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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Insurance has a language of its own and it’s always wise to involve your company’s insurance expert in any insurance negotiations. Each country you deal in may have different insurance requirements and lines. As a negotiator there are a number of things that you should know about insurance. Insurance is described by the types of “Lines” that are required.  Think of a line as a form of risk or risks the insurance policy is designed to provide financial protection against. Most contracts will include indemnifications against personal injury or property damage caused by the Supplier. One of the things insurance does is provide financial backing behind those indemnifications and promises so you aren’t solely dependent upon the assets of the Supplier. Here’s a listing of the most common types of insurances available in the U.S. that may be required:

Comprehensive general liability is a policy that is designed to protect a business from a wide variety of potential liability such as accidents on their premises or operations, liability from products they sell or services they perform, liability for operations completed and contractual liability.

Comprehensive Automobile Liability is a policy that covers potential liability for bodily injury or property damage caused by an automobile.

Workers Compensation is a policy that that covers potential liability of an owner that is imposed by a workers’ compensation law for injuries sustained by the worker in the performance of their work.

Employers Liability is a policy that covers against common law liability that an employer has for accidents and injuries to their employees.

Crime or Employee Fidelity is a policy that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees. These policies protect from losses of company monies, securities, and other property from employees who have intent to cause the company loss.

Property Liability is a policy that covers loss of damage to real and personal property caused by something your business does or doesn't do damages someone else's property. Even if you don't physically injure that property, you may do something that actually prevents its owner from continuing to use it. Coverage usually includes the physical damage to the property; or the loss of use of that property.

Professional Errors and Omissions is an insurance which gives physicians, attorneys, architects, accountants and other professional coverage for claims by patients and clients for alleged professional errors and omissions which amount to negligence.

Umbrella Liability is a policy that covers losses above the limits contained in underlying policies and coverage may be broader than the underlying policy. An umbrella policy is issued under the same terms and conditions as the policy(s) is sits above.

Excess Liability policy covers losses above the limits contained in underlying policies. Coverage may not have the same terms. Like an umbrella policy it provides coverage amounts over and above the primary liability policies.

As other potential risks arise, many times insurance is sought to provide protection against the risk. For example a recent requirement is coverage for loss of personal data that was entrusted to a company.

The main issues in dealing with Insurance are:

a)             Coverage limits. The primary issue is making sure that the coverage limits are adequate enough to protect against the risk. Coverage limits may be expressed in different ways such as total liability, total liability within a limited term or liability on a per incident basis.

b)             Financial Stability of the Insurer.  Insurance is only as good as the financial stability of the Insurer. Therefore its important that the insurance be from a viable insurance company.  There are companies that provide financial ratings of insurance companies such as AM Best. When an insurance provision requires that the insurance carrier have an AM Best rating of A- or better, it is requiring that the insurer must have that independent rating.

c)              Additional insured.  As an additional insured it makes you a party to that agreement. Being a party to the agreement, you would need to be notified of any cancellation or non-renewal of the insurance.  In the event the primary insured was fraudulent in their application for the insurance, their insurance may be cancelled, but as an additional insured, and provided that you were not fraudulent, you would remain protected even though the insured would not.

d)             Buyer as a loss payee.  This would create the situation where in the event of a loss, the insurance company would pay you directly so you are not dependent upon getting subsequent reimbursement from the Supplier

e)             Primary & non-contributory. A request that insurance be primary and non-contributory is seeking assurance that the Buyer’s own insurance policies will not be asked to contribute to a covered loss such as under a theory of contributory negligence.

f)              Waiver of subrogation. Subrogation is the right of an insurer who has paid the insured’s loss to pursue remedies against third parties.  As a condition of the payment the insured needs to assign all rights to the Insurance company who can then make a claim against any parties that contributed to the loss. As a Buyer would be a 3rd party to that insurance loss claimed by the policy holder against the insurance company, a waiver of subrogation is needed to protect the Buyer against the Supplier’s insurance company pursuing remedies against the Buyer. In a waiver of subrogation the insured would give up the right of subrogation against the Buyer but would still be free to pursue remedies against other parties involved.

g)             Severability of interests (Also known as Separation of Insureds) Buyer’s requesting that insurance coverage include severability of interests is requesting that each insured’s interest under the policy are treated separately for purposes of coverage under the policy.

h)             Subcontractor Coverage:  Many Buyers request that Supplier’s subcontractors maintain the same coverage and conditions as required.  Most Supplier policies do not cover Subcontractors so this requirement is more of a contract obligation than and insurance requirement.

i)              Copies of Insurance Policies:  Buyers may request copies of the actual insurance policies or “certificates of insurance” which are the standard industry method of evidencing insurance coverage. 

j)              Insurance Coverage Period:  Virtually all insurance policies have a one year term. This is because insurers transfer risk to other insurers via re-insurance agreements which are renewed and re-negotiated annually.  As a Buyer you will want the coverage to remain in effect for the term of the agreement. Supplier’s may want to avoid the responsibility by having the requirement subject to coverage being commercially available.

k)             Notice of Cancellation and/or Notice of Material Change:  Buyers often request that Suppliers provide notice of cancellation of, or notice of material change in insurance policies within 30 days. If the Buyer is named as an additional insured this is not needed as Buyer, as an additional insured will get such notices.

l)              Limitations of Liability vs. Insurance. Potentially the parties could agree to higher insurance limits than they agree for a limitation of liability between the parties.  As a Buyer it is important to ensure that the Limitation of Liability does not limit the insurance liabilities and that any payments under insurances not be counted towards a total cap on liability for breaches. To do that as part of the section of the agreement that required insurance you can make the intent of the parties clear by saying  “The provisions of this section are in addition to the other rights and obligations of the parties in this Agreement."  or as part of the limitation of liability you could specifically carve the insurance section out of the limitation.

m)           Companies that self-insure.
Some companies, especially large companies will self insure against certain perils. In that situation, it is only the assets of that Supplier that you can look to in the event of a problem. The requirements for the insurances should be the same, the only difference is that you allow them to self insure to provide that coverage. To ensure that they have the finances to meet those commitments you would require them to provide evidence of their ability to self-insure. Further a commitment for self insurance will usually require that the Supplier provide a bond or other financial guaranteed acceptable to the Buyer in there is
a claim. The amount of the bond or guarantee would be either the amount of the claim or the amount of the self insurance limit, whichever was less.

One of the most frequent issues that arises in the negotiation of Insurance provisions is the amount of the individual limits that the Buyer may require for individual coverage or the applicability of certain insurances to the business. For example,  a Supplier may not carry the required amount of coverage and may want Buyer to pay for any additional premium cost to meet the limit.  Before rushing out to do this the first thing you want to do is see if the Supplier has either an Excess or Umbrella liability policy. If they have an umbrella policy where the insurance policy has the same term as the other policy the values of the two can be added to see if they exceed the desired amount. If they do simply include the requirement for the Umbrella Liability policy as part of your insurance section, If they have an excess liability policy I would have your insurance person review it to see if you will still be protected under the different terms that could be in the excess liability policy. If they agree, add that insurance as a requirement for the agreement.

A second common issue is Supplier’s may say that they do not carry a certain policy such as Automobile liability as they don’t use vehicles in performance of the work. Rather than delete the requirement you could simply include a pre-condition such as “In the event vehicles will be used in the performance of the work….”.  This doesn’t force them to have insurance that they don’t need, or won’t use, but provides you with the protection that if they ever use vehicles in performing the work contractually they are required to carry the insurance.

In negotiations many Suppliers want to avoid:
1)    Having the Buyer named as an additional insured.
2)    Having the Buyer named as a loss payee.
3)    Having the insurance be primary and non-contributory
4)    Waiver of subrogation
To me the best way of dealing with their objections it to explain why you need the individual requirement.
Additional Insured:
You want to be named as an additional insured so you get notices of changes or cancellations. You want to be protected in the event they fraudulently applied for the insurance. You also want it so the Insurance Company can’t come back and sue your company as they can’t sue a named insured.
Loss Payee
You want to be named as a loss payee simply because you don’t want to be concerned about if or when the Supplier would pay you the proceeds.
Primary and Non-contributory
You want the insurance to be primary and non-contributory to avoid all the time and expense determining contributory liability.
Waiver of Subrogation
You want waiver of subrogation simply because you don’t want to receive the insurance proceeds only to turn around and be sued by the Insurance company.