Smoketree-Lake Murray, Ltd. v. Mills Concrete Construction Co.

Opinion

Smoketree-Lake Murray, Ltd., Brehm Construction Company and Forrest W. Brehm (hereafter Developer) appeal a judgment on a cross-claim for indemnification. On appeal, Developer contends the judgment must be reversed because the trial court erred in ruling a fraud finding barred indemnification and failing to find the jury committed misconduct. We reverse.

Facts

In 1985, the Smoketree-Lake Murray Owners’ Association, Inc., sued Developer and others for damage to their condominium complex. These damages manifested themselves as cracks in walls and slabs, doors which would not close properly, patios which pulled away from buildings and cracks causing leaks in the complex’s swimming pool. Developer eventually settled with the Association for over $3 million.

Developer cross-complained for indemnification against various subcontractors including Calego Excavating Company (Calego), which performed *1731 the grading work, and Mills Concrete Construction Company, Inc. (Mills), which did the concrete work. In defense, Mills and Calego contended Developer’s fraud, in making misrepresentations and concealing information from the condominium purchasers, barred Developer from obtaining indemnity. Developer also raised a fraud issue, contending the subcontractors had fraudulently induced Developer to enter into narrower indemnity agreements.

The trial court, ruling a finding of fraud would preclude indemnification, bifurcated the trial.

At trial, there was evidence presented that the damage to the condominiums and pool was caused, in part, by soil movement. The soil may not have been properly compacted by Calego or properly tested by Southern California Testing Laboratory (SOCAL), the soils expert hired by Developer. There was also evidence that the concrete slabs were improperly constructed. Among other things, there was evidence that the concrete used was of inadequate quality, contained too much water and that the slabs were poured too thin.

To support the claim Developer made material misrepresentations to the buyers, the subcontractors presented evidence indicating Developer knew at the time he bought the property there were expansive soils on the property which would make development more expensive, the initial soils report originally recommended specially designed footings and slabs but a subsequent report made after discussions with Developer recommended a less expensive alternative of capping the building pads with 2.5 feet of select (nonexpansive) soil; pockets of expansive soils were found in the upper 2.5 feet of some of the building pads but only one building received a reinforced slab; shortly after the concrete slabs were poured, cracks were observed which prompted a report from the soils experts stating the “structural integrity of the foundation system” was threatened; and despite this knowledge, Developer failed to disclose the existence of the expansive soils, the cracks in the concrete slabs or the soils expert’s report to the condominium buyers.

In response, Developer presented evidence showing it relied on the recommendations of its experts. Developer reinforced only one slab because SOCAL only recommended reinforcing one slab. Developer had, at SO-CAL’s recommendation extended the footings in other slabs. 1 Developer presented evidence that the cracks observed in the concrete slabs soon after *1732 they were poured were shrinkage cracks which were monitored over a period of months. Numerous witnesses, including Mills, testified shrinkage cracks normally or regularly occur, are not a matter of concern and do not need to be repaired. The soils expert who had reported the cracks would “have an adverse affect on the structural integrity” testified that was a bad choice of words and he did not believe the cracks actually threatened the structural integrity of the building because they were only shrinkage cracks. A number of experts testified Developer’s monitoring of the cracks rather than conducting additional investigation by taking core samples or drilling holes and Developer’s eventual conclusion the cracks were due to concrete shrinkage rather than soil subsidence were reasonable and therefore, according to Developer’s evidence, Developer did not make any material misrepresentations to the condominium buyers.

Discussion

I

Indemnification

As we explain below, we hold a jury’s finding Developer made misrepresentations to or concealed information from third parties does not negate the express indemnity agreements entered into between Developer and the subcontractors. 2

A. The Indemnity Agreements

The parties entered into more than one indemnification agreement. 3 In the original standard form contract between Developer and the subcontractors, an indemnity clause provided:

“Subcontractor does hereby release, and save Contractor harmless, from and against all claims and liabilities of every nature, including but not limited to injury to or death of Subcontractor’s employees, attorneys’ fees and court costs, directly or indirectly arising from the performance of this agreement, or, arising out of the failure of Subcontractor to comply with Paragraph 33 of this agreement [providing a safe place to work] or from *1733 Subcontractor’s liability for failure to provide a ‘safe place to work’ pursuant to Sections 3300, 6401 and 6406 of the California Labor Code, and from any claims, loss, damage, injury, death or liability however caused or incurred, including injury to or death of Subcontractor’s employees, resulting directly or indirectly from the nature of the work covered by this agreement. Such duties to release and save Contractor harmless shall apply to liability incurred or claimed as a result of negligence, regardless of responsibility for such negligence, provided; however, that nothing in this agreement purports to or should be understood to provide for indemnity of Contractor for Contractor’s sole negligence or willful misconduct.”

In August 1976, Developer individually negotiated agreements with Mills and Calego which contained indemnity clauses and personal guarantees for indemnity.

In the agreement between Mills and Developer, Mills acknowledged “[t]he concrete work performed by Mills on the Property may not have been done in accordance with the plans and specifications provided, the engineer’s requirements and the Uniform Building Code.” Developer agreed to accept Mills’s work and pay as provided by the original agreement and Mills and its two sole shareholders agreed to “indemnify and hold [Developer] harmless from any damage or loss [Developer] may suffer resulting from any failure by Mills to comply with the plans and specifications, engineer’s requirements or the Uniform Building Code, including but not limited to all actions, suits, proceedings, demands, assessments, judgments, attorneys’ fees, costs and expenses incident thereto.”

The agreement between Developer and Calego provided “[t]he grading and excavating work performed by Calego on the property was not done in accordance with the plans and specifications” and that Developer would only accept and pay for the work if (1) Calego entered an indemnity agreement, (2) Calego’s work was accepted by the city, (3) Developer verified the grading met foundation elevations and agreed banks between buildings and (4) Calego agreed to perform some remedial grading. In the indemnity provision, Calego and its partners agreed to hold Developer “harmless from any damage [Developer] may suffer resulting from any failure by Calego to comply with the plans and specifications through the fault of Calego including, but not limited to, all actions, suits, proceedings, demands, assessments, judgments, costs and expenses reasonably incident thereto.”

B. The Trial Court’s Ruling

The trial court bifurcated the trial ordering the fraud issues be tried before the issues of damages. During the course of the arguments on the issue, the trial court stated:

*1734 “It seems to me at this stage that if there is a finding of fraud there is going to be no indemnity.

“Now, if you can brief me on it and talk me out of that, either on an in pari delicto, on some kind of a severing the negligence from the fraud, that makes sense. Because that’s an awful harsh rule, an awful harsh rule. But seems to me, when I think about this thing, when a developer in the situation of Brehm finds out about something that he perceives to be a defect, whatever it is, his function in life is not to go to the subs and get an indemnity agreement and not fix it and sell it to the public, who is unaware. If that’s what he did, maybe public policy is that he ought to eat it. That’s my thoughts on it.”

In its instructions to the jury at the outset of the case, before opening arguments were made or evidence was presented, the trial court instructed the jury on the elements of fraud and then explained:

“Now, insofar as the construction developer is concerned, the pivotal—as the evidence comes in, the pivotal question is going to relate to what he knew at the time that he sold the property to the general public. With regards to the subs, the pivotal question is going to be what he knew when he was telling the general what he was doing on the project. So the dates are going to be a little different here.”

Throughout the case, Mills and Calego argued the Developer had committed fraud by failing to disclose information to the homeowners. 4 They maintain this position on appeal. 5

C. Right to Indemnity

“Indemnity may be defined as the obligation resting on one party to make good a loss or damage another party has incurred. [Citation.]” (Ross- *1735 moor Sanitation, Inc. v. Pylon, Inc. (1975) 13 Cal.3d 622, 628 [119 Cal.Rptr. 449, 532 P.2d 97]; Selma Pressure Treating Co. v. Osmose Wood Preserving Co. (1990) 221 Cal.App.3d 1601, 1611 [271 Cal.Rptr. 596].) Indemnity, involving an obligation to an injured third party, is distinct from an exculpatory clause or “exemption” from liability obtained from the injured party. (See Goldman v. Ecco-Phoenix Elec. Corp. (1964) 62 Cal.2d 40, 48 [41 Cal.Rptr. 73, 396 P.2d 377], disapproved on other grounds as stated in Bay Development, Ltd. v. Superior Court (1990) 50 Cal.3d 1012, 1030, fn. 10 [269 Cal.Rptr. 720, 791 P.2d 290]; Guy F. Atkinson Co. v. Schatz (1980) 102 Cal.App.3d 351, 356 [161 Cal.Rptr. 436]; Lemat Corp. v. American Basketball Assn. (1975) 51 Cal.App.3d 267, 278 [124 Cal.Rptr. 388].) As the court explained in Lemat Corp. v. American Basketball Assn., supra, 51 Cal.App.3d 267, 278:

“The distinction between an exemption ([Civ. Code,] § 1668) whereby a person seeks to avoid liability to a victim who has suffered due to that same person’s unlawful conduct and an indemnity has been recognized by the courts. [Citations.] A public policy consideration exists. An exemption may deprive a victim of compensation for injuries but an agreement to indemnify a person who may be responsible for a loss is additional assurance that the loss will be compensated.” 6

The right to indemnification arises from two general sources: “First, it may arise by virtue of express contractual language establishing a duty in one party to save another harmless upon the occurrence of specified *1736 circumstances. Second, it may find its source in equitable considerations brought into play either by contractual language not specifically dealing with indemnification or by the equities of the particular case. [Citations.]” (E. L. White, Inc. v. City of Huntington Beach (1978) 21 Cal.3d 497, 506-507 [146 Cal.Rptr. 614, 579 P.2d 505]; Bay Development, Ltd. v. Superior Court, supra, 50 Cal.3d 1012, 1029.)

The two types of indemnity are subject to different rules. As the Supreme Court has explained:

“[I]n E. L. White, [Inc. v. City of Huntington Beach (1978) 21 Cal.3d 497,] we recognized a distinction between an indemnity claim based on an express contract to indemnify, that is, an express contractual indemnity claim, and an indemnity claim based on ‘contractual language not specifically dealing with indemnification’ [citation], that is, an implied contractual indemnity claim. We explained that, unlike express contractual indemnity, implied contractual indemnity is a form of equitable indemnity. [Citation.]” (Bay Development, Ltd. v. Superior Court, supra, 50 Cal.3d 1012, 1029, italics changed from original, fn. omitted.)

Express indemnity reflects “its contractual nature, permitting great freedom of action to the parties in the establishment of the indemnity arrangements while at the same time subjecting the resulting contractual language to established rules of construction.” (E. L. White, Inc. v. City of Huntington Beach, supra, 21 Cal.3d 497, 507, fn. omitted.)

“[E]quitable indemnification is a matter of fairness.” (Jaffe v. Huxley Architecture (1988) 200 Cal.App.3d 1188, 1191 [246 Cal.Rptr. 432] [examining comparative equitable indemnification among joint tortfeasors].) The doctrine of comparative equitable indemnity is applied to multiple tortfeasors and is designed to apportion loss among tortfeasors in proportion to their relative culpability so there will be an equitable sharing of the loss among multiple tortfeasors. (American Motorcycle Assn. v. Superior Court (1978) 20 Cal.3d 578, 595, 597-598 [146 Cal.Rptr. 182, 578 P.2d 899]; GEM Developers v. Hallcraft Homes of San Diego, Inc. (1989) 213 Cal.App.3d 419, 426 [261 Cal.Rptr. 626].) Implied contractual indemnity is applied to contract parties and is designed to apportion loss among contract parties based on the concept that one who enters a contract agrees to perform the work carefully and to discharge foreseeable damages resulting from that breach. (Bear Creek Planning Com. v. Title Ins. & Trust Co. (1985) 164 Cal.App.3d 1227, 1237 [211 Cal.Rptr. 172], disapproved on other grounds in Bay Development, Ltd. v. Superior Court, supra, 50 Cal.3d 1012, 1031-1032.) Both doctrines of implied indemnity rest *1737 on the equities of the circumstances, i.e., tortfeasors sharing loss in proportion to their culpability, contracting parties sharing loss relative to their breach.

In contrast, express indemnity rests on the contract of the parties; it is the language of the contract, rather than the equities of the situation which govern. In an express indemnity agreement, the parties may agree to results which would not occur in the absence of an express agreement for reasons other than equally or “fairly” apportioning loss. 7 As one court has observed: “. . . California courts have come to regard indemnity provisions in construction agreements as a generally acceptable method of distributing loss among insurance carriers. [Citation.]” (Guy F. Atkinson Co. v. Schatz, supra, 102 Cal.App.3d 351, 356.)

In interpreting an express indemnity agreement, the courts look first to the words of the contract to determine the intended scope of the indemnity agreement. A key factor in determining the scope of the agreement, is the specificity of the language. An indemnity agreement which is broadly worded and refers only generally to indemnification for claims or losses, is interpreted as providing indemnity, at most, for the indemnitee’s passive negligence; to obtain greater indemnity, more specific language must be used. (See Gonzales v. R. J. Novick Constr. Co. (1978) 20 Cal.3d 798, 809-810 [144 Cal.Rptr. 408, 575 P.2d 1190]; MacDonald & Kruse, Inc. v. San Jose Steel Co. (1972) 29 Cal.App.3d 413, 419-420 [105 Cal.Rptr. 725].)

The Legislature has also placed limits on the scope of indemnity agreements in construction contracts. 8 Civil Code section 2782 declares indemnity clauses in a construction contract may not provide indemnification for injury or loss due to the indemnitee’s sole negligence or sole willful conduct; such provisions are “against public policy and are void and unenforceable.” (Civ. Code, § 2782; C.I. Engineers & Constructors, Inc. v. *1738 Johnson & Turner Painting Co. (1983) 140 Cal.App.3d 1011, 1018 [189 Cal.Rptr. 824].) “[T]he purpose of the Legislature in passing section 2782, having in view certain language previously uttered by [the Supreme Court] in the case of Goldman v. Ecco-Phoenix Elec. Corp. (1964) 62 Cal.2d 40, 48-49 . . . , was to insure that an indemnitee would not, by contractual language however specific, require indemnity for damages sustained as a result of its sole negligence or willful misconduct.” (Gonzales v. R. J. Novick Constr. Co., supra, 20 Cal.3d 798, 809, fn. 8, italics in original.) Civil Code section 2782 does not, however, prohibit agreements for indemnification when the loss or injury is due only in part to the indemnitee’s negligence or willful misconduct. (See C. I. Engineers & Constructors, Inc. v. Johnson & Turner Painting Co., supra, 140 Cal.App.3d 1011, 1018 [holding Civ. Code, § 2782 did not bar indemnity for “conegligence”].)

Mills and Calego argue the courts have repeatedly denied indemnity to an individual who has participated in the wrongful act causing damages for which they seek indemnity. They cite cases following language in Great Western Furniture Co. v. Porter Corp. (1965) 238 Cal.App.2d 502 [48 Cal.Rptr. 76]. (See County of Mariposa v. Yosemite West Associates (1988) 202 Cal.App.3d 791, 815 [248 Cal.Rptr. 778]; Bear Creek Planning Com. v. Title Ins. & Trust Co., supra, 164 Cal.App.3d 1227, 1237.) In Great Western Furniture, the court stated:

“[Wjhere the right of implied indemnity arises from a contractual relationship between the indemnitor and the indemnitee, it is predicated upon the indemnitor’s breach of such contract, the rationale of the cases being that a contract under which the indemnitor undertook to do work or perform services necessarily implied an obligation to do the work involved in a proper manner and to discharge foreseeable damages resulting from improper performance absent any participation by the indemnitee in the wrongful act precluding recovery. [Citations.] (Great Western Furniture Co. v. Porter Corp., supra, 238 Cal.App.2d at p. 517, italics added.) 10

*1739 Mills and Calego overlook the fact Great Western and the other cases address implied contractual indemnity, not the interpretation of an express indemnity agreement as is the case here. As we explained above, different rules govern implied and express indemnity. Great Western Furniture’s emphasis on “participation in the wrongful act” reflects the equitable underpinnings of implied indemnity; it does not illustrate the interpretation of an express indemnity agreement made by the parties. The Supreme Court has made it clear: “The contention that a claim for implied contractual indemnity should be equated with a claim for express contractual indemnity cannot be reconciled with case law involving express indemnification clauses in circumstances where both the indemnitor and the indemnitee bear some responsibility for the loss.” (Bay Development, Ltd. v. Superior Court, supra, 50 Cal.3d 1012, 1032, italics in original.)

Mills and Calego argue County of Mariposa v. Yosemite West Associates, supra, 202 Cal.App.3d 791, 815, is a contractual indemnity case which supports their position the jury’s finding of fraud bars Developer’s indemnity claim. In the Yosemite West Associates case, a developer, Yosemite West Associates (YWA) entered an agreement in 1967 with the County of Mariposa to develop a residential subdivision called “Yosemite West Subdivision, Unit Number One” (Unit #1). YWA agreed to complete all necessary improvements including a water and sewer system and to initiate the formation of Yosemite West Maintenance District. YWA also agreed to indemnify the county for loss, damage or liability due to YWA’s performance or nonperformance.

In 1971, YWA entered an agreement with Interwest Corporation of Utah (Interwest) to develop a condominium project next to Unit #1. YWA was responsible for land development, including off-site improvements, while Interwest was responsible for building and selling the condominiums. In 1973, YWA, Interwest and the county entered an agreement where the county approved the condominium project conditioned on, among other things, expansion of the sewer system and development of a well producing 100 gallons of potable water per minute. The water and sewer systems proved defective and inadequate for both Unit #1 and the condominium project. YWA and Interwest were sued by the county, homeowners and condominium association. YWA cross-complained against the county seeking injunctive relief and damages, claiming the county was at fault for not providing the homeowners with necessary services through the maintenance district. Interwest cross-complained against YWA for declaratory relief and indemnity.

*1740 On appeal, Interwest contended the court erred in not allowing its claim for indemnification against YWA. The appellate court’s entire discussion of Interwest’s contention is as follows:

“Interwest contends that it is entitled to indemnification from YWA for whatever damages it is required to pay as the result of the finding that it is jointly and severally liable for the payment of the condominium owners’ annexation fees [to annex the condominium project to the Maintenance District], This argument is without merit. One who participates in the wrongful act which causes injury is not entitled to indemnity. (Great Western Furniture Co. v. Porter Corp. (1965) 238 Cal.App.2d 502, 517 [48 Cal.Rptr. 76].)” (County of Mariposa v. Yosemite West Associates, supra, 202 Cal.App.3d 791, 815.)

This single, brief paragraph is the basis for the subcontractors’ claim a finding of fraud precludes express contractual indemnity. This paragraph makes no mention of express contractual indemnity; its only analysis consists of a paraphrase and citation to a case involving implied contractual indemnity. The only express indemnity provision mentioned in the opinion is one between the county and YWA for the development of Unit #1; the decision is silent as to the basis of Interwest’s indemnity claim. A logical inference, given the court’s citation to Great Western Furniture, an implied indemnity case, and the lack of any mention of a contractual agreement for indemnity between Interwest and YWA, is that Interwest’s claim was one for implied indemnity. The Yosemite West Associates case is not persuasive authority on the enforceability of an express indemnity agreement. 11

Mills and Calego have not cited nor has our research disclosed any cases holding that parties to an otherwise valid and enforceable contract can escape their promise to indemnify on the basis that some of the damages were due to negligent misrepresentations or nondisclosure of material facts to the injured third parties. 12 Mills and Calego argue as if the jury had returned a finding all the damages were due solely to Developer’s fraud and none were due to the subcontractors’ own negligence or failure to meet specifications. No such finding was made here. The jury simply returned *1741 verdicts finding Developer committed fraud while Mills and Calego did not. The critical issue of whether the circumstances requiring indemnification by Mills and Calego occurred, as provided by the agreement of the parties, was not resolved. 13

Mills and Calego argue the jury’s finding of fraud bars Developer’s indemnity action because contracts seeking to indemnify for fraud violate public policy and are void. In support of this contention, they cite Civil Code section 1668 which provides:

“All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.”

First, this section does not apply to express indemnity agreements; it applies to exculpatory clauses, releases or other provisions seeking to obtain an exemption or waiver of liability from the injured party. (State Farm Fire & Casualty Co. v. Eddy (1990) 218 Cal.App.3d 958, 967 [267 Cal.Rptr. 379]; Lemat Corp. v. American Basketball Assn., supra, 51 Cal.App.3d 267, 278; John E. Branagh & Sons v. Witcosky, supra, 242 Cal.App.2d 835, 838; 1 Witkin, Summary of Cal. Law (9th ed. 1987) contracts, §§ 630-633, pp. 568-570.) 14 Second, the contractual provisions here do not purport to provide indemnity for fraud; indemnity is provided for damages other than those due to Developer’s sole negligence or misconduct (original agreements) or due to the fault and/or failure of the subcontractors to meet the *1742 requirements of particular specifications (August 1976 agreements). Finally, Developer is not seeking indemnity for fraud; Developer is seeking indemnity for losses due to negligence and/or failure to meet specifications by Mills and Calego.

Calego argues:

“If Appellants are allowed to pursue their indemnity claims against Calego and Mills despite their fraudulent conduct, a disturbing and dangerous precedent will be set. A developer, aware of problems or defects in his project, will lose all accountability for his failure to disclose or correct these problems. He will be free to fraudulently conceal the problems, knowing that when the problems manifest themselves, he can promptly settle with the homeowners for compensatory and punitive damages, then turn to his subcontractors for indemnity for all damages wrought by his wrongful conduct, regardless of culpability.”

A conclusion Developer may seek indemnity under the contract for damages which Mills and Calego agreed to indemnify does not mean they are required to indemnify Developer for damages which are solely due to Developer’s fraud; such damages are specifically exempted by the terms of the original agreement and by Civil Code section 2782 and are not provided for in the August 1976 agreements which seek indemnity only for the subcontractors based on the subcontractors’ fault or failure to meet specifications. No “disturbing and dangerous” precedent is set by requiring Mills and Calego to indemnify Developer to the extent they agreed for losses for which they are at least partially responsible.

II

Unclean Hands

Calego argues Developer is barred from obtaining indemnification by the doctrine of unclean hands.

“Traditionally, the doctrine of unclean hands is invoked when one seeking relief in equity has violated conscience, good faith or other equitable principles in his prior conduct. [Citations.]” (Fibreboard Paper Products Corp. v. East Bay Union of Machinists (1964) 227 Cal.App.2d 675, 727 [39 Cal.Rptr. 64].) “The general principle behind the ‘clean hands’ doctrine is that a court will neither aid in the commission of a fraud by enforcing a contract, nor relieve one of two parties to a fraud from its consequences, where both are in pari delicto.” (Burton v. Sosinsky (1988) 203 Cal.App.3d 562, 573 [250 Cal.Rptr. 33].) “The bar applies only if the inequitable conduct occurred in a transaction directly related to the matter before the *1743 court and affects the equitable relationship between the litigants. [Citations.]” (California Satellite Systems, Inc. v. Nichols (1985) 170 Cal.App.3d 56, 70 [216 Cal.Rptr. 180].)

As Mills points out, “[t]he traditional defense of unclean hands . . . applies to facts involving only two (2) parties, Plaintiff and Defendant, and one transaction involving both parties.”

Here, in contrast, we have a third party indemnity situation. The fraud does not relate directly to the transaction at issue. The transaction at issue is the indemnity agreement, i.e., whether an indemnity agreement is enforceable against Mills or Calego. There is no claim these agreements were obtained by fraudulent conduct. 15 The fraud at issue was committed on third parties, i.e., the condominium buyers. It occurred after the agreements had been made, after the subcontractors had completed their work and included representations about the work performed by the subcontractors.

Calego argues:

“[Developer’s] conduct, which was found by the trial court to constitute fraud, consisted of a pattern of fraudulent behavior that began with the discoveries contained in SOCAL Report No. 9. This course of conduct inextricably intertwined Calego, Mills and the Smoketree-Lake Murray homeowners. Not only did [Developer] fail to disclose material facts to the purchasers of its condominium units, but rather than correct the known deficiencies it ran to its subcontractors to obtain additional assurances of indemnity for the damages that [Developer] almost certainly knew would occur.”

This argument ignores several important facts. Developer, Mills and Calego were “inextricably intertwined” because they all worked on the Smoketree-Lake Murray Project; whether the losses were sustained only because of Developer’s fraud or for other reasons has not been determined. Additionally, this case was tried on a theory Developer made misrepresentations to the condominium buyers, not that Developer made misrepresentations to the subcontractors when it obtained the indemnity agreements in *1744 <