Is Indemnifying Party Bound by Settlement?

By John S. Mrowiec

Possibly all construction contracts contain indemnity provisions. Contractors indemnify owners, and subcontractors indemnify contractors.

Under the indemnity provision, the party indemnifying (the indemnitor) protects the other party (the indemnitee) from the consequences of claims made by third parties. What acts or omissions are sufficient to trigger the indemnity obligation depend on the language of the indemnity provision. Using the owner-contractor context as an example, the indemnity provision might require that the underlying claim arise from “the performance of the Work by Contractor” or from “an act or omission of the Contractor.”

Commonly, after a third party, such as an injured worker or another, sues the owner-indemnitee, that party demands indemnity protection. The contractor-indemnitor might then deny any obligation to indemnify arguing the trigger to indemnity has not occurred or will never occur.

Depending on the language of the indemnity provision, the contractor-indemnitor’s argument might be that the underlying claim does not arise from the contractor’s performance of the work or from its acts or omissions.

The underlying claim will proceed, the owner-indemnitee might settle before trial, but the contractor might refuse to settle. The owner then seeks reimbursement from the contractor-indemnitor. Is the contractor-indemnitor bound to reimburse the owner for the settlement payment? That was the question in the recent decision of Estate of Williams v. Southern Illinois Gas & Electric Co., 2008 U.S. Dist. LEXIS 18046 (S.D.Ind., March 7, 2008).

Suit Arises After Explosion

An owner, Southern Indiana Gas and Electric Co., contracted with Iowa Pipeline Associates Inc. as contractor to update the utility’s gas lines. The contractor performed the work. Years later, a gas explosion occurred at a house of a utility customer killing two and injuring several others.

A fire department investigator determined that the explosion resulted from a water-company employee mistaking a gas valve for a water valve, turning on the valve, gas leaching into the soil and then into the house’s basement and igniting when one of the owner’s employees attempted to relight the furnace pilot. The asserted liability against the contractor was that the contractor had failed to remove a stop box containing the gas valve as required by the contract.

The estate of one of the deceased sued the owner, the contractor and others. The owner sought indemnity from the contractor. The indemnity provision read that the contractor owed indemnity to the owner from claims of third parties for injuries or property damage “growing out of the performance of this Contract.”

The contractor denied any indemnity obligation on a number of grounds. Included among the contractor’s arguments was that the underlying claim was caused by the actions of the employees of the water company and the owner, not the contractor’s failure to remove the stopbox.

Contractor Denies Liability

Settlement discussions occurred among all parties. All settled except the contractor “steadfastly denying liability for the explosion or any obligation of indemnity to [Owner]” Estate of Williams, 2008 U.S. Dist. LEXIS 18046 at *3.

The owner paid the claimant $1,950,000 in settlement. The owner then moved for summary judgment on the owner’s indemnity claim against the contractor seeking a judgment that the contractor reimburse the owner the full amount of the settlement payment.

Applying Indiana law, the trial court denied the owner’s motion for summary judgment finding there were questions of fact that could be determined only by a trial.

The contractor disputed that the underlying claim arose during the performance of the contractor’s work, the trigger to the contractor’s obligation. No court had determined the cause of the explosion because the owner had settled with claimant. Accordingly, the owner had not yet met its burden to trigger the indemnity. That had to await the outcome of a trial, Estate of Williams, 2008 U.S. Dist. LEXIS 18046 at *20.

Further, even if a trial determined the explosion had been caused by the contractor’s performance of the work, it did not necessarily follow that the contractor would have to reimburse the full amount of the owner’s settlement payment as the owner argued. The owner contended that by refusing to indemnify, the contractor had relinquished any right to question the amount of the settlement citing Sequa Coatings Corp. v. Northern Indiana Commuter Transportation, 796 N.E. 2d 1216, 1230 (Ind. App. 2003).

Estate of Williams distinguished the Sequa Coatings case cited by the owner on the ground that the indemnitor in that case was held to have acquiesced the settlement for failure to respond to the indemnity demand or to participate in settlement negotiations at all. By contrast, in Estate of Williams, “Contractor notified [Owner] almost immediately that it (through its insurer) was denying the indemnity claim” and then attended mediation sessions, the Estate of Williams court held.

When, as here, the law imposes a reasonableness requirement on an indemnitee settling a third-party claim, it would be particularly unjust if, at the same time, it imputed a waiver of that required reasonableness on the indemnitor who has clearly and consistently alerted the indemnitee that it is challenging its indemnity obligation under the contract, Estate of Williams, 2008 U.S. Dist. LEXIS 18046 at *23-24.

The lesson of Estate of Williams is that active protest of the indemnity obligation and participation in mediation may preclude the indemnifying party from being bound to the indemnified party’s settlement with the underlying claimant absent a trial.