Thursday, March 10, 2011

Indemnities and Hold Harmless

To manage the risk of 3rd party claims caused by the Supplier, most Buyer agreements will have two forms of indemnifications they want the Supplier to provide.
·      The General Indemnification primarily deals with 3rd party personal injury or property damage claims.
·      The Intellectual Property Indemnification deals with 3rd party IP infringement claims. An indemnification is a commitment that’s even higher than a warranty.
In a warranty, you have the right to sue for damages sustained for a breach of the specific warranty. An Indemnity requires the Supplier to “step into the shoes” of the Buyer and protect the Buyer from the claim so the Supplier also has the cost of any legal defense.

A General Indemnification which covers personal injury or property damage usually requires three things:
1) The Supplier must defend against the claim, which means that they assume the responsibility to manage and pay for the defense against the claim.
2) The Supplier must indemnify the Buyer against the claim, which means that they must pay for all costs and damages awarded or any settlement costs they may agree to.
3) The Supplier is asked to “hold harmless” the Buyer, which means that as between the Buyer and the Supplier, only the Supplier will be responsible. Suppliers usually resist holding the Buyer harmless as there could be acts caused by the Buyer’s negligence that contributed to the injury being claimed.  In those situations you may negotiate in a carve -out such as “except for the sole negligence of the Buyer” in their commitment. In doing that the Supplier would be fully responsible for both their sole negligence and in situations where both parties are negligent.

As a Supplier may not have sufficient assets to cover 3rd party claims for personal injury or property damage, most Buyer agreements will also contain requirements that the Supplier must carry “comprehensive and general liability” insurance with specified amounts of coverage. The insurance provides a form of financial protection on general indemnification commitment.  The Buyer could go against the insurance, up to the limits of the policy, and then look to recover from the Supplier any amounts not covered by the insurance.

From a negotiation standpoint, since you can’t cap the amount a 3rd party may sue for in a personal injury claim as it would be against public policy, you should not agree to a cap on the general indemnification and your limitation of liability provision and any dollar limit on liability should exclude the General Indemnification. There are two reasons to do this. First, a dollar cap could limit the coverage of the General Indemnification to only the amount of the cap. The second reason is normal Limitations of Liability will exclude claims for lost revenue; lost profits, and incidental, consequential, special or punitive damages. The net result would be that you could potentially only claim direct damages and that would significantly limit the types of costs that would be covered by the Indemnification.  When a Supplier want try to negotiate a cap on general indemnification liability I remind them that if the 3rd party were to sue them directly, there is no way they can limit the liability so they aren’t assuming any greater risk than they already have.

An Intellectual Property Indemnification established the responsibilities of the Supplier for 3rd party claims that the Supplier’s products or services infringe intellectual property rights of that 3rd party.  This type of provision requires Supplier to do the same “defend, indemnify, and hold harmless” of the Buyer on the claim. This has the Supplier assume financial responsibility for liabilities (e.g., damages, court costs, attorney fees) resulting from claims that the product or service infringed a third party’s intellectual property rights. Most IP indemnification provisions also describe the actions or remedies a Supplier must take to remedy any claimed infringements to allow for the continued purchase and use of the products from the Supplier. Normally these remedies would include:
1.     Get a license from the 3rd party to use the infringing product or service.
2.     Modify the product or service so it becomes non-infringing,
3.     Replace the product or service with a non-infringing products or services and
4.     Provide a refund of the purchase price. 
In the negotiation of the IP Indemnification provisions, Suppliers look for two things. First, they want to be excused from providing the indemnification in situations where the Buyer caused the infringement. As a result, most Buyer IP Indemnity provisions will have exclusions to the Supplier’s responsibility to provide indemnification in certain situations:
1.     If the claim is the result of a modification to the product not made by the Supplier.
2.     If the Buyer directed the Supplier to make the product in a specific manner and that causes the infringement.
3.     Where the claim is based on the combination or use of the product with another product where the claim would not result from the product itself
If any of these 3 situations existed, it would relieve the Supplier from providing the IP Indemnity and it would be the Buyer’s responsibility to defend against the claim and bear all costs.

Suppliers will usually also want the remedy to be at their option. The reason for this is so they can select the least expensive option. Most Buyer drafted IP Infringement remedies are structured in order of the Buyer’s preference starting with the remedy that has the least impact to the Buyer (get a license) followed by other remedies where the obligation is to provide the first of those remedies that are capable of being done. That remedy would have the least impact to supply and would also be a no cost implementation for the Buyer. If you allowed the Supplier the option to decide which of the remedies they can select, their priority would be to select the one that’s best for them, which could easily be the one that’s the worst and most costly for the Buyer. This means that you need to either not allow the Supplier to determine the remedy, or the remedies you do allow should be financially neutral to the Buyer. For example, you probably would not include the remedy of the refund of the purchase price if the Supplier had the option of selecting which remedy must be performed. If you don’t give the Supplier the option to determine which remedy will apply, they will normally want to include a standard reasonableness. While a remedy may be capable of being done, their concern is the cost to do it may be excessive. Work with your lawyer to determine the best approach.

Suppliers that balk at indemnifying the Buyer against intellectual property infringement should be told that the Buyer relies on the fact that they are in the best position to know the details of their Product or Service and can best manage the risk. 

Since agreements are read together to establish obligations, the commitments made in indemnifications can wind up being limited by the Limitation of Liability provision.
A Limitation of Liability provision will normally do two things. First it will exclude certain types of damages from being claimed by the parties. For example, typical limitation of liability provisions will exclude claims for lost revenue; lost profits, and incidental, consequential, special or punitive damages. A Limitation of Liability provision also may establish a specific cap on both parties’ potential liability.
Indemnifications are based on third party claims, they are not a loss that had been directly sustained by the Buyer, so indemnification provisions need to be excluded from any limitation of liability. Suppliers may also want to place a dollar cap on their liability for the indemnifications.  The problem with a cap on liability is the Buyer has no way of controlling what a third party can sue for. All a cap does is limit the Suppliers liability and make the Buyer subject to liability over the amount of the cap for risks that they have no way to manage.

Indemnities protect against 3rd party claims and there are a number of third party claims that can be made so you could potentially have an indemnity against each type of third party claim. Many companies use a combination of warranties and indemnities to provide protection against 3rd party cliams so most contracts include only 2 types of indemnities mentioned above.. There are three basic types of indemnities. The type of indemnity is determined by the language you use. A broad form indemnity provides coverage even if the indemnitee were negligent so it eliminates comparative negligence. If you have "hold harmless" in the indemnification language its a broad form indemnity. An intermediate form of indemnity requires the indemnitor to assume all of the risks associated, but not if the sole cause of risk is attributable to the indemnitee.  A comparative fault indemnity would hold the indemnitor responsible only for the loss caused by the indemnitor, or to the extent caused by the indemnitor.

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