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Published: July 7, 2009
Authors:
Michael Anderson and
John Mitby
Indemnification is the payment by one party (the indemnitor) of claims, losses, damages, expenses and other costs incurred by another party (the indemnitee). It is the shifting of liability for personal injury or damage to property from one party to another.
Indemnification may be required by statute, imposed by common law, or agreed to or implied by contract.
Contractual indemnity is distinguished from common law indemnity, which is an equitable remedy arising out of obligations imposed through special relationships. In order to prevail on a common law indemnity claim, the following two-pronged test must be satisfied:
- The party seeking indemnity (the indemnitee) must be without fault and its liability must be solely vicarious for the wrongdoing of another, and
- The party against whom indemnity is sought (the indemnitor) must be wholly at fault. [1]
Indemnification provisions are not "fail safe" for either side, and such agreements often wind up in litigation.
Even when a party is ordered to provide indemnification, it may not have sufficiently deep pockets to fulfill its obligation, leaving the indemnitee (i.e., the party entitled to be indemnified) financially exposed.
Indemnification Agreements
An owner may require engineers, architects, contractors, vendors, and others who perform services for the owner to assume the risk of damages arising out of the work. Indemnification agreements can be drafted to transfer a range of exposure from virtually all to only limited risk. Broad indemnification may require the indemnitor to reimburse the indemnitee for damages caused solely by the indemnitee's own negligence and/or for the negligence of third-parties over whom the indemnitor has no control. At the other end of the spectrum, the indemnitor agrees to indemnify the indemnitee only to the extent of the indemnitor's own negligence. In between are variations of risk-shifting, including, for example, the indemnitor's agreement to indemnify the indemnitee for all damages except those caused by the indemnitee's sole negligence.
For indemnification agreements with engineers, architects, contractors, vendors and others who perform services for the owner, factors that influence indemnification terms are:
- Nature of the business
- Respective market power of the parties
- The law and public policies of states in which the contract will be performed
- Indemnities can be rendered void and unenforceable under some state's anti-indemnity statutes
- Balancing legitimate goals of protecting investors, while also protecting directors and officers against shareholder litigation and regulatory proceedings
What Are The Most Critical Provisions?
A typical indemnification article suggests the following provisions and/or considerations:
- Survival of representations and warranties: How long?
- Indemnification by engineers, architects, contractors, vendors and others who perform services for the owner: (a list specifying the types of items that if they cause losses are covered by the indemnity).
- Indemnification by owner.
- Indemnification procedures (the mechanics): how to serve, when, where and under what circumstances.
- Certain limits on indemnification.
- Calculation of losses:
- Net of amounts recovered or recoverable by the indemnified party under insurance policies;
- No party liable for consequential, incidental, indirect or punitive damages of the other person.
- Mutual indemnification.
- Broad form indemnification - even if I am negligent, you indemnify me.
Key to Indemnification Claims
- Clear drafting of the indemnification provision itself is always a key.
- Having a clear dispute resolution mechanism is important since if the parties disagree over an indemnification claim made by indemnitee, the dispute resolution mechanism will come into play. Issues such as governing law and where disputes will be resolved become important.
- The indemnifying party should have the right, at it's sole option and expense, to be represented by counsel of its choice, which must be reasonably satisfactory to the indemnified party. If the indemnifying party elects not to defend, the indemnified party may defend. If the indemnifying party defends, the indemnified party may participate, at its own expense, in the defense.
- Neither the indemnifying party nor the indemnified party shall, without the written consent of the other party (which consent shall not be unreasonably withheld), settle or compromise any indemnification claim.
Keys to Drafting
When drafting, negotiating or entering into a contract with an indemnification provision, several issues should be kept in mind:
- Who is indemnifying whom?
- When does the duty to indemnify arise?
- Does the contract clearly express an intent to indemnify a party against its own negligence?
- Do the terms of the agreement determine whether the indemnitor is obligated to reimburse the indemnitee for a particular claim?
- What is being indemnified, i.e., personal injury, property damage, attorney's fees and costs of defense, economic loss?
- Is there a monetary limitation on the extent of the indemnification that bears a reasonable commercial relationship to the contract, and is such monetary limitation part of the project specifications or bid documents, if any?
- Is there a provision requiring that the risk be covered by insurance such that the indemnity is limited to the amount of the insurance coverage (contractual liability insurance)?
- Make sure there is symmetry between the owner's indemnification program and its insurance program; and, any uninsured risk should be offset by increasing the contract price or shifting the risk further downstream.
- To the extent its insurance program is intended to cover non-indemnifiable risks, make sure that the coverage is not subject to the kinds of exclusions described above that might render such coverage illusory.
- Balance the economics of an insurance program with increased protections and increased premiums, on the one hand, against the risk that the company may have substantial out-of-pocket exposure for defense costs in the event that the coverage is later determined to be incomplete or subject to coverage "gaps."
Joint vs. Several Liability: Which Approach?
Generally, an indemnitee prefers joint versus several liability so it does not need to "chase" multiple indemnitors to be made whole.
If there are multiple indemnitors and one indemnitor owns, for example, 90 percent of the outstanding voting stock, the 10 percent indemnitors can argue it is unreasonable for them to potentially sustain 100 percent of the liability and that several, not joint, liability is more appropriate.
- Sometimes an indemnitee will accept this argument (as is, or for a higher indemnification cap or escrow amount/holdback).
- Sometimes an indemnitee will require the 90 percent shareholder to assume 100 percent of the liability (in which case often the shareholders enter into a contribution agreement among themselves).
But this is not the whole story. About 40 states have anti-indemnity statutes that place some restrictions on allowable risk transfers in specified construction and/or design contracts. Some states forbid only the transfer of liability for one's negligence when it is the sole cause of a loss. Others prohibit any transfer of liability for one's negligence.
Presently, Wisconsin has no anti-indemnity statute. [2] Successful negotiating that transfers risk to a downstream party will be for naught if the contract language conflicts with a state's anti-indemnity statute.
Michael S. Anderson’s litigation practice, trial and appellate, focuses on a variety of commercial and business litigation, products liability and personal injury litigation. John C. Mitby is the Managing Partner of the firm and serves as counsel for numerous businesses, engineering firms, financial institutions, nursing and elder care homes, and hospitals. For more information on Wisconsin indemnification provisions, please call Mr. Anderson at 608.283.6708 or email him at manderson@axley.com, or Mr. Mitby at 608.283.6710 or email him at jmitby@axley.com.
[1] A. Barthet and S. Marsillo, Indemnification Clauses: Often Found, Rarely Understood @ note 1, (last accessed July 1, 2009).
[2] A. Hickman, "Additional insured status: It's not what it used to be", American Agent & Broker (July 1, 2005). Last viewed July 2, 2009. An older (2003) article, "Fifty-State Survey of Anti-Indemnity Statutes and Related Case Law" is available here.
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