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Keys to negotiating indemnity agreements

Posted On: Nov. 6, 2017 12:00 AM CST

Keys to negotiating indemnity agreements

The effective management of indemnification and related insurance obligations is an active agenda item for top-level business leaders, including any CFO, CEO and general counsel. It is, therefore, imperative, whether you are a Fortune 500 company or a small business, that your company’s risk management and legal departments strategically manage indemnification and insurance obligations to minimize the always increasing cost-of-business demands.

Commercial, construction and professional services contracts commonly include indemnification provisions, along with the requirement that an indemnified party be named as an additional insured on any applicable insurance policy. When a defense and indemnity claim is subsequently made, however, these apparently straightforward agreements often are subject to interpretation, which can lead to significant disputes among the parties and their respective insurers. As a result, nearly every state’s judiciary and/or legislature are undertaking a concerted effort to limit, and sometimes altogether invalidate, indemnity agreements. As new laws are passed and groundbreaking judicial decisions are issued, the insurance industry responds with frequent modifications to the language utilized in the standard ISO Additional Insured Endorsement Form.

Companies, and their respective legal and risk management departments are, therefore, confronted with increasing challenges in keeping up with changes in the law to ensure their company’s indemnity agreements are enforceable.

While the issues that arise in indemnity and insurance coverage disputes cannot be comprehensively addressed in a single article, there are common pitfalls that can be avoided. Focusing on five key issues can help to ensure that your company is well protected.

1. The language of the indemnity agreement

The party with a stronger bargaining position — often referred to as the “upstream” party, such as an owner or contractor — is often the drafter of a commercial contract and tends to initially control the indemnity obligations of the less powerful or “downstream” party, such as subcontractors and suppliers. One commonly overlooked issue by a downstream party, or even an upstream party in the case of mutual indemnification, centers upon the use of the language “arising out of” versus “to the extent caused by.” Some courts interpret the “arising out of” language to stand for a “but for” causation theory of liability. In other words, any remote causal relationship between the upstream party’s liability and the incident in question will suffice to trigger the downstream party’s indemnity obligations.

More recently, however, sophisticated companies are requesting that the phrase “to the extent caused by” be utilized in the indemnity agreements in place of the “arising out of” standard. “To the extent caused by” has been interpreted by some courts to mean legal and proximate causation. From a practical standpoint, this often results in no duty to defend or indemnify if the claimant does not allege the injuries or damages were caused, in whole or in part, by the upstream party’s negligence.

2. Selecting the governing law

While obvious, it cannot be stressed enough that parties negotiating a commercial contract should carefully consider which state’s law will control any subsequent contractual dispute. If there is no governing law provision in the contract, the laws of the state in which the incident occurred or where the service was performed will typically control. If you conduct business nationally, a governing law provision is critical because nearly every state has enacted anti-indemnification legislation.

In 45 states, anti-indemnification legislation has passed to protect parties with the weaker bargaining position in industries such as construction, transportation and oil field services. Depending on where you sit, that can be good, bad or both, but regardless it is always best to know how you may be impacted. It is critically important to thoroughly understand the language of these statutes; they are not consistent, do not always affect the same industry, and/or follow the same framework. Some states’ laws prohibit indemnification for another’s sole negligence, while others permit indemnification, but only for the negligence of the downstream party.

A majority of anti-indemnification statutes do not affect insurance coverage. Although the indemnity obligation may be void under a particular state’s law, additional insured coverage may not be prohibited. This result is typically referred to as the “additional insured loophole.”

3. Specificity in insurance obligations

Failure to include specific language identifying the type of insurance policy and the specific additional insured endorsement to be used can also lead to significant and costly coverage disputes.

When negotiating insurance obligations, it is always best practice to request the policy terms that your business requires. It is critical to define: whether the coverage should be occurrence-based or claims-made; what the per-occurrence or per-claim limits are; what the general aggregate limits are; and whether the limits must be satisfied through a primary, excess and/or umbrella policies. In doing so, consider whether the second layer of coverage is a true follow form policy, and if not, ensure the umbrella policy is designed to provide the same or substantially similar type of coverage as the primary policy. Gaps in coverage can be unintentionally created if these issues are not addressed in the original contract, and disputes often arise between primary and excess insurance carriers as a result.

4. Requesting the appropriate additional insured endorsement

The initial additional insured endorsement form was introduced in 1985, which is commonly referred to as “broad form” coverage. The 1985 endorsement provides the additional insured blanket coverage, but only with respect to a liability arising out of their work. Due to the “arising out of” language often being interpreted consistent with a “but for” causation standard, the insurance industry was saddled with unanticipated exposure. Subsequent endorsement forms introduced in 1993 through 2001 focused on terminating coverage after the additional insured’s work is “complete” and/or put to its “intended use.” In 2004, the revised endorsement incorporated “to the extent caused by” language and closed the perceived neverending defense and indemnity obligation under the “arising out of” standard.

In 2013, however, the ISO endorsement was drastically revised to link the additional insured coverage to the insurance obligations, and if drafted properly the indemnity obligations, in the commercial contract, as well as to specifically address anti-indemnification legislation. In short, the additional insured endorsement will not expand the amount of coverage required under the commercial contract. Indeed, the 2013 ISO endorsement only permits coverage to the “extent permitted by law.” Selecting the specific additional insured endorsement that best suits your company’s demands may ultimately depend upon your bargaining position. While upstream parties may still be demanding blanket coverage, the 1985 endorsement has quickly become obsolete, and the 1993 through 2001 endorsements are starting to follow suit.

Regardless of whether you are an upstream or downstream party — and particularly if mutual indemnification is required under the contract — the 2013 endorsement may prove to be the ideal option. This principle holds particularly true if careful consideration is given to selecting the appropriate state’s law to govern contractual disputes.

5. Communication between legal and risk management departments and brokers

Holding open communications between the legal and risk management departments in your company is a cornerstone to success. The risk managers need to be informed of the terms and conditions of each contract drafted by the legal department.

Similarly, the risk managers need to advise the legal department as to insuring obligations. While each department has their own priorities, a symbiotic working relationship between the two departments is truly an important key to effectively managing potential indemnity and insurance exposure. One big loss with indemnification consequences will prove this point.

It is equally important to provide your company’s insurance broker with all contracts in existence at the time of obtaining new policies of insurance and/or while renewing existing policies. While most companies are not willing to share their private business deals with third parties, including insurance brokers, having your broker sign a nondisclosure agreement to maintain confidentiality can easily alleviate this concern. Unless your broker is aware of your company’s specific contractual obligations, he or she will be unable to effectively obtain the right type of coverage.

Conclusion

Negotiating enforceable indemnity agreements and mirroring your company’s insurance program to the indemnity obligations is becoming increasingly more difficult in light of anti-indemnification legislation and the more recent evolution of the additional insured endorsement. If, however, your company’s risk management and legal departments focus on these five key areas, most of the potential pitfalls that lead to protracted litigation may be avoided.

James Buldas is a partner at Pietragallo Gordon Alfano Bosick & Raspanti L.L.P. in Pittsburgh. Mr. Buldas focuses his practice in insurance coverage, construction, professional liability, transportation and other various commercial disputes. He can be reached at 412-263-1814 or at jjb1@pietragallo.com