Defend Now, Allocate Later? An Unresolved Tension in Colorado Construction Law

For decades, Colorado law has recognized an important distinction between the duty to defend and the duty to indemnify.  The former ordinarily arises at the beginning of litigation; the latter generally cannot be determined until the underlying liability is known.  That distinction makes intuitive sense.  A defense that becomes due only after litigation concludes is not much of a defense.

But Colorado’s construction anti-indemnity statute, C.R.S. § 13-21-111.5(6), raises an interesting question about how that familiar rule operates in construction disputes.  The statute expressly regulates contractual obligations not only to indemnify, but also to insure and defend, and it reflects a legislative policy that construction businesses should bear financial responsibility for their own negligence.

Those principles have developed along separate tracks.  At some point, a Colorado appellate court may have to decide precisely how they fit together.

The Traditional Rule: Defense Now, Liability Later

The starting point is Hecla Mining Co. v. New Hampshire Insurance Co., which arose in the insurance context and established the familiar Colorado rule that the duty to defend is broader than the duty to indemnify.  The duty to defend turns on whether the allegations against the insured potentially fall within the policy’s coverage.  The insurer generally cannot refuse a defense merely because facts developed later may establish that the loss is not covered.  The distinction is important.  The duty to defend addresses what happens while liability is uncertain.  The duty to indemnify addresses who ultimately pays once the relevant facts are known.  Colorado courts subsequently applied similar reasoning to contractual defense obligations outside the traditional insurer-insured relationship.

In Lafarge North America, Inc. v. K.E.C.I. Colorado, Inc., a general contractor sought a defense and indemnification from its subcontractor following an accident on a highway construction project.  The subcontractor argued, among other things, that its obligations were dependent upon its own negligence.

The Colorado Court of Appeals nevertheless treated defense and indemnity as distinct obligations.  Borrowing from Hecla Mining and other insurance cases, the court held that the subcontractor’s duty to defend was triggered when the underlying allegations potentially triggered its obligation to indemnify.  Actual liability was not a prerequisite to the defense obligation.

The practical consequence of this approach is straightforward: defend now; determine liability later.

That same basic principle appears in other Colorado decisions involving construction disputes and additional-insured coverage.  It reflects the practical reality of liability litigation.  If every factual question concerning responsibility had to be resolved before a defense obligation arose, the underlying case might be over before anyone knew who was required to defend it.

Then the Legislature Changed Colorado Construction Risk Transfer

The complication is chronology.  The construction agreement at issue in Lafarge predated an important change in Colorado law.  Effective in 2007, the General Assembly enacted what is now C.R.S. § 13-21-111.5(6), substantially restricting contractual risk transfer in Colorado construction agreements.

The legislative declaration is unusually informative.  The General Assembly found that construction businesses had increasingly used contractual provisions to shift financial responsibility for their negligence to others, circumventing the intended operation of tort law.  It declared that responsibility for one’s own negligence should be nondelegable and expressed an objective that construction businesses remain responsible for their own actions.

The operative language goes beyond traditional anti-indemnity legislation.  Section 13-21-111.5(6)(b) provides, subject to specified exceptions, that a construction agreement may not require one person to “indemnify, insure, or defend in litigation” another against liability for damage caused by the negligence or fault of the indemnitee or certain persons under the indemnitee’s control.

Thus, the General Assembly did not limit the statute to ultimate indemnity.  It expressly included defense and insurance among the forms of construction risk transfer it chose to regulate.

Defense Costs and Proportional Fault

The next subsection adds another wrinkle.  Section 13-21-111.5(6)(c) preserves construction-agreement provisions requiring indemnification and insurance against certain liability, including the reimbursement of attorney fees and costs, but not for amounts exceeding the degree or percentage of negligence or fault attributable to the indemnitor and those for whom the indemnitor is responsible.  That language creates an interesting question when compared with the traditional duty-to-defend cases.

Under Hecla Mining and Lafarge, the defense obligation can arise precisely because the parties’ ultimate responsibility has not yet been determined.  Potentiality is enough.

Under § 13-21-111.5(6), however, permissible construction risk transfer is expressly linked to fault, and the statute discusses attorneys’ fees and costs in terms of reimbursement subject to proportional responsibility.

The resulting timing question is difficult to avoid:

How does a present duty to defend based upon potential liability operate when the statute governing the construction agreement ultimately limits the permissible transfer of financial responsibility according to fault that has not yet been determined?

The statute does not expressly tell us.

Additional-Insured Coverage Presents the Same Question From a Different Direction

The issue is not confined to contractual indemnification between general contractors and subcontractors.  Section 13-21-111.5(6)(d) expressly addresses insurance requirements in construction agreements.  A construction agreement may require an indemnitor to maintain insurance covering its own acts or omissions and may require the indemnitee to be named as an additional insured.  But the statute preserves such an additional-insured requirement only to the extent the coverage protects the indemnitee against liability due to the indemnitor’s acts or omissions.

The statute further declares void a construction-agreement provision requiring additional-insured coverage for damage arising from acts or omissions not caused by the negligence or fault of the party providing the additional-insured coverage.  This creates a related, but analytically distinct, issue.

The subcontractor’s defense obligation arises from the construction contract.  The additional-insured carrier’s defense obligation arises from the insurance policy and applicable endorsement.  For the insurer, Hecla Mining remains highly relevant.  But § 13-21-111.5(6)(d) expressly addresses the scope of additional-insured coverage that a construction agreement may require.  The interaction between the two therefore depends not only upon the construction agreement, but also upon the language of the particular additional-insured endorsement.

A provision granting additional-insured status for liability “arising out of” the named insured’s work may present a different coverage question from an endorsement limiting insured status to liability “caused, in whole or in part,” or “only to the extent” caused, by the named insured’s acts or omissions.

Accordingly, it may be too simple to say either that Hecla Mining resolves the issue or that the anti-indemnity statute resolves it.  They address different aspects of the problem.

The “Defend Now, Allocate Later” Approach

The traditional approach offers an apparent way to reconcile the timing problem: provide the defense while the underlying litigation is pending and allocate financial responsibility afterward.  There is obvious practical appeal to that model.  Defense obligations necessarily operate before liability is known.  Allocation necessarily becomes easier after the relevant facts have been established.  But § 13-21-111.5(6) creates a question that did not exist when many of the traditional cases arose.

If a subcontractor or its insurer is required to bear defense costs before fault is determined, subject to later reimbursement or allocation, is that merely a procedural mechanism for administering a present duty to defend?  Or does requiring one construction participant to finance another participant’s defense, at least temporarily, constitute the shifting of financial responsibility that § 13-21-111.5(6) was enacted to regulate?

The distinction between ultimate responsibility and present financing may prove important.  The statute can plausibly be read as concerned primarily with where the economic burden ultimately rests.  Under that view, an initial defense followed by allocation or reimbursement may harmonize the traditional defense rule with the statute.

But the statute expressly uses the term “defend in litigation.”  It does not merely prohibit ultimate indemnification for another party’s negligence.  And subsection (6)(c)’s express reference to proportional reimbursement of attorneys’ fees and costs raises the question whether the General Assembly intended something different from an unconditional complete-defense obligation followed by a later accounting.

Colorado’s appellate courts have not squarely reconciled those concepts.

Turner v. Lokal: The Issue Begins to Surface

The issue appeared more directly in Turner v. Lokal, a Denver District Court construction-defect case.  There, subcontractors faced claims for contractual defense and indemnification.  They argued that § 13-21-111.5(6) applied to defense obligations as well as indemnity obligations and that their responsibility for defense costs could not properly be determined without determining the negligence or fault attributable to them.  The district court declined to enter the requested summary judgment establishing the subcontractors’ defense obligations while factual issues bearing on those obligations and resulting damages remained unresolved.

Lokal is noteworthy because it brings the traditional defense doctrine and the post-2007 anti-indemnity statute into the same analysis.  It is equally important to recognize what Lokal is not.  It is a Colorado district court order.  It is not a published appellate decision, and it does not bind other Colorado trial courts.  It therefore illustrates the issue without conclusively resolving it.

Other Decisions Have Approached the Intersection

Other cases demonstrate how readily the two lines of authority can encounter one another.  In BKV Barnett, LLC v. Electric Drilling Technologies, LLC, a federal court applying Colorado law considered claims seeking declarations concerning contractual defense, indemnity, and insurance obligations.  The defendant invoked § 13-21-111.5(6), while the party seeking a defense relied upon the traditional rule that a defense obligation can arise when allegations potentially trigger indemnification.

At the pleading stage, the court could not determine that the agreement qualified as a statutory construction agreement.  In later proceedings, however, the court concluded that the agreement did qualify and held the challenged defense, indemnification, and insurance provisions void under § 13-21-111.5(6).

The case is instructive but again does not supply a controlling Colorado appellate resolution of the broader interaction between the potentiality doctrine and a statutorily permissible, fault-limited defense or additional-insured obligation.

An unpublished Colorado Court of Appeals decision, Brown v. Smith, demonstrates the continued vitality of the other side of the equation.  There, the court relied upon Lafarge in concluding that a contractual duty to defend could be triggered by allegations potentially implicating the subcontractor’s obligation, notwithstanding the absence of an existing determination of the subcontractor’s liability.

Again, however, the opinion does not squarely resolve the interaction between that principle and § 13-21-111.5(6).

Two Rules Awaiting Reconciliation

Colorado therefore appears to have two established principles whose interaction remains uncertain.  The first is the traditional defense principle reflected in Hecla Mining and Lafarge, a defense obligation can arise before liability is determined because defense and indemnity serve different purposes.  The second is the legislative policy embodied in § 13-21-111.5(6), construction agreements cannot be used to shift responsibility for one participant’s negligence to another through indemnification, defense, or required insurance beyond the limits the statute permits.

Neither principle is difficult to understand standing alone.  Their intersection is.

Does the traditional potentiality rule require a present defense, with statutory proportionality addressed later through allocation or reimbursement?  Does the statute’s express treatment of the obligation to “defend in litigation” mean that proportionality affects the defense obligation itself?  Does the answer differ when the obligation is imposed directly upon a subcontractor rather than upon an insurer that issued additional-insured coverage?

And, on the insurance side, how much turns upon whether the particular additional-insured endorsement grants broad insured status or expressly limits that status according to the named insured’s acts, omissions, or fault?  Those questions have practical consequences every day in Colorado construction-defect litigation.

Eventually, the Two Lines Will Meet

The tension is unlikely to remain academic.  Construction contracts governed by § 13-21-111.5(6) routinely contain defense, indemnification, and insurance provisions.  Construction-defect complaints routinely implicate the work of numerous subcontractors before anyone knows which participant, if any, ultimately bears responsibility.  General contractors routinely tender those claims to subcontractors and their additional-insured carriers.

The traditional defense cases provide one framework for handling those tenders.  The anti-indemnity statute provides another set of rules governing the permissible transfer of construction risk.

Lokal represents one trial court’s encounter with their intersection.  BKV Barnett provides another perspective.  Brown demonstrates that the traditional contractual duty-to-defend doctrine remains very much alive.

What remains missing is a published Colorado appellate decision squarely reconciling the two.  At some point, the right case is likely to present the question cleanly enough that an appellate court will have to decide whether Colorado’s traditional “defend now, allocate later” approach continues unchanged in the post-2007 construction context, whether § 13-21-111.5(6) requires a different approach, or whether the two doctrines can be harmonized in a way that preserves both a meaningful present defense and the Legislature’s fault-based limitations on construction risk transfer.

Until then, Colorado practitioners should at least recognize that the question exists.  The duty-to-defend cases and the anti-indemnity statute each make sense on their own.  Colorado law has yet to tell us definitively what happens when they meet.