Navigating turbulent waters: Insurers and indemnitors (Part 2)

We explore the issues of insurers and indemnitors in these two previous articles:

Navigating turbulent waters: Insurers and indemnitors (Part 1) >>

Indemnities and Warranty Deeds: Open-ended access to your checkbook >>

These blog entries primarily provide an understanding of indemnities from two different perspectives: That of the indemnitee (the person who is protected under an indemnity), and that of the indemnitor (the person providing the protection).

In this article, we explore multiple facets of the indemnity, and its enforcement.

As a starting point, in contractual indemnities, various terminology is used for risk-shifting provisions:

  • Indemnify
  • Defend
  • Hold harmless

These three terms, to us, have different meaning, but in application courts have interpreted them interchangeably, or at least to overlap.

  • “Indemnify” is an open-ended commitment to both cover the expenses of a third party claim and potentially to defend against that action, i.e., pay the the indemnity attorneys fees.
  • “Defend” more specifically covers that obligation to protect the first party from suits.  It probably does not include a broad indemnity for the underlying liability.
  • And “hold harmless” generally means simply that the second party will himself not raise a claim against the first party for certain claims, almost like a prospective release.  “Party B will hold Party A harmless from claims relating to the underground storage tanks on the property.”

But, because courts fail to make these fine-line distinctions, when drafting contract provisions perhaps more precision as to what is intended is in order.  In some instances, a party will provide all three protections: “Tenant will indemnify, defend and hold harmless Landlord from all claims relating to his occupancy of the property.”  Other times, it would be appropriate to tighten the scope of the risk-shifting provision: “Landlord has disclosed to Tenant the leaking roof on the property, and Tenant agrees to hold harmless Landlord against claims relating to the same.”

Because contractual risk-shifting provisions essentially provide open-ended access to a checkbook of the indemnitor, great care should be exercised in agreeing to such provisions.  For, even if a claim ultimately is unfounded, the cost to defend can bankrupt even well-capitalized parties.  Consideration also should be given to indemnities that must be personally signed, thus voluntarily piercing the corporate veil carefully constructed to protect the individual owners.

Today, for example, it is common for lenders to ask that individual investors in a real estate transaction personally indemnify and defend a lender against environmental risks associated with real property being financed.  Caution should be exercised in undertaking such an open-ended risk.  For, the very reason we advise clients to take title to property in the form of an LLC or corporation is to shield the individual form such open-ended liability.  An indemnity blows past that carefully-planned protection.

Finally, how is an indemnity or insurance provision enforced when the indemnitor or insurer chooses to ignore his contractual obligation?  This can be accomplished in one of two ways:

  1. At the time the claim is pending, the indemnitee can bring a “declaratory judgment” action asking the Court to declare that the indemnitor provide the promised protection.
  2. After the fact, as long as proper demand has been made previously for such a defense, a monetary damages claim can be brought to compensate indemnitee for the damages caused by indemnitor’s breach of his contractual obligation.

In many ways indemnities are “super” contract provisions because instead of defining specific contractual obligations (e.g., to make payments, to pay taxes, or to repair a roof) they protect against open-ended and sometimes unknown obligations, and indeed obligations from third parties who are foreign to the transaction being undertaken.

Whenever I review a contract, a lease, a mortgage or loan agreement, or other contractual agreement for a client, my antenna is raised when I read that my client is agreeing to “indemnify,” “defend,” “hold harmless,” “protect” or words of similar impact some other party. Those “super” contract provisions should be undertaken with due consideration to the impact on the indemnitor.