In a previous article, we discussed the importance of the indemnification clauses in contracts. To briefly recap, to “indemnify” someone means that one party agrees to compensate the other party for losses that the other party may suffer when things go wrong, especially for losses caused by injuries to a third party. An indemnification clause allocates and shifts potential risk in a contract from one party to another. In this article, we will delve into a discussion of the types of losses that are typically covered by an indemnification provision, the parties who are being indemnified, and what triggers a duty for one party to indemnify the other.
Let’s start with an example.
Company A enters into a contract with Company B to remove some dead trees from property owned by Company A. The terms of the contract provide that Company B will indemnify Company A for all losses, damages, judgments, rulings and settlements, including costs and attorney’s fees, incurred by Company A in connection with Company B’s performance of its obligations under the contract, as long as Company A has not been negligent. While removing trees from Company A’s property, a tree accidentally falls on a car that happens to be parked in the parking lot located on Company A’s property, causing significant damage to the car. The owner of the car, or the owner’s insurance company, files a lawsuit against Company A for the damage to the car.
At first, things seem pretty simple. The tree fell while Company B was performing the work in accordance with the contract, so Company B should have to indemnify Company A and pay for the damage sustained to the car, right? But when it comes to indemnification clauses, things are rarely simple. Let’s say that the contract between Company A and Company B specifically provided that no cars could be parked in the parking lot located on Company A’s property while the work was being performed. Does this mean Company A was negligent for not ensuring that the parking lot was empty, making the indemnification clause invalid? Alternatively, was Company B really the negligent party by proceeding with the work when it was obvious that there was a car in the parking lot, meaning that Company B is required to indemnify Company A for the damage to the car?
As this simple example points out, in an indemnification clause, every word counts. The indemnifying party is only required to indemnify the other party for the specific types of claims covered by the indemnity clause. Depending on how the clause is drafted, these obligations can be extremely broad, or very narrow. To draft a fair indemnity provision, the parties need to carefully consider the purpose of the contract, the types of risks involved, and which party should be responsible for bearing those risks.
Another aspect to consider in reviewing indemnification provisions is considering which parties should be indemnified. Returning to our example, let’s say Company A hires a management company to manage the parking lot. The owner of the damaged car sues both Company A and its management company. If Company B only agreed to indemnify Company A, it would not be obligated to indemnify the management company. However, if Company B agreed to indemnify not just Company A, but also its officers, directors, employees and agents, Company B may be required to indemnify the management company as well for any losses it sustains related to the damages to the car. (Just to add an additional layer of complexity, note that Company A may also have an independent obligation to indemnify its management company for any losses it sustains pursuant to the terms of the indemnification clause contained in the management contract between Company A and the management company.)
Most indemnification clauses apply to any monetary damages incurred by the indemnified party related to a covered loss. In addition, the indemnifying party typically also agrees to pay all costs and attorney’s fees incurred by the indemnified party in defending a covered claim. In other words, indemnification provisions also cover defense costs. Typically, the indemnification provision includes issues such as which party selects the attorney, which party has the right to settle a claim and can the indemnified party hire separate counsel. It’s important to understand these provisions, because depending on how the indemnification clause is written, the indemnifying party might have to pick up the defense tab for the indemnified party as soon as it receives notice of a claim. On the other hand, sometimes an indemnification obligation doesn’t kick in until there is a final adjudicated settlement of the claim.
Where indemnification clauses are concerned, it is absolutely true that the devil is in the details. Dismissing this important clause as mere “boilerplate” could lead to unexpected consequences later on.
For questions about this article, or any other contract related matter, please contact an attorney in our Business & Transactional practice group.