Contract Indemnity and Duty to Defend vs. Insurance Duty to Defend

A New Hampshire court has issued a thoughtful decision on the duty to defend arising from an indemnity obligation in a design contract. The court distinguished between the duty to defend often invoked for insurance coverage, from a duty to defend expressed in a contractual indemnity. Just the same, the court decided that an engineering firm owed a duty to defend the New Hampshire town that had hired the firm to design a wastewater treatment plant, from claims against the town made by the contractor arising from the design.

The Town of Newport, NH, was under an administrative order issued by the EPA after violating effluent limits in an NPDES permit. It engaged an engineering firm to design a new treatment plant or process. The engineer recommended a disc filter system, to implement a coagulation followed by direct filtration method of processing. The design was prepared, a contractor hired, but the project was never completed as the plant failed to perform as designed. The town never fully paid the contractor, who then sued the town.

In its design contracts (three contracts: for preliminary evaluation, study phase, and complete design), the engineer agreed to indemnify the town, via identical clauses. More specifically –

To the fullest extent permitted by law, the Engineer shall indemnify, exonerate, protect, defend (with counsel acceptable to the Town of Newport), hold harmless and reimburse the Town . . . from and against any and all damages . . . claims (including, without limitation, claims predicated on theories of negligence, fault, breach of warranty, products liability or strict liability), litigation, demands, . . . of any kind or nature whatsoever . . . asserted against, or awarded against the Town of Newport which are in any way related to the Engineer’s performance under this Agreement but only to the extent arising from (i) any negligent act, omission or strict liability of Engineers, . . . (ii) any default by the Engineer under any of the terms of covenants of this Agreement, or (iii) any warranty given by or required to be given by the Engineer relating to the performance of the Engineer under this Agreement.

The town demanded that the engineer indemnify and defend the town from the contractor’s claims, and cited insurance cases in support of its position that the engineer owed a duty to defend from the outset against allegations of the engineer’s negligence or breach. The engineer responded, that its duty to defend would not be established until its negligence or breach had been proven, and that it might then be liable for defense costs in proportion to its liability.

The court noted three factors to distinguish cases concerning insurance policy language from cases concerning contract indemnities. First, insurance policies are entered into to afford insurance coverage, and so any ambiguity is normally construed against the carrier. A contract indemnity clause, however, would be strictly construed by its plain language.

Second, many insurance cases are brought as declaratory judgment actions, and the NH declaratory judgment statute pertaining to insurance states that the insurance carrier bears the burden of proof to demonstrate lack of coverage. In contrast, the burden of proof on a contract indemnity clause would remain with the indemnitee seeking a defense.

Third, insurance policies and associated court cases have long distinguished between the duty to defend and the duty to indemnify, based on the scope of coverage. For a contract indemnity clause, however, normal rules of contract interpretation should apply.

Having distinguished many of the cases cited by the town, in favor of compelling the engineer to provide a defense, the court continued to review the plain terms of the indemnity clause quoted extensively above. It noted that parties are free to draft a duty to defend clause that may be broader than the indemnity, or commensurate with the indemnity, or to be determined only after the scope of the obligation to indemnify has been determined. Looking at the clause in question, the court held that the “language anticipates unproven allegations, meaning the duty to defend would necessarily arise prior to any factual finding as to [the engineer]’s negligence or breach.” It noted that this interpretation was consistent with the parenthetical calling for counsel “acceptable to the Town”.

The engineer’s position, per the court, would recast the indemnity clause to require only reimbursement of defense costs after the fact, and would render portions of the clause meaningless. Relying on long-standing (and almost universal) case law that attempts to give meaning to all clauses in a contract, the court held that the indemnity clause required the engineer to enter a defense of the town against the contractor’s claims. Thus, when the engineer failed to do so, that failure amounted to a breach of the engineer’s agreement, and the town was granted summary judgment against the engineer on the cause of action for a defense.

The lesson? An explicit contractual duty to defend against allegations of negligence or breach by the indemnitor may well be construed to require such a defense from the outset, even when parties are still arguing over ultimate liability. And an indemnitor who has not been in breach of its contract up to that point may yet breach its contract by refusing to defend when required.

The case is Penta Corp. v. Town of Newport, 2016 N.H. Super LEXIS 7 (May 11, 2016).