Saturday, November 1, 2014

Reverse Indemnities

I had an interesting discussion in a linkedIn group so I thought I would summarize the discussion. The initial question was about third party liability. That spun into discussions on warranties and indemnities as they relate to third party liability.

In a normal buyer / seller relationship the buyer will frequently require the seller to indemnify the buyer against personal injury or property damage caused by the seller that is related to either their product or service or an injury or property damage caused by the seller while employed by the Buyer. The underlying reason for requiring indemnity is in many locations the Buyer / Seller relationship may also be viewed a principal / agent. Under agency law the buyer is acting as the principal and the seller is acting as the agent performing work on behalf of the buyer. Under agency law the principal can be liable for the acts of the agent, but the agent can’t be liable for the acts of the principal. Under this general type of relationship you seldom would see a supplier request for a reverse indemnification as the normally would not be sued for the buyer’s negligence.

One of the things I discovered was that in the oil and gas industry the indemnity is sometimes reversed where the Buyer (well operator) will indemnify the service provider against the various types of claims that could occur in the event of a major explosion, etc. In that industry since buyer is providing the indemnification, it is common to include a reverse indemnification if the service provider is grossly negligent or acts with willful misconduct. Clearly that makes sense.

The next question was whether the breach of any warranty, or the act that would exclude warranty coverage could require a reverse indemnification. Typically a buyer doesn’t provide any warranties to the seller. There may be certain acts that void warranty coverage. For example:
“These warranties do not extend to, or apply to, any Product which has been (1) subjected to misuse, neglect, accident, improper installation, or to use in violation of instructions furnished by Supplier, (2) repaired or altered outside of Supplier’s factory by persons not expressly approved in writing by Supplier, (3) evaluated, screened, or tested by an outside testing laboratory not previously approved in writing by Supplier, or (4) based on design features provided by Buyer.”

Should one of these acts that would void the warranty substantiate the need for providing a reverse indemnity? They could, but the key is what caused the injury? Before I would agree to provide a reverse indemnity, I would clearly want that act to be the root cause or have directly contributed to the injury or damage.

Similarly in Intellectual Property Indemnification there carve outs or exclusions to the indemnification. A supplier may want to be excused from providing an intellectual property indemnification in several areas and want a reverse indemnification from the buyer. Examples of those are:
Claims that based on combination of Suppliers product with another product.
Implementation by the Supplier of a Buyer specified or provided design.
Modifications to the Suppliers Product made by Buyer.

In negotiating these I would first want the combination exclusion to be something that wasn’t reasonably foreseeable. Many items I’ve purchased had no useful value of their own and only after they are combined with something else do they become useful. I've had suppliers that had products that were designed for and marketed use with a specific product that wanted to be excused from the indemnity and want a reverse indemnity when they were used in that combination. If you tell me that it was designed for use in that combination, why would I ever want to excuse and indemnify that when it was used in that combination?

As to implementation of a buyer provided design there are three ways the resulting product could be infringing. First, the design itself is infringing. Second the process used to make the product is infringing. Third, materials used in the product are infringing. For me to be willing to provide a reverse indemnity, I would want the sole cause of the infringement to be my design. I would also also want the “Buyer’s modification” exclusion and any reverse indemnification to be contingent on the fact that buyer’s modification is the sole source of the infringement. If you ever purchased things like electronic components you would know that almost all require some form of modification to be used.

Indemnifications are important. Before you give one up by giving a reverse indemnification, make sure you significantly narrow down and make clear exactly what act you must do for that to occur.
For example, no form of maintenance will protect against a latent safety defect that exists in a product. For you to accept responsibility make sure that it was really your act that caused it.