New Restrictions to Contractual Defense and Indemnity
Category | Briefing Papers
Hugh is a shareholder in the firm’s Construction Law Department. He can be reached at 612.359.7663 or Hbrown@fwhtlaw.com
A significant result of Minnesota’s 2023’s legislative session is a new law restricting the “duty to defend” that one party can require of another under a construction contract. By restricting agreements to provide a defense to another party, the new legislation introduces a significant complication that contractors must address through their contracts.
New Legislation
Minnesota’s anti-indemnity statute,[1] first enacted in 1984, makes unenforceable indemnification agreements in construction contracts except[2] to the extent that the underlying claim is attributable to the negligent or wrongful act of the party providing the indemnity (or that party’s contractors, agent, or employees). Until 2023, the term “indemnification agreement”[3] was limited to agreement to “indemnify or hold harmless,” and accordingly, the statute did not restrict agreements to defend another party for that party’s negligent or wrongful acts or omissions. However, in the 2023 session, the Minnesota legislature added the term “defend” to the list of agreements prohibited by Section 337.02.[4]
The effect of this subtle change is significant. What we often generically refer to as “indemnity” provisions generally contain two duties – the duty to indemnify and the duty to defend. The duty to indemnify is a duty to pay for losses incurred by the indemnified party. As originally drafted, the purpose of Section 337.02 was to prohibit a party from requiring another party to pay losses caused by the other party’s negligence. The duty to defend is a separate and distinct duty, requiring the promisor to defend the promisee against lawsuits, either by appointing counsel on their behalf or by paying attorneys’ fees. With the passage of the amendment to 337.02, parties are now prohibited from agreeing to defend another party when the negligence of the party receiving the defense gives rise to the matter being defended.
Implications
The amendment to Section 337.02 will benefit downstream contractors who are contractually obligated to provide a defense. Moreover, it may well eliminate some situations that were unquestionably unfair, such as upstream contractors forcing their downstream contractors to fully defend them for claims that had little connection to any fault of the downstream contractor. However, these benefits carry complications.
First, the new legislation will, in many cases, result in no defense being provided at all – even for claims significantly caused by the downstream contractor’s negligence – until the trial is over and the percentage of fault is determined. In other words, the new legislation creates an allocation problems – how can the upstream contractor know the extent of the defense to which it may be entitled when the downstream contractor’s liability has not yet been established? As an example, a contractor may think its downstream contractor is negligent for an accident for which it has been sued, and tenders its defense expecting to get 100% of its defense costs paid. If the downstream contractor claims the upstream contractor was somehow also negligent, it can refuse the tender of defense until the percentage of liability has been finally determined after a full trial in court. Ultimately, the upstream contractor may be found correct and that the downstream contractor does owe 100% of its defense costs, but that won’t happen until AFTER trial, and then the upstream contractor has only a monetary claim for defense fees and costs. Since about 85% of cases settle before trial, this means the upstream contractor won’t get to recover its defense dollars, unless that is part of the settlement. And attorney fees are rarely, if ever, recovered as part of a settlement as parties are routinely asked to waive their claims for attorney fees in the first or second round of negotiation or mediation.
Second, unless the request to defend is accepted completely and there is no dispute about fault, the aggregate amount of attorney fees incurred in a case will increase, because each party will have to retain and pay for its own attorney. Under the prior version of the statute, contractors could rely on their lower-tier contractors for a complete defense. A leading treatise described the advantages of such an arrangement:
Because the contractual arrangements are such that liability is funneled down through the contracting chain, there is less need for upper tier contractors and the owner to retain counsel and otherwise devote time and resources in investigating and resolving these matters. Instead, they simply tender defense down through the contracting chain until responsibility and liability rests with that [lower tier contractor] who, by contract, has agreed to be responsible for the loss.[5]
Under Minnesota’s new legislation, however, upstream contractors can no longer rely on their downstream contractors for a complete defense up front. They will need to take a far more active role in investigating and defending claims, if the downstream contractor contests the percentage of fault attributed to it. This may lead, in some instances, to upstream contractors paying for a complete defense in cases in which they may have little practical exposure.
Recommendations
So how should upstream and downstream contractors react? Much boilerplate “duty to defend” contract language that was permissible before will no longer pass muster or be fully enforceable under the new statute. Upstream contractors will almost certainly need to revise their form downstream contracts to avoid running afoul of the new law. Downstream contractors will want to review the proposed contracts they receive to ensure they are not asked to bear costs for which they are not responsible. This will be a relatively easy exercise, and both should do this promptly.
A more difficult, but more impactful, question is whether an upfront duty to defend will survive the new amendment. If the upstream and downstream contractors disagree about their respective fault, will the upstream contractor be able to obtain a defense or will the question be delayed until the end of a trial in which a final fault determination is made? If the question of whether and to what extent a defense is due is delayed until after trial, the duty to defend will not really be provision of a defense but an indemnity of the costs of defense payable after trial.
Perhaps the duty to defend will still survive in cases in which one party acknowledges it is at fault. Even in cases in which the downstream contractor does not acknowledge complete liability, it should at least agree to pay for the costs of defense up to the percentage of fault it does admit. But there remain many instances where the parties hotly contest their respective liability, and we have been asked by both upstream and downstream contractors to draft contracts to address these situations. We believe there are contractual solutions that will not only preserve the upfront duty to defend but also respect the new statutory requirment that downstream contractors not bear costs beyond the extent of their liability.
[1] Minn. Stat. § 337.02.
[2] A second exception allows owners to indemnify contractors for strict liability under environmental laws.
[3] Minn. Stat. § 337.01, subd. 1a.
[4] See MN Laws, Ch. 53, Art. 7, Sec. 4. A parallel change was made to Minn. Stat. 15.71, subd. 1a, concerning government contracts.
[5] § 10:12. Policy considerations in favor of risk transference through express indemnity, 3 Bruner & O’Connor Construction Law § 10:12.
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