The Art of Contractual Indemnity

I'm pleased to welcome Matthew Copus of Hall and Company and Ryan Kohler of CCM+S as guest posters this week. They write on a topic of interest to A/E firm leaders and business developers—how to avoid bad contract terms.

An unfavorable indemnity clause signed today can create a catastrophic risk at some point in the future. There is an alarming trend of both private- and public-sector owners including onerous indemnity clauses in their contracts, and the magnitude of the risk transfer associated with these terms is on the rise. Every individual who signs contracts for your firm should understand the risks involved in accepting these clauses.

The Impact of Obligations Assumed Through Contract

California may be the most troublesome state for indemnity and defense issues. In the 2010 case UDC v. CH2M Hill, a jury found that CH2M Hill bore no responsibility for any damages claimed by a homeowners association in their lawsuit against UDC the developer. But the court nevertheless ruled that CH2M Hill had to pay more than $500,000 for UDC's defense costs due to an unfavorable indemnity and defense provision in their contract—even though the jury agreed they had met the standard of care!

Given that other states often follow California's lead, this line of reasoning may start to spread east. Many states currently have rules that bar contracts between A/E firms and government agencies requiring indemnification or defense beyond the designer's negligence. But these same states may have a more lax requirement for contracts with private parties. Regardless of the state you work in, the fundamental principle to keep in mind is: If you sign a bad contract, bad things can happen to you!

If your firm becomes liable simply due to contract language on indemnity or defense—in other words, without any breach of the standard of care—your insurance company might deny coverage for that claim. The claim arguably arose out of a "contractual" liability, not a breach of the standard of care typically intended by professional liability policy terms. Most professional liability insurance policies for A/E firms specifically exclude claims arising from contractual liability. That's the last thing you want to hear when facing such a claim.

The Duty to Defend

If your firm accepts an indemnity clause with a duty to defend, you may be agreeing to pay for the other party's out-of-pocket defense costs. The terms of professional liability insurance typically do not include defending your client. You should also understand that in some states (including California) the duty to defend is part of the duty to indemnify. The contract doesn't need to even mention this obligation if there is an indemnity clause.

The default contract interpretation reads the duty to defend into the indemnity clause. Therefore it is not enough to simply strike the mention of duty to defend in the contract. If your contract has an indemnity clause, you need to have it state explicitly that there is no duty to defend.

What Should You Do When Negotiating Indemnity Provisions?

Consider the following strategies: 

• If possible, eliminate the indemnity provision altogether. In the absence of an indemnity clause, you are still responsible for damages that you actually cause, which is fair.

• Make the indemnity agreement reciprocal.

• Tie an obligation to indemnify to a "finding" of negligence by a court or arbitrator. If the contract has two separate obligations or clauses (one to indemnify and one to defend), both obligations should be tied to a finding of negligence.

• Make it clear in the language of the indemnity clause that there is no immediate duty to defend.

• If the client won't agree to strike the duty to defend language, try to break the indemnity clause into two paragraphs: (1) one paragraph agreeing to indemnify the client only to the extent of your negligence, and specifically excluding your duty to defend; and (2) the other paragraph addressing non-professional services that may include the duty to defend (since it doesn't fall under your professional liability policy). This can be a delicate operation, so have your attorney and insurance carrier review the clause before proposing a change to the client.

• Lastly, if dealing with a public agency that refuses to make a single change, check with the laws of your jurisdiction. Some states have softened the impact of unfair indemnity provisions by making the onerous clauses void and unenforceable. So you can at least argue that the provision is void should a claim and demand for indemnity arise.

The best advice regarding contractual terms remains constant: Don't sign contracts that unfairly shift disproportionate responsibility for problems beyond your control. Do your best to serve the client and provide quality work, but don't assume responsibility for the negligence of local public agencies, developers, and third parties.

Nothing contained in this post should be considered legal advice. Consult with an attorney before acting on any legal matters that might be addressed here or in any article.

Contact the authors: Matthew Copus, Hall and Company, (360) 598-5016; Ryan Kohler, Esq., CCM+S, (626) 243-1100