New Supreme Court of Virginia Case Demonstrates the Peril of Bad Indemnity Clause

A general contractor could not recover indemnity from any of its subcontractors for losses the general contractor sustained as a result of an owner's claim for defective workmanship because of an indemnity agreement that was too broad under Virginia law. In Hensel Phelps Construction Co. v. Thompson Masonry Contractor, decided late last week by the Supreme Court of Virginia, Hensel Phelps sued four of its subcontractors and their performance bond sureties to recover monies it had to pay Virginia Tech for defects in work performed on a student health and fitness center.

The project began in 1997 and was completed in 1998. Over a decade later, Virginia Tech discovered defects in the project's construction, and in 2012 asserted a claim against Hensel Phelps for over $7 million. When Hensel Phelps's subcontractors refused its demand to pay costs attributable to their defect workmanship, Hensel Phelps settled with Virginia Tech for $3 million and then sued the subcontractors and their sureties for breach of contract and indemnity. The subcontractors requested the court to dismiss the suit, arguing that the five year statute of limitations applicable to the contract claims had expired and that the subcontracts did not include provisions sufficient to impose indemnity obligations upon the subcontractors. The trial court agreed and dismissed the suit against the subcontractors in its entirety and Hensel Phelps appealed to the Supreme Court of Virginia.

Because the statute of limitations does not run against the Commonwealth or its agencies, Hensel Phelps could not assert that the claim brought by Virginia Tech over ten years after completion of the project was barred as untimely. On appeal, Hensel Phelps argued that the flow down and incorporation by reference provisions of its subcontracts, which required that the subcontractors were bound to Hensel Phelps to the same extent that Hensel Phelps was bound to Virginia Tech, constituted a waiver of the subcontractors' right to rely on the five-year statute of limitations applicable to the written subcontracts.

The Supreme Court disagreed. The court noted that under Virginia law, a waiver of rights must be shown by proof that the party giving up a right has knowledge of the right's existence and intends to relinquish the right. Such a waiver, ruled the court, could not be read into a general flow down provision or the mere fact that the subcontract incorporated the prime contract by reference. The court ruled that Hensel Phelps's breach of contract claims against the subcontractors were therefore time barred.

As for Hensel Phelps's indemnity claims, the statute of limitations for indemnity does not begin to run until the party seeking indemnity, in this case Hensel Phelps, has paid or discharged the obligation to the injured party. Thus, if the subcontracts contained an enforceable indemnity provision, Hensel Phelps could lawfully request that the subcontractors reimburse it for monies it paid to Virginia Tech.

Each of the subcontracts contained an indemnification provision that required the subcontractor to indemnify Hensel Phelps and others from any claim arising from personal injury or death or property damage resulting from the work performed "including any claim or liability arising from any act, error, omission, or negligence" of Hensel Phelps. Because this provision required the subcontractor to indemnify Hensel Phelps for Hensel Phelps's own negligence, however, it was void under Virginia law. In recognition of this, Hensel Phelps did not seek indemnity from its subcontractors under the indemnification provision. Instead, Hensel Phelps argued that several other subcontract provisions contained language that required the subcontractors to indemnify it for monies paid to Virginia Tech. The court examined each of these provisions and determined they could not be read to require an obligation of the subcontractors to indemnify Hensel Phelps for its losses, "particularly when there is a freestanding, albeit ineffectual, indemnification provision in the contract." The court ruled that Hensel Phelps's indemnity claims against the subcontractors failed because there was no enforceable indemnity agreement in the subcontracts.

The painful lesson from this case is obvious and of particular importance to contractors and construction managers performing work under contracts with the state and its agencies: since the statute of limitations is no bar to actions by the state, and government contractors therefore can face liability for defective construction many years after a project is complete, it is vital that contractors' subcontracts contain clear and lawful indemnification provisions so that liability can be shifted downstream to the subcontractors responsible for the defective work.