (“Cal. Civ. Code § 2778” or “§ 2778”) has mandated that in a contract for indemnity, absent a contrary intention, an indemnitor must defend an indemnitee, upon the indemnitee’s request, in actions by third parties concerning subjects of the indemnity. An example of a subject of indemnity is a window supplier agreeing to defend a contractor that hired him to provide material and installation for said windows. Additionally, § 2778 requires an indemnitor to cover the indemnitee’s entire defense costs – regardless of whether the indemnitor is eventually found negligent.
Although the UDC-CH2M decision affected design professionals practicing only in California, it should serve as a reason for design professionals throughout the country to expressly disclaim any duty to defend a client.
Cal. Civ. Code § 2778 is deemed included in every indemnity contract. However, parties are free to contract around this statute and can negotiate to allocate risk differently. Specifically, parties may seek indemnification with or without proving fault and stipulate defense obligations. Those parties who do not contract around § 2778, however, must abide by the statute’s strict duties to indemnify, defend, and reimburse clients for their defense costs, even when they are not at fault.
Recognizing the undue burden this statute placed on design professionals, the California State Assembly passed Senate Bill 496 on April 28, 2017. The bill limits the design professional’s obligation to pay the client’s defense costs to an amount in line with the design professional’s proportionate fault. While this is a clear improvement for architects practicing in California, it is unclear how the new law will impact a design professional’s duty to defend its client. For more information on the statute, visit AIA California Council's overview of the bill. It should be noted that the bill is only effective for contracts signed on or after January 1, 2018.
It should also be noted that, a minority of state statutes track the ‘duty to indemnify and defend’ language of Cal. Civ. Code § 2778. Montana and North Dakota each have a statute that is virtually identical to § 2778. Oregon’s statute is like California’s with one exception: for claims against indemnitees, the indemnitor has an obligation to defend or pay for any reasonable expenses incurred by the indemnitee regarding claims for which the indemnitee is entitled to indemnification, rather than having an obligation to defend and pay. Design professionals in these states should recognize the heavy costs, liability, and lack of insurance coverage that a duty to defend—whether imposed by statute or explicitly agreed to in a contract—carries.
AIA has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice.
This article was contributed by the AIA Risk Management Program. The Risk Management Program posts new materials and resources on the first Thursday of every month.