Indemnity 1

2/21/2011

Indemnities, Part 1: Beware of Unfair Client Contracts

The following material is provided for informational purposes only. Before taking any action that could have legal or other important consequences, speak with a qualified professional who can provide guidance that considers your own unique circumstances. We would like to thank XL Insurance for their significant contribution to this material.

Of all contractual clauses between a design firm and its clients, indemnity agreements may have the most far-reaching implications. If a design firm agrees to an onerous client-written indemnity, that firm may find itself saddled with virtually all project risks – with many of them uninsured. That’s why it is imperative for you to understand the issues surrounding indemnities and to work with your attorney to ensure that your client-drafted agreements contain reasonable contract clauses.

The concept of indemnification originated in the construction industry as a method to hold project owners harmless from liabilities that arise during construction. The basic concept makes a great deal of sense: since the contractor has 100% control of the jobsite, it should indemnify -- or hold harmless -- the project owner for any site-related liabilities that arise. If a worker is injured during construction, for example, the contractor is generally held responsible since it controls jobsite safety.

Over time, unfortunately, the concept behind indemnification has been altered in ways that are unfair to design consultants. Architects and engineers now are often asked to sign indemnity agreements that make them assume a large portion of project risks. Indeed, it is not uncommon for design firms to find one or more clauses requiring them to indemnify the client from substantial liabilities, including those over which they exercise no control. The indemnification language may be short and seem innocuous, but it spells serious trouble nonetheless.

Many design professionals concede that they have unwittingly encouraged the use of onerous indemnifications by accepting them so readily. If they balk at an indemnity, the client may say, "Well, the design firm down the street doesn't object to the language.” Fearing they might lose the job, the design firm disregards better judgment and signs an indemnity-laden contract.

But before signing on that dotted line, consider:

  • Client-drafted indemnities typically ask you to assume liability for the client's negligence. Ask yourself: without the indemnity, whose risk would it be? Almost invariably it would be the client's risk.
  • Most client-drafted indemnities are uninsurable. If you sign an indemnity agreement that is not limited to your negligence, you are accepting liability beyond that required by law. Your professional liability policy likely includes a clause with language such as: “This insurance does not apply to liability assumed by you under any contract unless you would have been liable in the absence of such contract.”
  • Client-drafted indemnities frequently contain onerous, overreaching language. For instance, a client may ask for indemnity for your "intentional acts." Unfortunately, a crafty attorney could interpret virtually any of your acts as "intentional."
  • Client-drafted indemnities frequently ask you to defend the client. This provision could be interpreted as an obligation on your part to retain an attorney for your client and pay for this defense -- even before liability for negligence has been established.
  • Client-drafted indemnities may include inappropriate parties as indemnitees (parties to be indemnified). You should never agree to indemnify a client's agent, contractor, attorney, contract employee, lender, volunteer or anyone else who is not directly part of the client entity.

Types of Client-Drafted Indemnities

Client-drafted indemnities used in the design and construction industry can be separated into three general types: broad-form, intermediate-form and limited-form.

Broad-Form Indemnities. Of the three types of client-drafted indemnities, the broad-form type creates the greatest problems. Such an indemnity can make a design firm responsible for almost any problem that befalls its client during the project, whether or not the designer was negligent. A typical broad-form indemnity reads as follows:

Indemnification

Consultant agrees to hold harmless and indemnify Client from any and all liability, including cost of defense, arising out of performance of the services described herein.

Note that this clause does not limit the indemnification to liability that is the result of the design professional's negligent acts, errors or omissions. Obviously, such an all-encompassing indemnification creates enormous and largely uninsurable liabilities.

In some states, broad-form indemnification has been made illegal by virtue of court decisions or anti-indemnification statutes. But even in states where such indemnities are illegal, a judge might still rule that a given clause will be enforced when the parties to the contract have enjoyed relatively equal bargaining strength and the clause is written so clearly that its intent is unmistakable. And, of course, even if a court rules in your favor, litigation always means you have lost valuable time, goodwill, peace of mind and income.

Intermediate-Form Indemnities. An intermediate-form indemnity is not much better than a broad-form one, but it is legal in the majority of jurisdictions. It provides that a design professional will cover the client's risk whenever the design professional shares some of the liability due to negligence. A typical intermediate-form indemnity reads as follows:

Indemnification

Consultant agrees to hold harmless and indemnify Client from any and all liability, including cost of defense, arising out of Consultant's negligence, whether it be sole or in concert with others, in connection with performance of the services described herein.

Given a clause such as this, the client could be 99% at fault and, as long as the designer is at least 1% at fault, the consultant could pick up 100% of the tab. And in the event of a project upset, there is a very good likelihood that a design consultant would be held partly at fault. In fact, virtually any attorney could convince a jury that a design professional had at least a minor role in a project upset.

Limited-Form Indemnities. The limited-form indemnity assigns liability to the parties involved in proportion to the degree of fault. For example, if you are found to be 20% at fault, you will pay 20% of the damages. A typical limited-form indemnification may read as follows:

Indemnification

Consultant agrees to hold harmless and indemnify Client from and against liability arising out of Consultant's negligent performance of services.

While this limited-form indemnity is certainly more acceptable than the other two, it is best not to have it in a contract. First, it is unnecessary since you are already liable for your negligence. Second, it could muddy the waters regarding the insurability of your errors and omissions.

Making Your Stand

Regardless of how attractive a potential project may be, your guiding principle should be that you will not accept unlimited liability imposed by a client-written indemnity agreement. You must insist that liabilities remain with those parties who are in the best position to control them. You should do your best to persuade the client to remove any indemnity language that increases your liability beyond the liability you already have for your negligence, errors and omissions. Specifically, be sure you:

Know the law. Working with your attorney, find out whether your state has anti-indemnification statutes on the books. If so, what do they say and how have the courts interpreted them? Be aware that the law in your state may not apply to your project disputes. Client-drafted contracts frequently require that disputes be settled in the jurisdiction where the client is located and/or where the work is performed. This may be an out-of-state location where indemnities are enforceable.

Educate your client. Perhaps the best tactic for getting rid of an unfair indemnity is to demonstrate to the owner the ineffectiveness of such a contractual stipulation. Point out any anti-indemnification statutes on the books in your state or the jurisdiction where any dispute would be tried. Explain that any indemnification that expands your liabilities will be uninsurable and could even jeopardize coverages that would apply without the indemnification. As your insurance agent, we can help explain to your client that you are already liable for your errors and omissions and any resulting damages are covered within the available limits of your professional liability insurance policy. We’ll explain that an indemnity is unnecessary and may cloud the issue of your insurance coverage and legal responsibilities.

Plead for fairness. Explain that to hold you legally responsible for another's liability is simply unfair. Reaffirm your willingness to accept responsibility for your own errors and omissions but state your unwillingness to be liable for the mistakes and oversights of others. Explain that the theory of indemnities applies to contractors on the construction site since they assume control over the work site. Explain how it is unfair to hold a design firm responsible for liabilities that are completely out of its control.

Convincing an owner that an indemnification would be unenforceable and/or unfair can be difficult when the client has paid an attorney to draft the contract and the client has been told that another design firm will agree to the provision. What do you do when a plea for basic fairness does not work? There are still some options that while not ideal, are far better than accepting a client-drafted indemnity.

Next issue, Part 2 of this two-part report will address those alternatives. Plus we will examine certain cases where you might want to request indemnities from a client.

Why Indemnities Leave You Uninsured

Professional liability insurance specifically excludes liability you assume by contract; i.e., liability that would not be yours were it not for the fact that you specifically agreed to accept it. The insurers' position on this issue is understandable. The rates they charge are based on certain assumptions they make about known risks, given the types of services a design firm performs, types of clients, amount of fees earned and so forth. If insurers were to cover any and all additional risks a design firm agrees to assume by contract, the liability exposure could be made one thousand times greater than normal simply by the stroke of a designer's pen.

For the same reason, commercial general liability (CGL) insurers also disallow coverage of contractual liability. Note, however, that either usually will cover a limited-form indemnification that does not expand a design firm's liability beyond what common law says it must be responsible for in any event. Nonetheless, whenever a firm is considering acceptance of an indemnification clause, it should have the clause reviewed by an experienced agent or attorney first.

Can We Be of Assistance?

We may be able to help you by providing referrals to consultants, and by providing guidance relative to insurance issues, and even to certain preventives, from construction observation through the development and application of sound human resources management policies and procedures. Please call on us for assistance. We're a member of the Professional Liability Agents Network (PLAN). We're here to help.


2/18/2011
Meeting the Standard of Care
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Job Site Safety, Part 1
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