It is common today for contracts to require parties to indemnify the other and maintain insurance, or add the other as an additional insured under its commercial general liability (CGL) insurance. While some companies execute contracts without reading or understanding the significance of such provisions, others have come to appreciate that these terms constitute a risk-transfer tool that can help protect their business from potential future losses. Also, more and more insurance companies are requiring their insureds to use such provisions in order to obtain coverage at particular premiums.
As the law involving indemnification and insurance clauses suggests, there is great deal of flexibility in drafting these terms. Consequently, rather than using a standard indemnification or insurance provision or performing a “copy and paste” from a prior contract or form, businesses and their in-house counsel should consider the particular circumstances, issues and needs that exist in each transaction and draft the clauses accordingly.
Using the six techniques below while drafting indemnification and insurance clauses will help counsel avoid common obstacles and pitfalls inherent in these contractual terms.
1. Use definitions
Routine, standard or form indemnification and insurance clauses employ terms that are either insufficiently defined or undefined in the parties’ contract. “Claims,” “losses,” “damages,” “defense” and a long litany of other words appear in such clauses, making them confusing and difficult to understand. However, if you use customized definitions, then the actual terms of the indemnification and insurance clauses are relatively straight forward and much easier to understand.
2. Identify the parties
An advantage to using customized definitions is that you are able to identify precisely who is going to be providing and who is going to be entitled to receive the indemnity and insurance protection provided by the contract. For example, if you are dealing with a newly formed company, perhaps you want to have the indemnity provided by the company’s parent or affiliated entities. Similarly, you may want indemnity and insurance coverage provided for not only your company, but also its affiliates, shareholders, directors, officers, managers, members, partners, agents, representatives, attorneys, employees and representatives. Including such an extensive list of people in the language of the clauses can create long, run-on sentences. However, by using definitions for the terms “seller” and “buyer,” one can easily define who is going to be providing and who is going to be entitled to receive the indemnity and insurance protection provided by the contract.
3. Define the losses and damages covered
In addition to identifying the parties, it is important to clearly state what losses and damages you intend to be recovered (or not) by way of the indemnification and insurance clauses. For example, are fees of attorneys, accountants, experts and other professionals recoverable as part of indemnity, or are they limited to the duty to defend obligations? Does the indemnity obligation include consequential or indirect damages, including lost profits, or is the indemnitor only responsible for actual, direct damages? Are fines, penalties and costs included within proffered indemnity, or are these types of damages excluded from indemnity coverage? Again, these are questions that parties should consider and discuss when negotiating and drafting indemnification and insurance clauses.
4. Understand the terms’ meaning
So many times, counsel drafting contracts use terms without any appreciation of the legal significance that has been attributed to them. This is particularly true with respect to the use of the term “hold harmless” in indemnification provisions. Generally, a hold-harmless term requires one party to assume another’s third-party liability. Consequently, if a hold-harmless term exists in an indemnification provision, then courts are more likely to reject the argument that the indemnification provision is a broad-form clause encompassing all liability suffered by the indemnitee, and instead hold that the indemnification is only for third-party claims. As such, if you want broad-form indemnity coverage, then do not use the hold-harmless term.
5. Integration of indemnity and insurance coverages
When drafting indemnification and insurance clauses, it is important that they are incorporated into the CGL policy’s terms. Normally, the incorporation is accomplished by way of an insured or other endorsement. But, no matter how it is accomplished, incorporating the contract’s indemnification and insurance clauses into the CGL policy guarantees that the indemnity and insurance coverages are consistent and will be subject to the same rules of construction.
6. Exclusivity of remedies
Parties to a goods and services contract can agree that a contract’s indemnity and insurance coverage is the exclusive remedy available to the indemnitee for all claims that may arise, including those for breach of contract, tort or strict liability. Such a provision is particularly important to indemnitors who are seeking to limit their self-insured exposure. Failure to include such a provision may enable the indemnitee to pursue common law or other legal indemnification and thereby sidestep the contractual indemnity, including any financial limitations included therein.
Those who copy and paste contractual indemnification and insurance clauses run the risk of exposing their business to a substantial self-insured risk. Given their inherent flexibility, such clauses should be negotiated and drafted to fit the particular circumstances, issues and needs underlying the parties’ contract. When such an approach is taken, indemnification and insurance clauses can provide an effective means of bringing one’s self-insured risk to an acceptable level.