Risk Management 101: The Power of Indemnification (Part 1)

By Kristi A. Davidson

Last month’s article introduced ways to manage the risk of product liability through the design, manufacturing and distribution process. This month, let’s consider one way to shift the risk of product liability: contractual indemnity provisions.

“Indemnity is a contract by which one engages to save another from the legal consequence of the conduct of one of the parties, or of some other person.” See California Civil Code, Section 2772. Effectively, contractual indemnity works like an insurance policy – if damage occurs and liability is proven, then the party who has contractually agreed to “indemnify” the other pays for that damage.

There are countless reasons why a contracting party may ask for indemnification. For example, manufacturers may demand indemnity if the equipment will be manufactured to precise specifications, or because use of the equipment poses particular hazards requiring extra training or heightened supervision. If a component will be integrated into a larger product, the part manufacturer may ask the customer to indemnify it from damages arising from use of the integrated whole. Or it may be as simple as putting actions behind your words: If you represent or warrant X, but X is wrong, then you will indemnify me for resulting damages.

Historically, states have scrutinized indemnification provisions and have gone out of their way to strike them when possible – particularly when the indemnification concerned a claim of personal injury to a consumer or when the indemnified party was actively at fault. More recently, however, states have been willing to enforce indemnification provisions, especially in a commercial setting. For example, where there is the potential for multiparty liability arising out of multiparty participation in a transactional chain, states have permitted the parties to allocate among them, as a negotiated business matter, who is responsible for third-party claims resulting from the whole transaction.

The growing acceptance of indemnification provisions has opened the door to less traditional contractual indemnities. Sometimes a seller will demand indemnity just because it can; the purchaser agrees in response to adverse market conditions, its need for the product, the lack of an alternative source, its desire for exclusive distribution, a lower price or any other material term or condition.

As with any contractual term, negotiation and precision are key. Who is agreeing to pay whom? What losses are being indemnified and what losses are excluded? What acts are covered and are any carved out? Is this purely a duty to indemnify (i.e., to pay damages for which the indemnified party is ultimately found liable), also a duty to “defend” (i.e., immediately and actively fund the defense of any claim) and/or a duty to “hold harmless” (i.e., to release a party from any liability to you)? What triggers each duty? Who controls legal strategy? Who controls settlement terms? Is there any cap on the amount of damages or defense costs the indemnifying party is required to pay? Does the indemnification apply only to direct damages or to consequential and other forms of damages? Does indemnification survive termination or expiration of the contract? What law applies, and does the law of that state hold any type of indemnification void on public policy or other grounds?

Contrary to popular perception, there is no “standard” indemnification language. Parties should carefully consider the intent, purpose and consequence of each word. More on risk management next month.

Kristi Davidson is a shareholder in the New York City office of Buchanan Ingersoll & Rooney. She can be reached at kristi.davidson@bipc.com.

Editor’s Note: The comments are those of the author and are not necessarily views shared by HFN or Macfadden Communications.