While the blame game for gross negligence continues in Texas, Louisiana law is clear: a party may not contract for indemnification against its own gross negligence. Under article 2004 of the Louisiana Civil Code “[a]ny clause is null that, in advance, excludes or limits the liability of one party for intentional or gross fault that causes damage to the other party.” Gross fault includes gross negligence, as well as bad faith breach of contract and fraud.
In Occidental Chemical Corporation v. Elliott Turbomachinery Company, Inc., 84 F. 3d 172 (5th Cir. 1996), the Fifth Circuit applied article 2004 to invalidate a clause indemnifying a subcontractor against its own gross negligence. Under a subcontract with Occidental’s general contractor, Elliott modified (“rerated”) a compressor owned by Occidental. The contract limited the duration of Elliott’s warranty for its work and made Elliott “completely immune” from liability for any damages. When the compressor failed, Occidental was forced to shut down its plant and incurred $7 million in damages. Occidental sued Elliott and alleged that Elliott had used inferior parts to modify the compressor. The district court found that under the contract most of Occidental’s claims were untimely. However, the district court also concluded that under article 2004 any time limit on Elliott’s warranty for gross fault was invalid.
On appeal, Elliott argued that article 2004 did not apply to a warranty duration provision and that invalidating the provision would destroy the parties’ freedom to contract. In interpreting article 2004, the Fifth Circuit was “convinced that although limitations regarding warranties are permissible in most circumstances, such limitations are prohibited when the obligor is guilty of gross fault. . . . Thus, any contractual clause which operates to limit a plaintiff’s right to redress a violation for gross fault violates Louisiana public policy. . . . [W]hile Louisiana law permits parties to limit, by contract, the duration of a warranty, article 2004 prohibits provisions limiting the duration of a warranty when gross fault is involved.” Otherwise, good faith in the performance of a contract would be destroyed because “‘gross fault’ involves a certain degree of fraudulent intent.”
Elliott’s further attempts to distinguish between gross fault and gross negligence failed to persuade the court. “We previously have determined that article 2004 encompasses gross negligence,” the court responded. “Louisiana opinions . . . have reached the same conclusion.”
Gross fault is broadly defined
Louisiana courts construe the term “fault” more broadly and comprehensively than the term “negligence.” In Wadick v. General Heating & Air Conditioning, LLC, 14-0187 (La. App. 4 Cir. 7/23/14); 145 So. 3d 586, two homeowners filed suit against General Heating for breach of contract and alleged that General Heating had installed and maintained the homeowners’ air condition in a defective manner, causing mold and mildew. In response, General Heating sought to enforce a provision of the installation contract that excluded liability for mold. The trial court dismissed the plaintiffs’ claims, erroneously reasoning that article 2004 applied only to tort claims.
But on appeal, the Louisiana Fourth Circuit reversed. It held that whether the plaintiffs’ claims were based in contract or tort was not relevant to the application of article 2004. The court explained that “[u]nder Louisiana law, liability, in both the contractual and delictual [tort] context, is incurred because of fault” and that gross fault under article 2004 “includes both contractual and delictual [tort-based] fault.” Consequently, gross fault contemplated by article 2004 “includes not only gross negligence, but also bad faith breach of contract or fraud.” Thus, the Fourth Circuit held the exculpatory provision for mold damage invalid under article 2004.
Indemnification uncertain for gross negligence to a third party
Despite the certainty of Louisiana law on indemnification for gross negligence, it remains unclear how article 2004 may apply to an indemnification agreement benefiting a third party. While not an official part of the law, a comment to article 2004 suggests that the law does not govern “agreements were parties allocate between themselves, the risk of potential liability towards third persons.” For example, in Lifecare Hospitals of New Orleans, L.L.C. v. Lifemark Hospitals of Louisiana, Inc., 07-914 (La. App. 5 Cir. 4/15/08); 984 So. 2d 894, the court suggested that an insurer may waive its subrogation right to recover claims paid for gross negligence and that an insured may waive his insurer’s right of subrogation. A court may even find article 2004 inapplicable to the extent a party can characterize its agreement as one shifting risk, as opposed to completely excluding liability for gross fault. This is more likely to be true when an agreement requires insurance against the reallocated risk.
A question of public policies
The validity of an indemnification agreement waiving a third-party right of subrogation for gross negligence is a factually intensive inquiry. Courts will more likely uphold such agreements when the parties are of equal bargaining power and have clearly expressed the intent to reallocate such risk. As the Louisiana Supreme Court noted in Home Insurance Co. of Illinois v. National Tea Co., 588 So. 2d 361 (La. 1991): “To ensure that the indemnitee is not unjustly enriched at the obligor’s expense, equity dictates that such a provision be enforced only if there is clear evidence that the risk was bargained for and accepted.” In analyzing jurisprudence on this subject, a federal court noted that the Louisiana Supreme Court upheld a release provision that was clear and express, and where there was no “suggest[ion] that one side had an unfair bargaining advantage over the other.” McAuslin v. Grinnel Corp., Nos. Civ. A. 97-803, 97-775, 1999 WL 203279 (E.D. La. 1991). Using that rationale, the federal court maintained a clause in a lease between a city and an industrial lessee where the city waived the subrogation rights of its insurer. In so finding, the court noted that “this case involves a bargained-for agreement among sophisticated parties.”
Similar to the blame game in Texas, a resolution of this issue in Louisiana will require balancing the state’s public policy on good faith performance of contracts, with the freedom of parties to make their own bargain. Weighing in on this issue, one federal court suggested that “[t]o nullify one bargained-for clause would upset the balance negotiated by the parties to [a] bona fide commercial transaction. [A]rticle 2004 does not mandate such a perverse result.”