Illinois Construction Law Blog : Illinois Construction Lawyer & Attorney : Foran Glennon Palandech & Ponzi Law Firm : Chicago IL

 Maybe…maybe not. Typically, a party will invoke an indemnity provision to seek protection from claims made by some third party. 

However, consider a situation where an owner files suit against its architect alleging certain errors and omissions. In the Complaint, the owner cites the indemnity provision contained in the Owner-Architect Agreement and alleges that it is entitled to damages associated with the retention of experts to investigate the claimed defects and attorneys’ fees and expenses to prosecute the lawsuit against the architect. 

 

Is the owner’s indemnity claim viable? Not surprisingly, the answer depends on the particular language of the indemnity provision. In Illinois, courts interpret indemnification agreements like any other contract clause – a court must give effect to the intention of the parties as determined from the language of the agreement as a whole. See Zadak v. Cannon, 59 Ill.2d 118, 319 N.E.2d 469 (1974) and McRaith v. BDO Seidman, LLP, 391 Ill. App. 3d 565, 577-78, 909 N.E.2d 310 (1^st Dist. 2009).

 

Recently, we successfully defeated an indemnity claim similar to the hypothetical above. Essentially, the owner was seeking indemnification from its own claim against the architect. In the case against our client, the Owner-Architect Agreement contained the following indemnification provision:

 

Notwithstanding any other terms and conditions stated herein, including any obligations regarding insurance coverage, Architect agrees to defend, indemnify, keep, save and hold harmless fully the Owner, its agents, officials and employees, against all claims, suits or judgments, costs or expenses, including attorneys’ reasonable fees, that may be based on or the result of any error, omission, negligence, or any willful or intentionally tortious conduct of Architect or of any person employed or engaged by Architect to perform Services under this Agreement. 

 

The Architect shall promptly provide to the Owner copies of such notices as it may receive of any claims, actions or suits as may be given or filed in connection with Architect’s performance or the performance of any person or entity employed or engaged by Architect to perform Services under this Agreement.

 

In response to the Owner’s Complaint, we filed a motion to dismiss arguing that the Owner’s indemnity claim does not exist in the absence of a claim or judgment against the Owner. To support this argument, we cited Open Kitchens, Inc. v. Gullo International Development Corp., 126 Ill. App. 3d 62, 466 N.E.2d 1313 (1^st Dist. 1984). In Open Kitchens, the indemnity clause in the contract between the plaintiff and Gullo provided:

 

To the extent permitted by law, [Gullo] shall indemnify and hold harmless the [plaintiff] and their [sic] agents and employees from and against all claims, damages, losses, expenses, liabilities, and demands, including attorneys' fees, of whatsoever kind or nature, arising out of, resulting from or connected with the performance of the Work by the Contractor or any Subcontractor for and in behalf of the [plaintiff] or Architects. The Contractor shall defend at its own expense, any actions based thereon and shall pay all attorneys' fees, costs and other expenses arising therefrom.

 

Open Kitchens, Inc. v. Gullo International Development Corp., 126 Ill. App. 3d 62, 63-64, 466 N.E.2d 1313 (1^st Dist. 1984). 

 

The First District Court held that Gullo’s obligations under the indemnity provision did not arise until a third party asserted an action against Open Kitchens. Open Kitchens, Inc. v. Gullo International Development Corp., 126 Ill. App. 3d 62, 65, 466 N.E.2d 1313 (1^st Dist. 1984). The Court explained that in reading the indemnity provision as a whole, including the last portion of the subject provision requiring Gullo to defend actions arising out of its performance of the contract, the agreement indicated that the indemnity was only intended to apply to matters involving losses incurred by third parties. Id. 

 

As in Open Kitchens, where the indemnity provision contained language referencing actions by third parties, the indemnity provision contained in our client’s Owner-Architect Agreement refers to claims filed by others (i.e. “The Architect shall promptly provide to the Owner copies of such notices as it may receive of any claims, actions or suits as may be given or filed in connection with Architect’s performance”). Accordingly, we argued that the First District’s analysis in Open Kitchens applied and the language of our client’s indemnification clause indicates that the indemnity was only intended to apply in the context of losses incurred by third parties. 

 

The court agreed with our analysis and dismissed the Owner’s indemnity claim with prejudice. In her order, the judge relied on the language contained in the second paragraph of the indemnity provision stating that “this language immediately follows the indemnity language, making it clear the intent of the parties was to limit the indemnification to instances where third party claims are raised.” 

The lesson here is that not all indemnification provisions are created equal. The specific language must be reviewed so that risks are allocated as intended.

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 The Second District recently addressed this inquiry in American States Insurance Co. v. CFM Construction Co.  CFM Construction (CFM) was a general contractor which entered into subcontract agreements with NF Construction and International Decorators on a certain project. Under each of its subcontract agreements, CFM required NF Construction and International Decorators to name CFM as an additional insured on their respective general liability policies. NF Construction was insured by American States Insurance Company (American States), and International Decorators was insured by Michigan Mutual Insurance Company (Michigan Mutual). 

 

During the construction, Francisco Flores, an employee of International Decorators, was injured when he fell from a scaffold. Mr. Flores filed two separate lawsuits to be compensated for his alleged injuries. One lawsuit was against CFM and the other named NF Construction as the defendant. Both lawsuits claimed that the defendants negligently managed, supervised, and controlled the construction site.

 

The two lawsuits were consolidated, and CFM tendered its defense to Michigan Mutual. In turn, Michigan Mutual sought contribution for the defense of CFM from American States. However, American States denied the requested for contribution and filed a declaratory judgment action seeking a declaration that it had no duty to contribute to the costs of defending CFM in the Flores lawsuit. 

 

On cross-motions for summary judgment, the trial court ruled against American States, and American States filed its appeal. On appeal, the Second District Appellate Court held that American States owed a duty to defend CFM as an additional insured.

In the interim, the underlying Flores lawsuit was settled. Michigan Mutual paid $700,000 in the settlement, but American States only agreed to pay $200,000 on behalf of NF Construction and refused to contribute to the settlement on behalf of CFM.

 

On remand from the original appeal, American States filed a second amended complaint seeking a declaration that it had no duty to indemnify CFM. Michigan Mutual filed its counter-complaint seeking reimbursement for half of the $700,000 it paid to settle the Flores claims on behalf of CFM. Furthermore, Michigan Mutual sought attorney fees and prejudgment interest from American States. Again, on cross-motions for summary judgment, the trial court granted Michigan Mutual its requested relief, except for the attorney fees and interest.

 

American States again filed its appeal. In the appeal, American States argued that equitable contribution does not apply because the policies insured completely different risks. Generally, when an insurer has paid the entire loss, the doctrine of equitable contribution allows it to be reimbursed by other insurers that share the same liability as the insurer seeking contribution. This doctrine applies only where concurrent insurance policies insure the same entities and the same risks. The Second District Appellate Court held that equitable contribution applied as both policies insured the same risks.   

 

Nonetheless, the decision is puzzling as it fails to explain why CFM’s tender to Michigan Mutual did not foreclose Michigan Mutual from seeking equitable contribution from American States. See Kajima Construction Co. v. St. Paul Fire & Marine Ins. Co., 227 Ill.2d 102, 108, 879 N.E. 2d 305 (2007) (when an insured has knowingly chosen to forego one insurer’s assistance by instructing that insurer not to involve itself in the litigation, the targeted insurer has the sole responsibility to defend and indemnify the insured and is foreclosed from seeking equitable contribution from the other insurer that was not selected by the insured). 

Perhaps CFM’s tender to Michigan Mutual did not state that it was deselecting all other insurance and demanding that Michigan Mutual accept its tender on a primary and non-contributory basis. However, the American States Ins. Co. v. CFM Construction Co. opinion provides no explanation as to why CFM’s tender to Michigan Mutual did not foreclose it from seeking equitable contribution as explained by the Illinois Supreme Court in Kajima.

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Yesterday we examined the astute discussion of the duty to mitigate found in Judge Cole’s recent opinion in R.R. Donnelley & Sons Co. v. Vanguard Transportation Systems, Inc.

Today we discuss that portion of the opinion directed at R.R. Donnelley’s request for attorneys’ fees based on the indemnity provision of the contract.

The contract’s indemnity provision read:

[Vanguard] shall indemnify and hold [Donnelley] harmless from any from any liability, loss, cost, damage or expense, including attorneys' fees, which may accrue against [Donnelley] by reason of any liability claims, cargo claims and workers compensation claims by an entity that arise out of or are due to acts or failures to act of [Vanguard].

R.R. Donnelley sought to use this provision to recoup the attorneys’ fees it expended in prosecuting the action against Vanguard. In essence, although the court would only award nominal damages to R.R. Donnelley, it hoped to have Vanguard pay the cost of achieving that award.

The court rejected the argument that the provision could be read to imply that attorneys’ fees would be awarded to R.R. Donnelley in a dispute with Vanguard over the enforcement of the indemnity provision. Instead the court found that the “by an entity” phrase could not be read to include Vanguard. The court found that the provision applied to disputes between R.R. Donnelley and others, but not between R.R. Donnelley and Vanguard for the enforcement of the indemnity agreement.

This interpretation is important because it serves to remind everyone contracting for indemnification to include the phrase “including the enforcement of this agreement” in their indemnity clauses.

The court pointed out that the varying interpretations of indemnity provisions could be read to mean that a self-referencing portion in a clause was necessary to include disputes over the indemnity agreements themselves, even though the court referenced the Illinois Supreme Court’s own admission that little guidance can come from attempting to analyze or reconcile the numerous cases interpreting indemnity clauses.

The interpretations cited by the court were:

Cincinnati Ins. Co. v. Leighton, 403 F.3d 879, 881 (7th Cir.2005)(indemnification required “from and against any liability, loss, cost, attorneys' fees, and expenses whatsoever, including the enforcement of this agreement”);

Central Die Casting and Mfg. Co., Inc. v. Tokheim Corp., 1998 WL 160900, *8 (N.D.Ill.1998)(fees incurred in enforcing indemnity provision not caused by “the specific claim indemnified against. Instead, they are costs incurred to sue for breach of contract, or the failure to indemnify.”);

Fidelity Mut. Life Ins. Co. v. Harris Trust & Savings Bank, 1997 WL 308846, *2 (N.D.Ill.1997)(fees incurred in pursuing indemnification allowed where language “expressly permits ... recover[y][of] attorneys' fees and expenses ‘incurred in connection with the enforcement of th[e] Agreement’ ”);

Board of Trustees of University of Illinois v. U.S. Fidelity and Guar. Co., 1991 WL 274462, *3 (N.D.Ill.1991)(contract specifically included “all attorney's fees and costs incurred in bringing an action to enforce the provisions of this indemnity....”);

Eckley v. Lone Star Forge Co., 1991 WL 222076, *2 (N.D.Ill.1991)(noting “the distinction between attorney's fees in defending a third party suit and attorney's fees in enforcing a right to indemnity and thus offer no guidance to the court.”).

Jackson v. In-tertech Resources, Inc., 1990 WL 16969, *1 (N.D.Ill.1990). (The seller agreed to “indemnify and hold harmless Buyer from and against any and all actions, suits, proceedings, demands, judgments, losses, costs, damages, and expenses (including with-out limitation, attorney fees and disbursements) resulting from or arising out of: ... (d) any breach of any of the representations or warranties, covenants or agreements of Seller set forth in this Agreement.” The plain language of the clause contemplated a suit by one party to the contract against the other in the event of any breach of the agreement and provided for reimbursement of attorney's fees should that occur.)

The indemnity agreement in this case did not.

Again, while we are consistently warned that interpretations may be inconsistent, the self-reference in an agreement appears necessary for recouping the costs of enforcing the agreement itself.

 

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As Judge Posner has put it:

“If you invite someone to dinner, and hours after he was due he still hasn't arrived, you had better infer that he isn't coming, and start eating. You can't let yourself and your other guests starve merely because there is a slight chance that he will show up days later.”

The recent case of R.R. Donnelley & Sons Co. v. Vanguard Transportation Systems, Inc. (N.D.IL Doc. No 06 C 5837) has ended in an interesting decision based entirely on the failure of one party to affirmatively act to “mitigate” its damages even though the other party breached their agreement and could also just as easily have mitigated the damages.

The opinion has an excellent description of the duty to mitigate:

“The so-called duty to mitigate damages, which is often referred to as a general contractual duty is a principle of ancient vintage.  Referring to mitigation of damages-or as it is called in tort law “avoidable consequences “in terms of a “duty” is somewhat misleading, because a plaintiff incurs no liability for failing to act.  Rather, the amount of loss that could reasonably have been avoided by stopping performance or making substitute arrangements is simply subtracted from the amount that would otherwise have been recoverable as damages.  Phrased differently, the duty to mitigate damages “forbids the victim of a breach of contract, which might well be involuntary, to allow his damages to balloon (when he could easily prevent that from happening), as he might be tempted to do in order to force a lucrative settlement.”

“The victim of the breach must “ ‘exercise reasonable diligence and ordinary care in attempting to minimize the damages after injury has been inflicted.’ “ And while he must act with “reasonable dispatch,” the injured party is not required to take steps that involve “undue risk or burden.”  But there are instances where the victim of the breach might be lulled by the breaching party into inaction because of assurances that all will be well. “[T]o put this differently, the [breaching party] may not insist on mitigation when by its words or deeds it has led the [non-breaching party] to believe that it has assumed what would otherwise be the buyer's burden of mitigation.” While that is going on, the duty to mitigate is suspended.” [Internal citations omitted]

The case involved the shipment of time-sensitive brochures by Vanguard to an R.R. Donnelley facility in Atlanta. The brochures were for a Macy’s after-Christmas sale and needed to be delivered by December 21 in order to be mailed out and received timely by consumers for the December 27^th Sale. 

R.R. Donnelley contracted with Vanguard to deliver the brochures to its facility by no later than 2:00 p.m. on December 16^th. This time was important because the contract between the parties contained a “time is of the essence” clause. Vanguard got to the facility after 2:00 p.m. on the 16^th and delivery was not made. Rather than wait to be able to unload the delivery on the 16^th, the driver for the Vanguard truck took the trailer with the materials to a facility and left them there. The parties contacted each other regarding scheduling a new delivery over the next few days each time a delivery was expected or possible, something occurred to kept that delivery from happening, and ultimately, no delivery was ever made. The brochures did not get mailed in time for the Macy’s sale.

R.R. Donnelley paid the company that printed the brochures $81,650 for damages it suffered because the brochures did not get mailed for Macy’s and then sued Vanguard for the $81,650 in damages for breach of the agreement to deliver the brochures by the 16^th.

The parties completed discovery and had a trial. Of the many findings made by the Court after it heard the evidence one regarded R.R. Donnelley’s failure to take action and mitigate its damages.

In many cases, the steps for mitigation are varied and may not amount to a full recovery of the damages suffered by a party because of the breach, but for R.R. Donnelley in this case the Court decided:

“all that would have been entailed was the minimal cost of renting a truck from a local cartage company and driving the half hour to the Vanguard lot to pick up the load and delivering it to the Atlanta facility.   Mr. Menne, of Vanguard, estimated that the cost would have been about $250. Even if that estimate is low, the cost would have been less than the $750 it cost to haul the load the several hundred miles from Kentucky to Georgia.”

The court found that of the roughly $81,000 in damages claimed by R.R. Donnelly, $80,000 could not be assessed against Vanguard because of R.R. Donnelly’s failure to mitigate. The court held that because the money at issue was only nominal, and R.R. Donnelley didn’t request nominal damages, judgment should be made in favor of Vanguard due to the failure of the plaintiff to mitigate.

This same duty to mitigate applies to construction. It is best to understand that you cannot sit around and wait for something to happen thinking you have a remedy at law when some action on your part could completely alleviate your damages.

Tomorrow we will discuss Part 2 – The reason R.R. Donnelley wasn’t entitled to enforcement of its indemnity provision for attorney’s fees.

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The recent case of Peregrine Financial Group, Inc. v. TradeMaven, LLC, has at least offered some guidance.

In Peregrine, both the plaintiff and the defendant had been sued in another action over a patent dispute. The initial action had been resolved by a federal court through a settlement between the parties and the plaintiff in the patent action and  a consent judgment had been entered.

The indemnity provision in the TradeMaven contract stated that it agreed to hold Peregrine harmless from any claims for “expenses and costs (including any reasonable legal fees and expenses related to [Peregrine’s] defense) arising from any claim of infringement of any trademark, service mark, trade name, copyright, or other proprietary right.” In the patent suit, the parties placed a provision in the consent judgment that each party would bear its own costs and attorneys fees. 

After the federal suit, Peregrine sent a letter to TradeMaven’s counsel requesting the $416,081.22 in attorney's fees. TradeMaven didn’t indemnify Peregrine for the fees so Peregrine filed the indemnification claim in state court for recovery of those fees. The state district court ruled that the claim was precluded by res judicata.

One of Peregrine’s arguments on appeal was that even if Peregrine could have brought its claim for indemnity in the federal suit, it didn’t need to because a previous Illinois Supreme Court Case, Guzman, held that the claim for indemnification did not accrue until after the patent dispute concluded and TradeMaven rejected Peregrine’s written demand for indemnification. 

Guzman ruled that the 13-204 statute of limitations was applicable in construction defect contract dispute for indemnification between a defendant and a third-party in a situation where the third-party suit had been brought with three counts – implied indemnity, express indemnity, and breach of contract – and the opinion was rendered without an express statement of which theory the Court was considering.

The Appellate Court in Peregrine rejected Peregrine's argument and said that Guzman involved an “implied contract of indemnity” and a third-party complaint and that the instant case involved no third-party action where both parties had been named as defendants in the federal action and that the parties had an express contract of indemnity.

Peregrine then argued that the more recent Illinois Supreme Court decision in Travelers extended Guzman to express indemnity agreements. The Appellate Court said that because the indemnity provision in Travelers contained the words “on demand” – “Payments of amounts due Surety hereunder together with legal interest shall be payable on demand” – the express terms of the indemnity agreement in Travelers implied that the indemnity action did not accrue until demand was made and therefore, the instant action was different because the indemnity provision at issue in Peregrine contained no language providing that payment was triggered by demand for payment. 

In Travelers the Supreme Court apparently determined that the fact that the Guzman did not especially state whether it was addressing the nature of the indemnity claim on a breach of contract, implied indemnity or express indemnity basis meant that Guzman did not provide enough guidance to aid in the assessment of a suit based on express contractual indemnity.

Travelers also held that implied contractual indemnity is only available in tort. Which makes it odd that the court in Peregrine could say that the claim in Guzman was about implied contractual indemnity because it was a construction defect case and not one about a tort. 

Travelers also didn’t offer guidance on whether carefully constructed indemnity provisions in regular construction contracts could serve as the basis for a claim for breach of contract premised upon the breach of an indemnity provision thereby making them claims regulated by the ten-year statute of limitations addressed in Travelers,  or whether a claim for "express contractual indemnity" was different than a breach of contract claim and in construction defect case which could be brought as a third-party action (the commercial equivalent of contribution).  In the second type of claim, the defendant is basically saying “if I’m liable to the plaintiff, it is because this third party made a mistake.”  In the latter instance, Travelers would seem to imply that the four-year 13-214 statute of limitation would apply because the claim was based on the construction defect, in the former, because the claim is actually for failure to indemnify after a demand, it would appear that this is a 13-206 matter as discussed in Travelers.

By distinguishing the Travelers case based on the demand language the Appellate Court in Peregrine has created an interesting distinction and not resolved the issue created in Travelers regarding how and under what theory a defendant should sue a third-party in a construction dispute not based on negligence such as one where the party is looking to pass-through any potential economic damages.   Another question raised by these line of cases:

• Is the claim properly one for "express contractual indemnity" because there is an indemnity provision of the contract and the third-party contract was breached, or is it a claim for breach of contract for breach of the indemnity provision or both?

We know that professionals and contractors should arguably include indemnification for “economic damages” in their indemnification provisions if they want to attempt to recover those forms of damages at a later date. Friedman, Alschuler & Sincere v. Arlington Structural Steel Co., Inc., 140 Ill.App.3d 556, 489 N.E.2d 308 (1 Dist., 1985). Friedman and a line of cases following it support the contention that the indemnity provision needs to be specific as to the type of damages the parties will be able to seek, but nothing has settled the question raised by Travelers about where and when, if the provision is drafted properly, a party, if at all, must seek this contractual indemnity and what the cause of action actually is in third-party claims for construction defect where someone is looking to pass-through the claims of another.

For now the best practice seems to be to ensure that the contractual indemnity provisions include the “on demand” language in an effort to preserve a claim and to assert both a claim for express contractual indemnity and a claim for breach of that provision as a breach of contract.

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Answer: When your contract obligates you to do so.

We’ve all seen the terms in our contracts, this one is particular to leases:

INSURANCE. (a) Tenant shall, at its sole cost and expense, maintain at all times with responsible insurance carriers acceptable to Landlord licensed to do business in the State of Illinois, insurance covering the premises for the mutual benefit of Landlord and Tenant as follows:

*** (v) Comprehensive General Liability Insurance, with such limits as may be reasonably requested by Landlord from time to time, but not less than a $5,000,000.00excess liability for bodily injury and property damage;

*** (c) All insurance policies shall name Landlord *** [and others] as additional insureds, as their respective interests may appear. Landlord may, by written notice to Tenant, designate other parties as additional insureds. All such insurance shall provide that:

(i) The coverage provided includes the premises;

***(iii) All losses shall be payable notwithstanding any act or negligence of Tenant or Landlord or the occupation or use of the premises for purposes more hazardous than permitted by terms of such policy.

That last part is important. In Illinois, most agreements to indemnify someone for their own negligence are void as a matter of public policy, however, agreeing to obtain insurance to cover someone’s negligence is not void. In fact, it creates an enforceable contract and if you fail to obtain it, even by way of your insurance company providing a policy that excludes it, you’ve breached the lease (or any contract with such a provision for that matter) and can be held liable for the damages that result from failing to obtain the insurance.

In Clarendon America Insurance Co. v. Prime Group Realty, Inc. (1^st Dist., Doc. No. 1-08-0791 & 1985 cons.) that’s exactly what happened. The facts are that Prime Group was the lessor to an entity named Ala Carte Entertainment that ran a restaurant on the property. The lease between the two included the provision above as well as multiple provisions stating that Ala Carte was not indemnifying Prime Group for Prime’s own negligence (something caused by Prime).

A worker was injured fixing HVAC units on the roof of the building. Fixing the HVAC saw Ala Carte’s responsibility, maintaining the rest of the roof was Prime’s. After the worker sued Prime, Prime sued Ala Carte and tendered the defense of the claim to Clarendon, with whom Ala Carte had the policy that was required under the INSURANCE clause. Clarendon filed a declaratory action to have a court find that it had no duty to indemnify Prime and later agreed to defend Prime under a reservation. Prime then sued Ala Carte for breaching its contract because there was a clause in the Clarendon policy to Ala Carte that read:

Policy Change No. 8 Endorsement

If liability for injury or damage is imposed or sought to be imposed on the additional insured because of: (a) Its own acts or omissions, this insurance does not apply.

The circuit court found in favor of Ala Carte and Prime appealed. On appeal, the appellate court found that the anti-indemnity provisions of the contract (those stating that Ala Carte was not to indemnify Prime for Prime’s negligence) did not contradict the insurance provisions because Illinois law has found that you can contract to get insurance for your negligence acts even if you could not be indemnified by a party for them.

Importantly, the court also held that the Endorsement’s negation of coverage for Prime was a breach of the contract provision between Prime and Ala Carte and remanded the case for a hearing on the damages resulting from that breach.

Make sure you read the contract language and either insert or remove this language depending upon your needs… and always read the policy once you get it to make sure it is in compliance with such a provision. A little double-checking in the beginning could have saved everyone this headache later on.

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The first district has upheld an arbitrator’s decision regarding the implication of an indemnity provision and given us a useful reminder that some rote contract language is actually important.

Undoubtedly in your contracts you’ve seen language binding or implicating those subsidiaries, affiliates, successors and assigns – some have argued that the language be removed from agreements or given their own clauses. In Rexnord Industries, LLC v. RHI Holdings, and The Fairchild Corporation (1^st Dist, Doc. No. 1-08-0562) it turned out to make quite a bit of difference.

In Rexnord, two parties agreed to an arbitration of the percentage of a $1.8 million settlement each was responsible for. The settlement was for an environmental claim against Rexnord. Rexnord had previously been owned by RHI, was sold to another company (A), which was acquired by yet another company (B) and was sold before the arbitration to yet another company (C).

The original sale agreement between RHI and company A obliged RHI to indemnify:

“[company A] its affiliates, subsidiaries, successors and assigns from "any and all losses, liabilities, claims, damages, *** costs, etc." relating to RHI's ownership and operation of the property before the spinoff date, "so long as these ‘Losses' arise out of or are in any way related or connected to any Environmental Law; result from any claim by any governmental or private party arising out of or in any way related or connected to any Environmental Law; or result from the generation, use, handling, storage, transport, disposal, release or threatened release of any Materials of Environmental Concern." The indemnity obligation created by the agreement applied "only to the excess of (x) Losses over (y) the sum of amounts collected by Purchaser or Rexnord from third parties." (Slip Op. at 2. emphasis added.)

An arbitrator determined that RHI was responsible for 90% and ordered that it pay Rexnord for that 90% and some other damages. It also determined that company B was an indemnitee under the agreement between RHI and company A. RHI asked a circuit court to vacate the award and the circuit court declined to do so. RHI then appealed.

On appeal, RHI argued that because company B had paid the $1.8 million it was not obliged to pay because company B was a “third party” by virtue of being a subsequent purchaser of company A and by having sold to company C prior to the arbitration. RHI also argued that the arbitrator should not have considered the position of company B as an indemnitee because company B was not a party to the arbitration.

The appellate court disagreed and upheld the award. In doing so, it found that:

• The arbitrator was correct in considering company B as an affiliate or successor.
• The clause for indemnification did not exclude amounts reimbursed by owners or affiliates.
• The arbitrator had the power to consider company B’s status because the issue was raised by Rexnord and RHI in the arbitration.
• Company B was a “successor” under the agreement even though it had subsequently sold Rexnord to company C.

This is a lesson for contracting parties. Even though some language may appear rote or inapplicable, understanding the effect of that language in the context of the deal and knowing the obligations it imposes may help in your transactions and knowing what a court will do can add certainty to the language you are choosing. The inclusion or exclusion of any contractual clause is a determination best made by the parties after considering the eventualities, risks and obligations they wish to plan for.

 

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The situation is common… You’ve decided to build, there’s a building on the site and you need to tear it down and excavate in order to construct your project. You get a policy for the work, but you’re not performing it – you’ve hired a contractor who’s hired a sub to do the tear-down and excavation. Something goes wrong during the excavation and the building next to your site is damaged, or collapses… sometimes beyond repair.

You are sued, and beyond looking to your contractor and the subs for indemnification and possible coverage under their policies, you figure, “no sweat, I’ve got my own policy,” so you tender the complaint to your own carrier expecting coverage under a policy that you’ve paid for… but your insurance company says “sorry, you’re not covered here… take a look at the exclusions.”

They point you to a standard comprehensive general liability policy (CGL) exclusion that continually has varying application:

EXCLUSION - CONTRACTORS AND SUBCONTRACTORS

The following exclusion is added to Paragraph 2. Exclusions of SECTION I - COVERAGE A - BODILY INJURY AND PROPERTY DAMAGE LIABILITY, COVERAGE B - PERSONAL AND ADVERTISING INJURY LIABILITY and COVERAGE C - MEDICAL PAYMENTS:

This insurance does not apply to "bodily injury", "property damage", "personal and advertising injury" or medical payments arising out of operations performed for you by contractors or subcontractors you hire or your acts or omissions in connection with your general supervision of such operations.

Your carrier feels so right about the determination that they file suit seeking a declaration that there is no coverage under your policy, a court agrees… and just like that, you’re back to hoping that your contract with your GC has an indemnity provision and requires that someone name you as an additional insured.

The recent, Seventh Circuit case of Nautilus Ins. Co. v. 1452-4 N. Milwaukee Ave. LLC, has done a good job in both analyzing this matter and making it understandable for owners who find themselves in this predicament. 

The situation in Nautilus is that described above. The owner/developer was sued under multiple theories including negligence and liability under the Adjacent Landowner Excavation Protection Act (740 ILCS 140/0.01 et seq.) after the work of its GC/subs caused damage to building next door that required the demolition of the neighboring building.  A copy of the original complaint filed by the insurance company with the policies attached is here.

Here’s what was at the spot:

Here’s what it looked like after it was demolished:

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The insurance company moved for a determination that there was no coverage under the policy based on the Contractors and Subcontractors exclusion (along with another exclusion – which was not terribly relevant to the appeal). The district court found that there was coverage and the company appealed - on appeal the court held that the exclusion applied and there was no coverage given that the policy’s exclusion was clear and that all the theories for recovery advanced against the owner were directly caused by the work of the GC/subs… to which the exclusion applied.

The theories of liability directly attributed to the damage cause by the GC/subs made for an easy determination under the policy language, but the owner raised an interesting argument with respect to the statutory claim:  it was the failure of the owner to give the required notice to neighboring owners under the act that gave rise to liability under the statute… so the statutory claim should be covered because liability under it was directly caused by the owner.

The court said that the statutory claim against the owner was also not covered because it sought “recovery for the same loss as all the other claims – the property damage arising out of the faulty excavation performed by [the owner’s] contractors and subcontractor – and coverage for that property damage is excluded by the contractor-subcontractor exclusion.”

In normal situations there would be other opportunities for coverage or indemnification by contract. An owner would likely have included the indemnity provision in its contract with its GC as well as a provision requiring indemnity or that it be named as an additional insured on the GC/subs policies.  

 

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News & Notes is a section we have dedicated to interesting items that do not contain enough information to have full entries but are certainly worth noting.

Blair Kamin over at the Chicago Tribune’s Skyline Blog has posted some interesting stories:

Today’s is a piece on Chicago philanthropist Richard Driehaus’ announcement at a Landmarks Illinois event on Saturday night of the creation of grant program to preserve Historic Illinois Courthouses – certainly of interest to anyone in the restoration business.

Skyline also has this piece featuring an article about the new Blue Chip Casino Hotel  in Michigan City by Chicago architect Lucien Lagrange.

Additionally, the best video of the Trump spire going into place comes from the Tribune.

The South Carolina Construction Law Blog has an article detailing a New York case interpreting a New York statute similar to Illinois’ own Construction Contract Indemnification for Negligence Act. The Illinois statute has become a must-know for anyone in the industry since the Virginia Surety decision and carries the possibility of drastically altering the limitation of liability that would otherwise be in place for parties under the worker’s compensation statutes.

We’d also like to be the first to welcome the Chicago Construction Law Developments blog to the blogosphere. Illinois is gaining independent information sources for its construction industry at a fast pace.

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Michael Downs v. Rosenthal Collins Group, LLC, (Ill. App. 1^st, Doc. No. 1-08-0636) will be of interest to anyone reviewing their own contracts.  The case involves a contract's indemnity provision and whether or not it included an indemnification for attorney’s fees.

In a prior action, the plaintiff, a CEO and Member of a limited liability company, had been sued for breach of his fiduciary duties and breach of contract.  He successfully defended those claims and then filed a separate action against the corporation for breaching their agreement to indemnify him by not paying him for the attorney’s fees he expended in the prior case.

The agreement’s indemnification provision read:

“21.2  The Company shall indemnify each Member for any act performed by such Member with respect to Company matters permitted by this Agreement and/or Majority Approval, but in no event for fraud, willful misconduct, negligence or an intentional breach of this Agreement.”

The plaintiff argued that because only the word indemnify was used, it should be interpreted to have a broad meaning that included attorney’s fees.  The court analogized this case to a case where the word “defend” had been used in the indemnification agreement… “to protect, defend, indemnify and hold harmless” and noted that the agreement in this matter failed to use such language.  Combining the contract’s lack of specificity regarding attorney’s fees and noting that the American system of jurisprudence favored parties bearing their own costs and attorney’s fees unless otherwise agreed, the court found that attorney’s fees were not included in the agreement.  The court went on to state that a well-settled bright-line rule on the issue provided certainty in the law and would put parties on notice to include precise language on attorney fees when negotiating their contracts.

The lesson is to ensure that you’ve included or at least considered whether you want an attorney fee provision in your indemnification clause.  Although the court in this case seems to agree that the word “defend” added to the word indemnify may have made things come out differently, it would be best to specifically request the fees and/or costs that you want.

 

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    A surety issues performance bonds to a contractor.  A third-party signs an indemnification agreement with the surety, agreeing to indemnify the surety for the payments made on the bonds.  The contractor breaches its contract for construction services and the surety pays out on the bonds.  The payments were made between 1994 and 1996.  The  surety demands payment, the third-party refuses and in 2004, the surety sues for breach of contract stating that the third-party has breached the indemnity agreement.

    That’s the start of the situation in Travelers Casualty & Surety Company v. James Bowman et al. (Ill. Sup. Ct. 2008, Doc. No. 103759).  The trial court dismissed the action of the surety, Travelers, finding that section 13-214(a) which applies a four-year statute of limitations to certain construction actions applied.  Travelers appealed and the appellate court held that the section 13-206 10 year statute of limitations applied to the action.

    For those interested, section 13-214(a) and 13-206 read in relevant part as follows and are important to anyone contracting in the construction setting as they are the statutes of limitations usually found applicable to actions arising from disputes over construction agreements:

• 13-214(a)

“Actions based upon tort, contract or otherwise against any person for an act or omission of such person in the design, planning, supervision, observation or management of construction, or construction of an improvement to real property shall be commenced within 4 years from the time the person bringing an action, or his or her privity, knew or should reasonably have known of such act or omission. Notwithstanding any other provision of law, contract actions against a surety on a payment or performance bond shall be commenced, if at all, within the same time limitation applicable to the bond principal.”

• 13-206

“[A]ctions on bonds, promissory notes, bills of exchange, written leases, written contracts, or other evidences of indebtedness in writing … shall be commenced within 10 years next after the cause of action accrued…”

    Travelers asserted in the Supreme Court that the appellate court was right and that a 10 year statute of limitations was correct since they had brought a claim for breach of contract based on the indemnity agreement with the third-party.  The third-party claimed that either the four-year statute of limitations applied, or that an even shorter two-year statute of limitations for contribution and indemnity expressed under section 13-204 applied.

     The Supreme Court agreed with Travelers.  The court noted that it is the nature of the liability to which a person is subject and not the nature of the relief sought by a party is the test for determining the character of a cause of action.  In other words no matter what an attorney might call an action, it is the underlying nature of the action and the facts of the dispute that will determine what kind of action it is.

    Here, although construction omissions had led to the payment by Travelers on the bonds, the payment on the bonds triggered obligations under the separate indemnity agreements with the third-parties and when the third-party refused to pay under the indemnity agreements, Travelers had a cause of action against them for breach of contract.

    With regard to the second theory of a two-year statute of limitations, the Supreme Court held that the third-party was incorrect in claiming that any of its cases had ever held that a two year statute of limitations would ever apply to actions based on written indemnification agreements.  The court stated that the claims of indemnity and contribution addressed under the section 13-204 addressed “cases involving the allocation of damages in connection with an underlying tort claim for injury to person or property.”  It went on to state that such a claim based on indemnity was only for “implied indemnity” (where the law offers indemnity) not for the express indemnity (where the indemnity claim is based on an agreement providing that one party will indemnify the other). 

“In sum, section 13–204 is applicable to claims for implied indemnity involving allocation of damages in connection with an underlying tort claim for injury to person or property, regardless of whether subsection (a) or (b) is at issue. Section 13–204 is not applicable to claims for express indemnification based on a written contract. Because the claim at issue is based on a breach of express indemnification provisions in a written agreement, it is subject to the10-year limitations period in section 13–206.”  Slip. Op. at 12.

The court then held that the 10 year statute of limitation applied to the indemnity agreement.

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            There's an interesting This American Life episode about the current mortgage crisis entitled "The Giant Pool of Money" (the link lets you listen for free).  It's a primer on the current mortgage crisis and how we got into the mess that's currently being reported on across the internet.  The effects are varied and will continue to expand, today's Wall Street Journal has a page one piece on the mortgage insurance industry and its own response to the crisis.  The TAL is a must-listen and takes you through the history about how the financial industry's craving for investment instruments led to brokers offering mortgages with no money down to individuals without verifying salary histories.

            While the spot is an introduction, it gives context for a recent case that should pique the interest of financers.

            In First Franklin Financial Corporation v. Amerihome Mortgage Company (IL N.D. Doc No. 08 C 1089) we find First Franklin (a financer) suing Amerihome (a company acting as an independent mortgage broker for First Franklin) to recoup the monies from defaulted mortgages.  Amerihome entered into an agreement with First Franklin to act as a mortgage broker.  The agreement contained an indemnification provision and a provision requiring Amerihome to investigate and verify the information about an applicant's creditworthiness by asserting that the information contained in the application and supporting documentation for the loan was true.  Sure enough, some of those applications were for borrowers who later defaulted on their loans.  First Franklin filed an action against Amerihome alleging that Amerihome breached its agreement with First Franklin by submitting loan applications with false information and alleging that Amerihome has a duty to indemnify First Franklin for the losses incurred because of the breach.

This case is unique in that Amerihome is solvent.  For too many lenders, the mortgage brokerages they have dealt with have since gone out of business, or have filed for bankruptcy.  It is also unique in that Amerihome may be able to pay the amount First Franklin alleges it is owed, while smaller mortgage brokers would have a harder time coming up with the cash to satisfy a judgment for the amount of an entire mortgage deficiency.

Amerihome filed a motion to dismiss the action for indemnification claiming that the indemnity provision which the court denied and the case will now go forward.  If you've heard the TAL piece, then it should come as no surprise that a company is going after the individuals that procured the investment for it in the first place, and of course it doesn't hurt that First Franklin apparently insisted on the indemnification provision in the first place.  It will be interesting to see how actions such as this one continue to develop as institutions investigate ways to recoup their losses. 

[UPDATE]:  Bill Henderson, professor at Indiana University School of Law is also asking some questions about this debacle today on the Legal Profession Blog.

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In Stoneridge, the court addressed the issue:  Whether an insurance company needs to provide coverage to its insured as well as to an additional insured under the policy.

A company had built townhomes and sold one to the Walskis.  Six years after the Walskis bought the home, they sued Stoneridge, the home company, because structural problems in the compaction of the soil underneath the home had cased the home to move, crack and fail.  Claims were filed against Stoneridge and an additional warrantor as well as several other parties.  Stoneridge tendered the complaint to its insurer and the insurer defended under a reservation of rights.  An arbitration award against Stoneridge and in favor of the Walskis, afterward Stoneridge pursued an action for declaration that its insurer had a duty to indemnify it which had been pending.

The parties to the declaratory action all filed motions for summary judgment.  Stoneridge and those arguing on its behalf (it has since gone insolvent) argued that the insurer was estopped from denying coverage where it had arguably accepted that coverage for an implied warranty of habitability claim may exist by failing to explicitly deny such coverage in its reservation of rights letter and where the appointed counsel for Stoneridge had sought to have that claim dismissed in the arbitration seven separate times while not failing with such vigor to motion for the dismissal of the uncovered breach of contract claim.  The trial court agreed and found that the insurer was estopped from denying coverage to Stoneridge under the policy.

The insurer appealed and the appellate court reversed the trial courts estoppel decision and also found that there was no coverage under the CGL policy for the damage caused to a house by the settling of a house due to improper compaction of the soil.

In the first portion of the opinion regarding estoppel the court determined that the insurer was not estopped from denying coverage because it had never said there would be coverage.  The letter had properly categorized both the breach of contract claim and the implied warranty of habitability claims as being contractual in nature and expressed doubt as to the existence of coverage under the policy in its reservation of rights letter.

Note that in reaching this opinion, the court reaches two others:

• A trial court may properly examine a reservation of rights letter in determining whether there is a conflict of interest between an insured and an insurer and is not relegated solely to considering the policy and the underlying complaint.

• The implied warranty of habitability is a contractual claim under Illinois law.

In determining that no coverage existed under the policy the court cited to several other opinions holding that the damage caused directly to a project by faulty work was not an "occurrence" as defined in the policy because it was not accidental in that it could be foreseen that cracks and failures in the project would be the necessary result of faulty workmanship and improper construction techniques.  In defining "property damage" the court also held that there was not property damage in this instance that would be covered by a CGL policy because the clause did not apply to damage to the project, but to damage to other property which was not the project.  (i.e., if the townhouse fell onto someone else's house or their car, that would be "property damage" as defined under the policy).  The court also reiterated the holdings of several other Illinois opinions finding that CGL policies do not include coverage for damage to the project by faulty workmanship and that contrary to other jurisdictions, an exception for subcontractors to an exclusion for faulty work in the standard CGL policy that, in other jurisdictions has been interpreted to provide coverage for damage to the project when the fault work was performed by a subcontractor, is not applicable in Illinois because in Illinois, there is no coverage under a CGL policy for damage to the project from faulty work, period.

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In McGrath, et al. v. American Family Mutual Ins. Co. (N.D. IL, 07 C 1519) the court has delivered some poignant remarks concerning both the standard under Daubert for expert engineer testimony as well as provided some issues to think about regarding the "latent defect" and "construction design defect" exclusions issued under all-risk insurance policies.

The plaintiffs submitted a claim to their insurance company for water damage inside their home.  The insurance company denied coverage based on two exclusions in the policy, one for construction or design defects and one for latent or inherent defects.  The plaintiffs sued, and the insurance company hired an engineer to provide an opinion regarding the cause of the water damage.  Motions for summary judgment and for judgment under Federal Rule 56(d) limiting the issue of liability were cross-filed.

The engineer had found that external water or moisture from humidity, ice, snow and rain had penetrated the exterior brick walls of the plaintiffs' home due to construction or design defects. 

The plaintiffs moved to have portions of the testimony of the defense expert stricken by questioning his methodology.  Plaintiffs asserted that the expert needed to perform in depth testing of the humidity levels to provide precise calculations regarding his opinions.  The court ruled that the pictures examined by the expert provided enough information for someone with his experience to reach an acceptable opinion regarding the intrusion points of the moisture and that in-depth analysis was not necessary.

The court then went on to interpret the policy exclusions for construction and design defects and latent defects against American Family and in favor of the plaintiffs.  In assessing the nature of the water damage, the court found that because the exclusion failed to include language addressing exclusions for losses resulting from ancillary damages caused by a design or construction defect, that the exclusion only applied to the actual defect and not to the water damage to other portions of the home caused by the defect.  In assessing the latent defect exclusion, the court found that the latent defect exclusion applied to "a hidden defect other than a construction or design defect."  The court analogized latent defects to hidden defects that are unrelated to construction or design such as finding lead paint under layers of previous coats.

Given its conclusions that no exception applied, the found that liability under the policy was established and that the only issues for trial were the amount of damages.

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This is a procedural case.  A worker was hurt on a school construction site.  A lift rolled over and fell on him.  He sued the school district, the electrical contractor that the school district had contracted with for sound equipment and the design-build architect for the project.  The insurer for the electrical contractor brought a declaratory judgment action in federal court against the architect and the school district to determine whether exclusions to the policy applied to those defendants as additional insureds.

For carriers, there's an interesting point about federal law governing necessary parties to a declaratory action:

"Underlying tort claimants are not necessary parties to a declaratory judgment action regarding an insurer's duty to defend what the action is filed by the insured.  However, if the declaratory judgment action is filed instead by the insurer or involves a determination of insurance coverage or both, then the underlying claimant is considered a necessary party."

The plaintiff's in the underlying tort action had been brought in as defendants by the insurance company and asked that they be dismissed or that the action be stayed until their underlying claim was resolved.   The court held that it could dismiss the underlying tort plaintiffs from the action, and that a decision regarding the insurers duty to indemnify the school district and the architect would be stayed until judgment in the underlying proceeding.  The court determined that it could not stay the portion of its case regarding the insurers duty to defend the school district and the architect and allowed that claim to progress since the duty to defend was a ripe issue where the underlying tort action was progressing.  The opinion is available here.

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In Cincinnati Insurance Company v. Taylor Morley, Inc., (Doc. No. 06-cv-1035-MJR, S.D. Il, 2008) the Southern District of Illinois has issued a coverage opinion reaffirming the substantive Illinois law.   Construction defects alleged by a buyer against a builder and claims by buyers against a builder for diminished property values because of the builders failure to fulfill its contract and construct a "championship golf course" around which their homes were to have been built, are not afforded coverage under a CGL policy. 

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    A case from the Northern District (Smith v. The Village of Norridge), involving actions brought by an individual against the police, a landlord shopping center and its tenant, emphasizes the significance of indemnity provisions in a contract.

   At issue are cross-claims filed by the landlord of the facility arguing that the tenant is required to indemnify the landlord under a paragraph of the lease which reads that the tenant must:

"[i]ndemnify and save Landlord ... harmless from and defend against any and all demands,claims, actions, damages, costs and expenses, including [costs and attorneys' fees] arising from the conduct or management of the business conducted by Tenant."

  The lease contained a similar provision requiring the tenant to procure insurance for such acts and that the insurance was required to cover the landlord as well.  The cross-claims are pled as breach of contract actions stating the because the contract contains the indemnity provisions, the tenant's failure to indemnify (and obtain insurance in the second claim) amounts to a breach of the contract.

  The court disagreed with the tenants' argument that the Illinois Landlord-Tenant Act (765 ILCS 705/1(a)), which provides:

"(a) Except as otherwise provided in subsection (b), every covenant, agreement, or understanding in or in connection with or collateral to any lease of real property, exempting the lessor from liability for damages for injuries to person or property caused by or resulting from the negligence of the lessor, his or her agents, servants or employees, in the operation or maintenance of the demised premises or the real property containing the demised premises shall be deemed to be void as against public policy and wholly unenforceable."

would bar this action.  The Court found that the provision would apply if the claim against the tenant had been one for indemnity for the negligent acts of the landlord.  However, the landlord pled an action for breach of contract, and the acts alleged as the root of the claims were intentional, so under two separate rationales, the ILTA did not apply.

 
  Accordingly, the court denied the tenant's motion to dismiss the cross claims.

 

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    Here's a Seventh Circuit decision (Foskett v. Great Wolf Resorts, et al.) full of information regarding claim accrual for negligent design, indemnification, and the theory of risk allocation.  Two parties had entered into an asset purchase agreement with mutual indemnification clauses.  Buyer and Seller had agreed to a sunset provision in Seller's indemnification provision.  A claim accrued after the sunset provision and, on appeal, the court enforced the provision.

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