Tuesday, July 5, 2011

Indemnity types

Indemnities are described in a number of different ways depending upon the scope of the indemnification and the subject matter.  The indemnitor is the party providing the indemnity and the indemnitee is the party being protected by the indemnification.

A “broad form” indemnity has indemnitor hold the indemnity harmless from the risk in question, even if the entire loss was caused by the indemnitee. 

A “intermediate form” requires the indemnitor to assume all of the risks associated with the subject of the indemnification, 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. 

A “mutual” indemnity has each party indemnifying the other party for losses that they caused the other party. For example the supplier indemnifies the buyer for losses the supplier causes and the buyer indemnifies the supplier for losses the buyer caused.

In many jurisdictions a broad form indemnity may not be enforceable as it goes against the principles of equity where the party providing the indemnity is being penalized for something they didn’t do. Most buyers prefer intermediate form indemnities rather than comparative fault or indemnities.  The reason why they don’t like comparative fault remedies is it almost always requires both parties going to court to establish their percentage liability.  Mutual indemnities are not frequently used as between a buyer and supplier the liability risks are different. A buyer may be liable for the acts of a Supplier because the law of agency would consider the buyer the principal and the supplier the agent, and principal are liable for the acts of their agents. A supplier would not be liable for the acts of the buyer under the theory of agency.  As a result most indemnity provisions will carve actions of the Buyer out of the indemnification.  For example, in an indemnity provision against personal injury or property damage claims,  injuries or damage caused by the sole negligence of the buyer would be carved out of the suppliers indemnification.  For intellectual property indemnifications suppliers will want to be excused from providing the indemnification in situations where the Buyer caused the infringement.

There are other potential indemnities such as “work related” indemnities that relate to the indemnitor’s  work and would not require negligence. In many contracts rather than include an indemnity the buyer may include a warranty that would require certain facts be true now and in the future or they could require insurance.  For example a partially constructed building could have damage in which the contractor wasn’t negligent so instead of an indemnity you might require insurance on the completed operations as protection against the loss. A “financial” indemnity is nothing more than a guarantee of payment by a third party to the indemnitee.  For example the buyer a third party to purchase items directly from the supplier and the supplier wants protection from the buyer that the third party will pay for what they purchase. Most buyers seek to avoid providing any form of financial indemnity or other payment guarantees for third parties such as other suppliers as the risk can be managed in a number of other ways.


What is really meant by "Good Faith" ?

There can be many different standard of commitment based upon the words that are used. Will or shall are firm commitments. When you talk about "efforts" you can have best efforts, reasonable efforts and commercially reasonable efforts and the only commitment out of those is the party making that commitment only needs to exercise that level of effort. Good faith is a level of commitment that is less that the different efforts standards. All it means is that the party has to exercise "good faith" in their dealings. There is no obligation that they have to agree, nor do they have to extend a level of effort to agree. It is very difficult to prove bad faith, so using good faith alone is something I don’t recommend.

If there are issues that are open and you need to use good faith as a minimum I would require that “neither party shall unreasonably delay or withhold the agreement”.  That makes the commitment subject to the standard that they must act reasonable.  A standard that they must be reasonable is more enforceable.  Another alternative could be to set a parameter in advance for the agreement.  For example if you could not determine the final price until a final design was complete you could agree to negotiate the price in good faith in the future but include a not greater than amount or a band width for agreement.  By including the parameter, if you offered to pay the price at the not greater than amount, the failure of the other side to agree would be bad faith.

I don’t like good faith commitments. Most of the time what happens is when it comes time to agree in good faith on an item you usually have less leverage.  For a good faith commitment to work both parties need to be at risk if there is failure to come to agreement.  For example it probably would work if you structured your contract where you could terminate with no liability if you failed to reach agreement on that item.   The supplier would lose what they have into the work and you would lose by having to start over again with a new supplier. It won’t work if you have a high cost of terminating the agreement.

If you really need performance on an issue, avoid using "good faith" and use a higher standard of commitment.


In the early 1950s the Uniform Commercial Code ("UCC") was created in the United States. Every state in the United States has adopted the use of the UCC. Article 2 of the UCC governs the sale of goods. In 1980 the United Nations enacted the United Nations Convention on Contracts for the International Sale of Goods (CISG). CISG has been adopted by seventy-six countries including most of the major trading countries. Major exceptions are the United Kingdom, Ireland and Brasil. Many countries also have their own statutes or laws regarding the sale of goods between companies.

If you write a contract with a U.S. company and the applicable law is any state but Louisiana, the UCC will apply unless you opt out of having the UCC apply. CISG does not apply to domestic sales within a country. CISG only applies to international sales. If you write a international contract and both parties are in countries that have adopted CISG, CISG will apply unless the agreement specifically disclaims the CISG from applying.

For example, if the parties do not agree to the contrary, a commercial sales agreement between a business in Chicago and one in Toronto would automatically be subject to its provisions. If they agree to exclude CISG from applying:
·       They could agree U.S. law where the UCC would apply.
·       They could agree upon Ontario law, where the Ontario sales laws would apply.
·       They could agree to have the laws of another location apply. This is done when that other location may be more favorable to the specific type of transaction or may have more law or case law on the subject.

In the U.S, the scope and impact of CISG depends upon whether it is purely a domestic sale or international. For domestic U.S. sales CISG does not apply. For international sales the impact is significant, as use of CISG would replace UCC Article 2. Many U.S. companies opt out of using CISG, preferring to use the familiar UCC where there is substantially more case law.  As most purchase orders of U.S. Companies are drafted relying upon the protections of the UCC, if you will use your purchase order form for international purchases, the purchase order terms should also opt out of CISG.

In foreign transaction whether CISG should be used will depend upon a number of factors because there are differences between CISG and the UCC and there will be differences between CISG and local sale of goods laws.
For example, here are a few differences between the UCC and CISG,

Applicable transactions
Applies to both consumer and commercial transactions
Specifically excludes consumer sales from its provisions
Sale of goods
Excludes goods purchased at auction, securities, aircraft, ships, electricity, and service contracts. 
Statute of Frauds
Requires writing over $500
Writing not required
Requirements of contract
Mutual assent, consideration, legal capacity, legal purpose.
Not directly concerned with validity of the contract
Offer & Acceptance
Modifications in acceptance are counter offer.
Modifications are counter-offer, unless they do not materially alter the terms and are not objectionable to the offeror. Requires offeror to object verbally without undue delay, or terms become those of the offer, as modified by the acceptance.
Buyer has the right to terminate when the seller has breached a "condition" of the sale, no matter how minor.

Allows the seller who fails to perform on time, or who delivers nonconforming goods, to correct the performance as long as it does not cause the buyer an unreasonable delay or inconvenience.
Withholding shipments
Unless authorized by the contract, Seller has no right to withhold delivery simply due to fear of non-payment.

If seller provides notice, they may suspend delivery or prevent the release of goods if buyer may not have the ability to pay for the merchandise. Seller must deliver if the buyer then provides adequate assurance of payment.
Price reduction for non-conforming goods
Would be addressed as damages for breach
Allows buyer the right to reduce the price in the same proportion as the decrease in the value of the goods.
Includes incidental and consequential damages. Consequential damages are limited to those that could not be reasonably prevented.
Includes lost profit that the other party foresaw or should have forseen.

When might the use of CISG make sense for U.S. based companies? The first thing you would consider is whether the country you are dealing with has adopted CISG. If they have not it would not automatically apply as it will only automatically apply to transactions between countries that have adopted CISG.  If the buyer or seller are from countries that haven’t adopted it, it doesn’t automatically apply although the parties could mutually agree to have CISG apply.

If you were doing an international transaction with a supplier that was unwilling to agree to have U.S. law be applicable to a transaction, you would need to get local guidance on which approach will better protect the buyer. Will it be local sales laws or CISG?  A problem with having CISG apply for a buyer or seller that is located in a country that has not adopted CISG is since it hasn’t been adopted there will be no local case law governing its interpretation. If CISG was determined to be the better alternative than local sales law, you could always agree to have the applicable law and jurisdiction become a third country that has adopted CISG.

My own opinion of CISG is I feel that it is more favorable to sellers than buyers.

Want to learn more? The companion book "Negotiating Procurement Contracts - The Knowledge to Negotiate" is now available on Amazon.com.