Indemnification is the legal obligation of one party, the indemnifier or indemnitor, to compensate for the loss or damage to another party, the indemnitee.1 In indemnification actions, practitioners who are not mindful of the applicable statute of limitations may win their battles but ultimately lose the war.
Consider the example of a large, sophisticated client that is doing everything right before closing a lucrative deal, including performing its due diligence and thoroughly researching the other party. The client assumes that in the best-case scenario, everyone will profit. Nevertheless, the client includes a fail-safe provision in its contract: an indemnity clause. Then, even if the deal turns bad, its liabilities would be covered.
Unfortunately, the client finds itself mired in litigation because of its reliance on the representations made by the other contracting party. A third party files suit against the client, asserting that the products the client purchased from the other contracting party infringes upon the third party's intellectual property. As the client litigates the suit, it seeks compensation for reasonable attorney's fees from the other contracting party, which replies that there is no need to rush into indemnification proceedings.
Wisely, the client does not take the indemnitor's advice. Otherwise, it could be barred from recovering reasonable attorney's fees because of the statute of limitations--despite having included within its contract a valid, enforceable indemnification clause.
The scenario highlights how efforts to recover damages pursuant to an indemnification clause are prone to complication. At the root of these difficulties is the fact that the Code of Civil Procedure's statute of limitations for indemnity actions is not sufficiently explicit. Indeed, the Code of Civil Procedure does not categorically differentiate the respective statutes of limitations for express and equitable indemnity actions. This ambiguity, combined with confusion as to when the statute of limitations begins to run, can cause clients to lose their right to recover attorney's fees.
Historically, courts recognized three forms of indemnity actions: express indemnity, implied contractual indemnity, and traditional equitable indemnity. California courts now acknowledge only two basic types of indemnity--express and equitable. Implied contractual indemnity is considered to be a form of equitable indemnity.2
Express indemnification is an obligation created by express contractual language. Equitable indemnity, on the other hand, is the obligation to indemnify another party arising from a particular circumstance. Equitable indemnity, unlike express indemnification, requires no contractual relationship between an indemnitor and an indemnitee. Implied indemnification is the obligation to cover another party's loss or damage implied from a contract that does not specifically mention indemnity. In the past, implied contractual indemnity was available when two parties in a contractual relationship were both responsible for injuring a third party. Correctly identifying an indemnification by type is critical because different statutes of limitations apply to each variant under the Code of Civil Procedure and case law.
The statute of limitations for actions based on express indemnification is straightforward, unlike the statute of limitations for actions based on equitable indemnity. Code of Civil Procedure Section 337(1) requires "[a]n action upon any contract, obligation or liability founded upon an instrument in writing" to be commenced within four years. In contrast, Code of Civil Procedure Section 339(1) requires that "[a]n action upon a contract, obligation or liability not founded upon an instrument of writing" be commenced within two years. Therefore, the statute of limitations for a claim based upon an expressed promise to indemnify in a written contract is four years, while a claim grounded upon an oral contractual term is two years.3
Likely Two Years, Not Four
The statute of limitations for actions based on implied indemnity claims and traditional equitable indemnity claims is more ambiguous than for actions based on express indemnity. This is so even though a California Supreme Court decision in 1962 found that when a written contract exists between the indemnitor and indemnitee, the applicable statute of limitations for an implied obligation to indemnify is four years.
In Amen v. Merced County Title Company, the supreme court held that an action against an escrow holder for failure to comply with escrow instructions was founded upon an instrument in writing, despite the fact that the escrow holder and its agents did not sign the instructions. The buyer of the property sued the escrow company when the escrow closed without payment to the state for liens on the property. The escrow holder argued that the two-year statute of limitations for actions on oral contracts barred the action. The supreme court held otherwise: "A contract may be 'in writing' for purposes of the statute of limitations even though it was accepted orally or by an act other than signing." The court then applied the four-year statute of limitations.4
Following Amen, California courts continued to recognize that "[w]hen the law implies a promise from the terms of a written contract, the promise is as much a part of the contract as if it was written out."5 Therefore, if an implied obligation to indemnify exists in a written instrument, Code of Civil Procedure Section 337(1) may control.
Even when no written or oral contract exists between an indemnitor and indemnitee, the California Court of Appeal has held that the statute of limitations on an indemnity action is four years. In Liberty Mutual Insurance Company v. Hartford Accident & Indemnity Company, the court ruled that an action brought by one insurer against another based on a written policy of insurance between one of the insurers and an insured individual was an action upon an obligation or liability founded upon an instrument in writing.6
The defendant insurer argued that the plaintiff's claim was based upon an implied contract of indemnification, and thus a two-year statute of limitations controlled. The court agreed that actions for implied indemnification are "subject to the two-year period of limitations." The court, however, found the plaintiff's claim was based on a written contract for indemnification, even though there was no contractual relationship between the indemnitor and indemnitee. The cause of action stemmed from another contract and was founded on principles of equity, which is characteristic of traditional equitable indemnification actions. Nevertheless, the appellate court held that a four-year period of limitations applied pursuant to Section 337(1).
Despite these authorities, however, prudent practitioners should consider the statute of limitations for equitable indemnity claims to be most likely two years. In an 1896 decision, the California Supreme Court in McCarthy v. Mount Tecarte Land & Water Company ruled that for a cause of action to be founded upon an instrument in writing, "the instrument must, itself, contain a contract to do the thing for the nonperformance of which the action is brought."7 Therefore, if there is no written contract, or the written contract does not contain an expressed indemnification clause, the indemnification action cannot be founded upon an instrument in writing. A two-year statute of limitations would apply.
This is supported by the Ninth Circuit's holding in Pacific Employers Insurance Company v. Hartford Accident & Indemnity Company. In that case, insurance companies were disputing the nature of their respective insurance agreements with a mining company as well as the distribution of policy settlements following an incident. The Ninth Circuit, interpreting California law, held that an insurer as subrogee to an insured was required to bring an action based upon an implied contract of indemnity within two years.8 The court ruled that a two-year limitation was applicable to implied indemnity pursuant to Code of Civil Procedure Section 339(1).
Similarly, in Century Indemnity Company v. Superior Court, the California Court of Appeal held that an insurer's cause of action for contribution from a coinsurer is based on an implied promise to contribute, which invokes principles of equitable contribution or indemnity. The court posited that when no privity of contract exists between the parties, any obligation to contribute is recognized as a matter of law and founded in principles of equity, not in the terms of an agreement.9 Thus Code of Civil Procedure Section 339(1) would apply, not Code of Civil Procedure Section 337(1). In fact, the court expressly concluded that "Liberty Mutual was wrongly decided."10 Other courts have recognized that "the two-year statute of limitations [applies] for implied contract claims."11
Practitioners clearly should be cautious when faced with an indemnity action that is not grounded upon an expressed indemnification clause in a written instrument. The cases addressing the statute of limitations for traditional equitable indemnification and implied indemnification are scant. Courts have ruled on the issue of when a cause of action accrues, but few have specifically decided what limitation period applies--whether four years under Section 337(1) or two years under Section 339(1). Appropriately wary attorneys will do best if they assume that a two-year statute of limitations pursuant to Section 339(1) applies to equitable indemnity causes of action.
Beginning to Run
When transactions go awry, attorneys must pay attention to more than just the type of indemnity at issue. While the type of indemnification affects the length of the statute of limitations, the nature of the indemnity agreement affects the time the statute of limitations begins to run. Civil Code Section 2778 prescribes rules on interpreting indemnity contracts. When an agreement indemnifies against "liability," "the person indemnified is entitled to recover upon becoming liable."12 Conversely, when an agreement indemnifies against "damages," "the person indemnified is not entitled to recover without payment thereof."13
In covenants indemnifying against liability, the statute of limitations begins to run when liability is incurred. For example, in Oaks v. Scheifferly, the California Supreme Court affirmed that a cause of action for breach of a covenant to indemnify against liability "would accrue as soon as a judgment [is] recovered."14 An obligee of a bond in the Oaks case was permitted to bring suit after a judgment had been obtained against him, although the obligee had not paid the judgment.
In contrast, for the statute of limitations covering covenants indemnifying damages, "it is well settled that a cause of action would not accrue for a breach of that covenant [to indemnify against damages] until the obligee had been compelled to pay and had paid damages."15 Federal and state courts have affirmed this distinction.16
When an agreement contains covenants to indemnify against liability and to indemnify against damages, a cause of action for one can still exist even if the other is barred. In Oaks, for example, the supreme court affirmed a judgment against an indemnitor because the indemnitee's suit for the recovery of damages was filed within four years of his payment to a third party--although he had been liable for longer than four years.17 Thus statutes of limitations on separate indemnity clauses within an agreement run independently of one another, and one recovery action can be valid even if the other is not.
Indemnity Actions for Attorney's Fees
Civil Code Section 2778(3) provides that the costs of defending claims are included in the expenses to be indemnified, unless the contract provides otherwise. It is important to keep in mind, however, that only the costs of defending underlying claims are indemnified under Section 2778(3). Any costs incurred in pursuing an indemnity claim against the indemnitor are not indemnified.18
When the indemnitee does not successfully defend against a claim and pays a legal obligation, whether toward a settlement or a judgment, the statute of limitations commences on the date when payment is made to satisfy the liability, not when attorney's fees are paid. For example, in Globe Indemnity Company v. Larkins, the court of appeal used the date of payment to satisfy a liability to determine that an indemnity action was not barred by the statute of limitations. The court did not use the dates when the indemnitee had paid attorney's fees.19
Moreover, in Gribaldo v. Agrippina Versicherunges A.G., the supreme court explicitly held that "an indemnitor is not liable for a claim made against the indemnitee until the indemnitee suffers actual loss by being compelled to pay the claim."20 Similarly, the court of appeal in Ramey v. Hopkins dismissed a complaint that did "not allege payment, nor…show payment of the sum for which judgment was entered."21 When an indemnitee loses a suit, the attorney's fees paid by the indemnitee are added on to the payment made to satisfy the liability, and the indemnitor must indemnify the total amount.22
Thus, a potential pitfall exists in cases when an indemnitee successfully defends itself against a claim. While the indemnitee can recover the reasonable costs of attorney's fees from the indemnitor when the indemnitee is victorious in litigation, the statute of limitations may block its efforts. In United States Fidelity & Guaranty Company v. Smith, the court of appeal held that an obligee who in good faith successfully defends a claim may be indemnified for attorney's fees pursuant to Civil Code Section 2778(3).23 The date when the expenditures for attorney's fees are made, however, is when the cause of action accrues. This can create a situation in which the indemnitee pays its attorney's fees for a case that it ultimately wins but the case is not resolved until after the applicable period of limitations has expired. Consequently, the indemnitee finds itself barred from recovering the amount it paid to its attorneys.
Given the possibility of this type of scenario, attorneys and clients face a peculiar Catch-22 in indemnity actions. There is a perverse incentive for the indemnitee to lose the litigation so that it can be assured of recovering all attorney's fees. One way for both client and counsel to avoid this pitfall is for the client to sign another agreement with the indemnitor in which the indemnitor promises to pay later. This contract will protect the indemnitee even if it wins the case after a trial that outlasts the statute of limitations. Another, more speculative, option is for the indemnitee to seek advance recovery of payments made to attorneys within the statute of limitations period, even if the litigation is ongoing.
Counsel should also advise their clients to include in indemnification contracts express language permitting recovery of attorney's fees and costs in an action between the indemnitee and indemnitor. This will ensure that the client indemnitee will be compensated for costs incurred in pursuing an indemnity claim against the indemnitor.
Practitioners and their clients should never assume that an indemnity clause is a definitive guarantee against disputes. Indemnity clauses are limited by statute and case law. Even though the statute of limitations for express indemnity claims based on a written contract is four years, practitioners should operate under the prudent legal assumption that the statute of limitations for implied indemnity actions and traditional equitable indemnity actions is most likely two years.
If the indemnity agreement covers liability, the statute of limitations does not commence until the indemnitee becomes legally liable. If the indemnity agreement covers losses or damages, then the statute of limitations does not begin to run until the indemnitee makes a payment to satisfy a settlement or judgment. In the event that the indemnity agreement contains provisions for both liabilities and damages, the statutes of limitations for the respective provisions run separately.
Paid attorney's fees generally are indemnified and added to the losses and damages that an indemnitee may recover once payment on a settlement or judgment is made. Expenditures for attorney's fees in an action in which the indemnitee successfully defends against a third party's claim are recoverable, but the statute of limitations is initiated when the expenditures are made. To ensure that clients are protected in the event of litigation, practitioners should advise clients regarding the type and timing of the statute of limitations in indemnity actions before and after the clients agree to contracts.