An unfavorable indemnity clause signed today can create a catastrophic risk that will not come to pass until some unknown time in the future. There is an alarming trend of owners (both private and public) including onerous indemnity clauses in their contracts with design profes-sionals, and the scope, breadth, and danger of risk trans-fer associated with these terms are on the rise. This trend has accelerated over the past 15 years to the point where design professionals know that just about every project will have a contract with some form of an indemnity clause. Every individual who signs contracts must under-stand the mechanics and impact of these clauses to avoid disproportionate, uninsured, and potentially catastrophic risk exposure.

Design professionals will encounter indemnity clauses of all stripes, from the relatively benign to the grossly unfair. These clauses lie inert through the course of a project but rear their head when a claim approaches. Because the contract was negotiated long before any claim surfaces, the indemnity clause sometimes is placed under a micro-scope for the first time by the designer, its insurance carrier, and their counsel only after an owner makes a claim. At that point, it is much too late to do anything about the language of the clause except advance

arguments that the language actually does not mean what it says. If these arguments are implausible, the designer may have to negotiate an unfavorable settle-ment before the court imposes an unbearable indemnity liability on the designer. To avoid this scenario, the designer must avoid contracts that contain onerous and potentially uninsurable indemnity clauses.

WHAT IS INDEMNITY?In short, indemnity is the obligation of one person to pay for a liability incurred by another. We see indemnity every day in things as simple as our car insurance. If you get into a car accident, your insurance company “indem-nifies” you for the liability you incur. The insurance company did nothing wrong – they did not drive through a red light – but they agreed by contract to pay for your negligence in return for your payment of the insurance premium. In a construction context, if a contractor sues the owner on your project, the owner might decide to seek indemnity from you. That is, the owner may demand that you pay for some or all of the damages claimed by the contractor. If you are not at fault, a bad indemnity provision can still require you to pay – you’ve agreed to pay for the owner’s fault, just like an insurance company!

Indemnity agreements typically contain two parts: the indemnity clause (money to pay for a claim against the Owner) and a defense component (money to pay for the Owner’s attorney and expert fees). Imagine on a typical construction project that Architect agrees by contract to indemnify the Owner for claims stemming from Architect’s negligent actions. Third Party sues Owner over an allegedly unsafe design. The first thing Owner will do is tender its defense and indemnity to Architect, based on the contract. If Architect ultimately pays any money to Owner or to Third Party to settle the claims against Owner, this is the very definition of an indemnity arrangement.

The defense components in this example consist of the costs Owner pays its attorney and experts to defend against Third Party’s lawsuit. The problem with the defense component is that Architect may have to pay all of Owner’s defense cost even if a jury finds the Architect was not negligent (met the standard of care) and did not breach the contract. This component will depend on the particular state law selected in the contract.

IMPACT OF OBLIGATIONS ASSUMED THROUGH CONTRACTCalifornia may be the most onerous state for indemnit and defense issues. In the 2010 case, UDC v. CH2MHill, a jury found CH2MHill bore no responsibility for any damages related to an HOA lawsuit against developer UDC. But the court then found CH2MHill had to pay more than $500,000 in UDC’s defense costs, due to an unfavor-able indemnity and defense provision in the contract – even though the jury agreed CH2MHill met the standard of care!

With the tendency of other states to follow California’s lead, this line of reasoning may start to spread east. Many states currently have rules barring contracts between engineers or architects and government agencies that require indemnification or defense beyond the designer’s

negligence, like Texas and Florida. But states may have a more lax requirement for contracts between private parties. Regardless of the state you work in, the funda-mental principle to keep in mind is if you sign bad contracts, bad things can happen to you!

If the design professional becomes liable simply due to contract language on indemnity or defense without any breach of the standard of care, the insurance company might deny coverage for this element of the claim as it arguably arose out of a “contractual” liability and may not be a type of “damage” contemplated under the professional liability policy terms. In addition, most professional liability insurance policies for A/E firms specifically exclude claims arising from contractual liability. The insurance carrier could then refuse to cover the portion of any judgment that consists of contractual defense costs, because the liability did not arise from any professional services. When facing a claim, the last thing a design professional wants to hear is that their insur-ance company may not cover part of the exposure.

THE DUTY TO DEFENDIf a design professional accepts an indemnity clause with a duty to defend, they may be agreeing to pay for the other party’s defense costs out-of-pocket. The terms of professional liability insurance generally do not include defending the client of a design professional. The insurance carrier may however, indemnify the client for reasonable costs of defense to the extent of the design professional’s negligence, as that is tied to a breach in the standard of care. Each carrier is slightly different, and this question should be discussed with your broker. Another important element to understand is that in some states (including California) the duty to defend is part of the duty to indemnify – a contract does not even need to mention the duty to defend if it has an indem-nity clause. The default contract interpretation reads the duty to defend into an indemnity clause. Therefore it is not enough to simply strike the duty to defend. If your

contract must have an indemnity clause, it should change the default and clearly state that there is no duty to defend.

WHAT SHOULD YOU DO WHEN NEGOTIATING INDEMNITY PROVISIONS?Consider the following:• If possible, eliminate the indemnity provision altogether – in the absence of indemnity provisions you still will be responsible for damages 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 your intent clear in the language of the indemnity clause that there is no immediate duty to defend. If your client will not allow you to strike the duty to defend language try to break the indemnity out in two paragraphs. One paragraph should cover professional services, which simply indemnifies the client to the extent of your negligence and specifically excludes the duty to defend. The other clause will cover indemnity for non-professional services which may include the duty to defend (since it is not for professional services, it should not be under you professional liability policy). As this can be a delicate operation, your attorney and insurance carrier should review this type of clause before proposing this change to your 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 onerous clauses void and unenforceable, so you can at least argue the provision is void if a claim and demand for indemnity arises.

The best advice regarding contractual terms remains

constant: do not sign contracts that unfairly shift dispro-portionate levels of responsibility for things beyond your control. You can and should continue to perform good work and stand behind your efforts, but you cannot and should not be responsible for the negligence of local public agencies, developers, or third parties.

Please contact Collins Collins Muir + Stewart ,LLP at one of our offices throughout California, or Hall & Company at their Poulsbo office, to discuss further.

Nothing contained within this article should be considered legal advice. Anyone who reads this article should consult with an attorney before acting on anything contained in this or any other article on legal matters, as facts and circumstances will vary from case to case.

CCM+S Newsletter:Zen and the Art of Contractual Indemnity

HALL & COMPANYServing Architects, Engineers and Environmental Consultants

An unfavorable indemnity clause signed today can create a catastrophic risk that will not come to pass until some unknown time in the future. There is an alarming trend of owners (both private and public) including onerous indemnity clauses in their contracts with design profes-sionals, and the scope, breadth, and danger of risk trans-fer associated with these terms are on the rise. This trend has accelerated over the past 15 years to the point where design professionals know that just about every project will have a contract with some form of an indemnity clause. Every individual who signs contracts must under-stand the mechanics and impact of these clauses to avoid disproportionate, uninsured, and potentially catastrophic risk exposure.

Design professionals will encounter indemnity clauses of all stripes, from the relatively benign to the grossly unfair. These clauses lie inert through the course of a project but rear their head when a claim approaches. Because the contract was negotiated long before any claim surfaces, the indemnity clause sometimes is placed under a micro-scope for the first time by the designer, its insurance carrier, and their counsel only after an owner makes a claim. At that point, it is much too late to do anything about the language of the clause except advance

arguments that the language actually does not mean what it says. If these arguments are implausible, the designer may have to negotiate an unfavorable settle-ment before the court imposes an unbearable indemnity liability on the designer. To avoid this scenario, the designer must avoid contracts that contain onerous and potentially uninsurable indemnity clauses.

WHAT IS INDEMNITY?In short, indemnity is the obligation of one person to pay for a liability incurred by another. We see indemnity every day in things as simple as our car insurance. If you get into a car accident, your insurance company “indem-nifies” you for the liability you incur. The insurance company did nothing wrong – they did not drive through a red light – but they agreed by contract to pay for your negligence in return for your payment of the insurance premium. In a construction context, if a contractor sues the owner on your project, the owner might decide to seek indemnity from you. That is, the owner may demand that you pay for some or all of the damages claimed by the contractor. If you are not at fault, a bad indemnity provision can still require you to pay – you’ve agreed to pay for the owner’s fault, just like an insurance company!

Indemnity agreements typically contain two parts: the indemnity clause (money to pay for a claim against the Owner) and a defense component (money to pay for the Owner’s attorney and expert fees). Imagine on a typical construction project that Architect agrees by contract to indemnify the Owner for claims stemming from Architect’s negligent actions. Third Party sues Owner over an allegedly unsafe design. The first thing Owner will do is tender its defense and indemnity to Architect, based on the contract. If Architect ultimately pays any money to Owner or to Third Party to settle the claims against Owner, this is the very definition of an indemnity arrangement.

The defense components in this example consist of the costs Owner pays its attorney and experts to defend against Third Party’s lawsuit. The problem with the defense component is that Architect may have to pay all of Owner’s defense cost even if a jury finds the Architect was not negligent (met the standard of care) and did not breach the contract. This component will depend on the particular state law selected in the contract.

IMPACT OF OBLIGATIONS ASSUMED THROUGH CONTRACTCalifornia may be the most onerous state for indemnit and defense issues. In the 2010 case, UDC v. CH2MHill, a jury found CH2MHill bore no responsibility for any damages related to an HOA lawsuit against developer UDC. But the court then found CH2MHill had to pay more than $500,000 in UDC’s defense costs, due to an unfavor-able indemnity and defense provision in the contract – even though the jury agreed CH2MHill met the standard of care!

With the tendency of other states to follow California’s lead, this line of reasoning may start to spread east. Many states currently have rules barring contracts between engineers or architects and government agencies that require indemnification or defense beyond the designer’s

negligence, like Texas and Florida. But states may have a more lax requirement for contracts between private parties. Regardless of the state you work in, the funda-mental principle to keep in mind is if you sign bad contracts, bad things can happen to you!

If the design professional becomes liable simply due to contract language on indemnity or defense without any breach of the standard of care, the insurance company might deny coverage for this element of the claim as it arguably arose out of a “contractual” liability and may not be a type of “damage” contemplated under the professional liability policy terms. In addition, most professional liability insurance policies for A/E firms specifically exclude claims arising from contractual liability. The insurance carrier could then refuse to cover the portion of any judgment that consists of contractual defense costs, because the liability did not arise from any professional services. When facing a claim, the last thing a design professional wants to hear is that their insur-ance company may not cover part of the exposure.

THE DUTY TO DEFENDIf a design professional accepts an indemnity clause with a duty to defend, they may be agreeing to pay for the other party’s defense costs out-of-pocket. The terms of professional liability insurance generally do not include defending the client of a design professional. The insurance carrier may however, indemnify the client for reasonable costs of defense to the extent of the design professional’s negligence, as that is tied to a breach in the standard of care. Each carrier is slightly different, and this question should be discussed with your broker. Another important element to understand is that in some states (including California) the duty to defend is part of the duty to indemnify – a contract does not even need to mention the duty to defend if it has an indem-nity clause. The default contract interpretation reads the duty to defend into an indemnity clause. Therefore it is not enough to simply strike the duty to defend. If your

contract must have an indemnity clause, it should change the default and clearly state that there is no duty to defend.

WHAT SHOULD YOU DO WHEN NEGOTIATING INDEMNITY PROVISIONS?Consider the following:• If possible, eliminate the indemnity provision altogether – in the absence of indemnity provisions you still will be responsible for damages 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 your intent clear in the language of the indemnity clause that there is no immediate duty to defend. If your client will not allow you to strike the duty to defend language try to break the indemnity out in two paragraphs. One paragraph should cover professional services, which simply indemnifies the client to the extent of your negligence and specifically excludes the duty to defend. The other clause will cover indemnity for non-professional services which may include the duty to defend (since it is not for professional services, it should not be under you professional liability policy). As this can be a delicate operation, your attorney and insurance carrier should review this type of clause before proposing this change to your 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 onerous clauses void and unenforceable, so you can at least argue the provision is void if a claim and demand for indemnity arises.

The best advice regarding contractual terms remains

constant: do not sign contracts that unfairly shift dispro-portionate levels of responsibility for things beyond your control. You can and should continue to perform good work and stand behind your efforts, but you cannot and should not be responsible for the negligence of local public agencies, developers, or third parties.

Please contact Collins Collins Muir + Stewart ,LLP at one of our offices throughout California, or Hall & Company at their Poulsbo office, to discuss further.

Nothing contained within this article should be considered legal advice. Anyone who reads this article should consult with an attorney before acting on anything contained in this or any other article on legal matters, as facts and circumstances will vary from case to case.

Zen and the Art of Contractual Indemnity

Zen and the Art of Contractual Indemnity

An unfavorable indemnity clause signed today can create a catastrophic risk that will not come to pass until some unknown time in the future. There is an alarming trend of owners (both private and public) including onerous indemnity clauses in their contracts with design profes-sionals, and the scope, breadth, and danger of risk trans-fer associated with these terms are on the rise. This trend has accelerated over the past 15 years to the point where design professionals know that just about every project will have a contract with some form of an indemnity clause. Every individual who signs contracts must under-stand the mechanics and impact of these clauses to avoid disproportionate, uninsured, and potentially catastrophic risk exposure.

Design professionals will encounter indemnity clauses of all stripes, from the relatively benign to the grossly unfair. These clauses lie inert through the course of a project but rear their head when a claim approaches. Because the contract was negotiated long before any claim surfaces, the indemnity clause sometimes is placed under a micro-scope for the first time by the designer, its insurance carrier, and their counsel only after an owner makes a claim. At that point, it is much too late to do anything about the language of the clause except advance

arguments that the language actually does not mean what it says. If these arguments are implausible, the designer may have to negotiate an unfavorable settle-ment before the court imposes an unbearable indemnity liability on the designer. To avoid this scenario, the designer must avoid contracts that contain onerous and potentially uninsurable indemnity clauses.

WHAT IS INDEMNITY?In short, indemnity is the obligation of one person to pay for a liability incurred by another. We see indemnity every day in things as simple as our car insurance. If you get into a car accident, your insurance company “indem-nifies” you for the liability you incur. The insurance company did nothing wrong – they did not drive through a red light – but they agreed by contract to pay for your negligence in return for your payment of the insurance premium. In a construction context, if a contractor sues the owner on your project, the owner might decide to seek indemnity from you. That is, the owner may demand that you pay for some or all of the damages claimed by the contractor. If you are not at fault, a bad indemnity provision can still require you to pay – you’ve agreed to pay for the owner’s fault, just like an insurance company!

Indemnity agreements typically contain two parts: the indemnity clause (money to pay for a claim against the Owner) and a defense component (money to pay for the Owner’s attorney and expert fees). Imagine on a typical construction project that Architect agrees by contract to indemnify the Owner for claims stemming from Architect’s negligent actions. Third Party sues Owner over an allegedly unsafe design. The first thing Owner will do is tender its defense and indemnity to Architect, based on the contract. If Architect ultimately pays any money to Owner or to Third Party to settle the claims against Owner, this is the very definition of an indemnity arrangement.

The defense components in this example consist of the costs Owner pays its attorney and experts to defend against Third Party’s lawsuit. The problem with the defense component is that Architect may have to pay all of Owner’s defense cost even if a jury finds the Architect was not negligent (met the standard of care) and did not breach the contract. This component will depend on the particular state law selected in the contract.

IMPACT OF OBLIGATIONS ASSUMED THROUGH CONTRACTCalifornia may be the most onerous state for indemnit and defense issues. In the 2010 case, UDC v. CH2MHill, a jury found CH2MHill bore no responsibility for any damages related to an HOA lawsuit against developer UDC. But the court then found CH2MHill had to pay more than $500,000 in UDC’s defense costs, due to an unfavor-able indemnity and defense provision in the contract – even though the jury agreed CH2MHill met the standard of care!

With the tendency of other states to follow California’s lead, this line of reasoning may start to spread east. Many states currently have rules barring contracts between engineers or architects and government agencies that require indemnification or defense beyond the designer’s

negligence, like Texas and Florida. But states may have a more lax requirement for contracts between private parties. Regardless of the state you work in, the funda-mental principle to keep in mind is if you sign bad contracts, bad things can happen to you!

If the design professional becomes liable simply due to contract language on indemnity or defense without any breach of the standard of care, the insurance company might deny coverage for this element of the claim as it arguably arose out of a “contractual” liability and may not be a type of “damage” contemplated under the professional liability policy terms. In addition, most professional liability insurance policies for A/E firms specifically exclude claims arising from contractual liability. The insurance carrier could then refuse to cover the portion of any judgment that consists of contractual defense costs, because the liability did not arise from any professional services. When facing a claim, the last thing a design professional wants to hear is that their insur-ance company may not cover part of the exposure.

THE DUTY TO DEFENDIf a design professional accepts an indemnity clause with a duty to defend, they may be agreeing to pay for the other party’s defense costs out-of-pocket. The terms of professional liability insurance generally do not include defending the client of a design professional. The insurance carrier may however, indemnify the client for reasonable costs of defense to the extent of the design professional’s negligence, as that is tied to a breach in the standard of care. Each carrier is slightly different, and this question should be discussed with your broker. Another important element to understand is that in some states (including California) the duty to defend is part of the duty to indemnify – a contract does not even need to mention the duty to defend if it has an indem-nity clause. The default contract interpretation reads the duty to defend into an indemnity clause. Therefore it is not enough to simply strike the duty to defend. If your

contract must have an indemnity clause, it should change the default and clearly state that there is no duty to defend.

WHAT SHOULD YOU DO WHEN NEGOTIATING INDEMNITY PROVISIONS?Consider the following:• If possible, eliminate the indemnity provision altogether – in the absence of indemnity provisions you still will be responsible for damages 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 your intent clear in the language of the indemnity clause that there is no immediate duty to defend. If your client will not allow you to strike the duty to defend language try to break the indemnity out in two paragraphs. One paragraph should cover professional services, which simply indemnifies the client to the extent of your negligence and specifically excludes the duty to defend. The other clause will cover indemnity for non-professional services which may include the duty to defend (since it is not for professional services, it should not be under you professional liability policy). As this can be a delicate operation, your attorney and insurance carrier should review this type of clause before proposing this change to your 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 onerous clauses void and unenforceable, so you can at least argue the provision is void if a claim and demand for indemnity arises.

The best advice regarding contractual terms remains

constant: do not sign contracts that unfairly shift dispro-portionate levels of responsibility for things beyond your control. You can and should continue to perform good work and stand behind your efforts, but you cannot and should not be responsible for the negligence of local public agencies, developers, or third parties.

Please contact Collins Collins Muir + Stewart ,LLP at one of our offices throughout California, or Hall & Company at their Poulsbo office, to discuss further.

Nothing contained within this article should be considered legal advice. Anyone who reads this article should consult with an attorney before acting on anything contained in this or any other article on legal matters, as facts and circumstances will vary from case to case.

Matthew Copusmcopus@hallandcompany.comMichael J. Hall & Company A/E Insurance Services19660 10th Avenue NEPoulsbo, WA 98370Phone: 360-598-5016

www.hallandcompany.com

HALL & COMPANYServing Architects, Engineers and Environmental Consultants

Ryan J. Kohler, Esq.rkohler@ccmslaw.com1100 El Centro StreetSouth Pasadena, CA 91030Phone: 626-243-1100Fax: 626-243-1111

www.ccmslaw.com