Understand the Legal Issues in Indemnity Agreements

frankAlmost every contract a firm faces has one or many indemnity agreements in which the firm promises some sort of payment to or on behalf of the client. From a professional liability insurance perspective, contractual indemnity obligations are easy to analyze—if they promise anything other than the correction of harm or the payment of damages caused by the firm’s negligence in performing professional services, they exceed coverage.

From a legal perspective, however, indemnity provisions are difficult to analyze. And that is why firms need local legal counsel to parse out the obligations and business risks in such provisions. Parties to a contract have breach of contract rights and some level of tort rights against each other; these are inherent in the contractual relationship. But contractual indemnities create supplemental rights that are often independent of the normal rights established by contract. And how those rights are interpreted state-to-state differs significantly depending on statutes and rulings. So unless a firm is willing to take an unknown business risk, a careful legal analysis is critical.

One of the issues is the underlying purpose of an indemnity provision. While the concept of indemnification is based on protecting a party from third-party claims, not all contractually assumed obligations are so limited. The obligation to indemnify may refer more broadly to compensation for costs, losses, or damages without referral to third parties. And often courts will, as a matter of law, liberally construe an indemnity clause in favor of the beneficiary if it deals with the negligence of the indemnifying party. And that could extend to paying up front defense costs irrespective of any final determination of negligence.

Many firms seem to accept the uninsurable contractual exposures of indemnity provisions seemingly without concern about the possibility of loss. That risk, however, should be prudently evaluated with the help of legal counsel.

For a professional liability look at contractual indemnity, you can examine one of these Schinnerer Management Advisories titled “Indemnification Issues“, “Limiting Risk When Negotiating Indemnity Provisions” or “Defending and Indemnifying a Client.” (Access is limited to brokers and policyholders.)

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