Indemnify is a Funny Word Carrying Historical Baggage—Be Aware and Use with Care

Glenn West | Weil, Gotshal & Manges

Despite the proliferation of R&W insurance as the sole recourse for buyers with respect to sellers’ breach of representations and warranties, an indemnification remedy against sellers (subject to a cap) continues to find its way into many private company acquisition agreements.  Indemnification, as a concept, originated in the context of one party to a contract agreeing to ensure that the counterparty was held harmless against claims by third parties for which the indemnifying party had agreed to be responsible.  In other words, indemnification was not a concept that ordinarily applied as a means of ensuring that a non-breaching party was compensated by the breaching party for direct losses the non-breaching party sustained by virtue of the breaching party’s breach of contract.  Indeed, absent an exclusive remedy provision, a non-breaching party is entitled to damages under the common law for a breaching party’s failure to abide by the terms of the contract irrespective of whether that contract contains an indemnification clause.  Nevertheless, indemnification provisions in most acquisition agreements today purport to cover losses sustained by a non-breaching party, whether those losses arise directly from the breach or arise as a result of a third party claim.  But the historical fact that indemnification was not normally associated with direct (or first party) claims continues to cause courts some confusion and requires care by deal lawyers to avoid misunderstandings and unintended results.

The dictionary definition of “indemnify” includes both “secur[ing] against hurt, loss, or damages,” as well as “compensat[ing] for incurred hurt, loss, or damage.”  Nonetheless, cases across the country have suggested that there is a presumption that the term “indemnify” only applies to losses arising from third party claims, not losses incurred directly by a party as a result of a counterparty’s default under a contract.[1] While most of these cases do not involve the indemnification provisions contained in private company acquisition agreements, and are focused on whether the indemnification provision allows recovery for attorneys’ fees related to direct claims between the parties,[2] it is not clear that they can be completely discounted on that basis. 

To overcome the general presumption that an indemnification provision only covers third party claims, it is important to state in clear and unequivocal terms that the indemnification provision applies to both direct and third party claims.  Language that simply provides that the breaching party shall indemnify the non-breaching party for losses sustained by the non-breaching party, as a result of the breaching party’s breach of representations, warranties or covenants set forth in the agreement, may be deemed insufficient to clearly cover first party (or direct) claims, as opposed to be presumed to only apply to third party claims.  While we have addressed this issue before in a series of posts to Weil’s Global Private Equity blog,[3] some recent Delaware cases have suggested that a reminder of these principles may be in order.

For example, in a recent Delaware Superior Court decision, Sarn Energy LLC v. Tatra Defence Vehicle A.S., C.A. No.: N17C-06-355 EMD CCLD, 2019 WL 6525256 (Del. Super. October 31, 2019),  a party’s claims for attorney’s fees and costs incurred in pursuing its claim for damages against the breaching party were denied despite the existence of the following indemnification clause in Section 11 of the Agreement:

11. Indemnification. Parties shall defend, indemnify and hold harmless each other and its officers, directors, employees, agents, parent, subsidiaries and other affiliates, from and against any and all damages, costs, liability, and expense whatsoever (including attorneys’ fees and related disbursements) incurred by reason of (a) any failure by Parties to perform any covenant or agreement of the Parties set forth herein; (b) injury to or death of any person or any damage to or loss of property which is due to the negligence and/or willful acts of the Parties; or (c) any breach by Parties of any representation, warranty, covenant or agreement under this Agreement. (emphasis added)

Notwithstanding Section 11’s seeming breadth, the court held that: “Section 11 is a standard indemnity provision that applies to third party actions not to first party claims like the one asserted here by [plaintiff].” And, as such, it did not otherwise qualify as a valid fee shifting clause that overrode the American Rule which “provides that litigants generally are responsible for their own litigation costs.”

Similarly, in a granted motion for re-argument in Winshall v. Viacom International, Inc., C.A. No.: N15C-06-137 EMD CCLD, 2019 WL 5787989 (Del. Super. November 6, 2019), the court held that the following indemnification clause in Section 8.6 of the Merger Agreement only applied to third party claims, not to first party claims:

a) Indemnification. Subject to the limitations set forth in this Article VIII, from and after the Effective Time, each of Parent [Viacom] and MergerCo, jointly and severally, shall indemnify, defend and hold harmless each Merger Consideration Recipient [Mr. Winshall and the other Harmonix Shareholders] against any and all Losses actually incurred or suffered by any such Merger Consideration Recipient as a result of:
(i) the breach of any representation or warranty of Parent or MergerCo set forth in this Agreement or in any Ancillary Document; and
(ii) the breach of any covenant or agreement of Parent or MergerCo contained in this Agreement or in any Ancillary Document.

Losses were defined in the Merger Agreement as follows:

any and all losses, liabilities, damages, claims, awards, judgments, diminution in value, Taxes, fees, costs and expenses (including reasonable attorneys’ fees and expenses, expenses of investigation, defense, prosecution and settlement of claims (including any claims under Article VIII hereof), court costs or enforcement of the provisions of this Agreement) suffered or incurred by such Person, plus any interest that may accrue on the foregoing.

According to the court, the absence of explicit language covering the reimbursement of attorneys’ fees for directly enforcing the breaching party’s obligations (i.e., first party claims), which were the only claims asserted, meant that the indemnification clause was limited to third party claims.  Hmmmm.

But, in Collab9. LLC v. En Pointe Technologies Sales, LLC, C.A. NO. N16C-12-032 MMJ CCLD, C.A. NO. N19C-02-141 MMJ CCLD, 2019 WL 4454412 (Del. Super. September 17, 2019), the court was able to conclude that the indemnification provision covered both direct and third party claims (this case did not, however, involve a dispute over the recovery of attorney’s fees).  After noting that typically “indemnification [only] comes into play when one party to a contract agrees to indemnify a second party to the contract for liability resulting from third-party claims against the second party,” the court note that the Asset Purchase Agreement “states that Seller indemnification may apply ‘whether or not involving a third party claim’ resulting from ‘any breach or inaccuracy of a representation or warranty….’” The court further noted additional language that made clear that indemnification was available for both direct and third party claims. 

The good news is that most private company acquisition agreements cover this issue explicitly and make clear that despite the historical limitations placed on the word “indemnify,” both direct and third party claims are intended to be covered by the indemnification regime.  Moreover, the indemnification provisions in many private company acquisition agreements use terms more expansive than simply “indemnify, defend and hold harmless,”[4] which are terms more traditionally related to third party claims.  But many ancillary agreements do not explicitly cover this issue or use the more expansive terms. 

Perhaps we would all do well to heed this observation from a 2012 Delaware Superior Court case attempting to decipher an indemnification provision: 

When the Court considers the indemnity clause here, even if the Court was kind in its description, it would have to guess that it was written by counsel who never litigate, whose days are filled with the excitement of writing contract terms that only they will understand or can reasonably interpret, and who obviously have lost the ability to write in a clear and common-sense manner. While this may be a well-respected and sought-after art form, it does not help the client insure their expectations and demands are understood by all parties. Instead, the Court is left with the challenge of deciphering terms that were perhaps in vogue in the nineteenth century but whose days have clearly passed.[5]

Remember, the word “indemnify” carries historical baggage; be aware and use care. 

Endnotes    (↵ returns to text)

  1. See e.g., TranSched Sys. Ltd. v. Versyss Transit Sols., LLC, 2012 WL 1415466, at *1-*2 (Del. Super. Mar. 29, 2012); Hopper Assoc., Ltd. v. AGS Computers, Inc., 548 N.E.2d 903, 905 (N.Y. 1989); Hot Rods, LLC v. Northrup Grumman Sys. Corp., 272 Cal. App.4th 1166, 1179 (2015); Claybar v. Samson Exploration, LLC, NO. 09–16–00435–CV, 2018 WL 651258, at *3 (Tex. App.—Beaumont Feb. 1, 2018); see also Kenneth A. Adams, A Manual of Style for Contract Drafting §13.416 (4th Ed. 2017).
  2. See Richard L. Levine, Peter Feist and Jessica N. Djilani, Clarifying the “Unmistakable Clarity” Standard in Contractual Indemnification Provisions,  85 U.S.L.W. 1391 (April 13, 2017), reproduced here.  The fact that many of these cases concern the recovery of attorneys’ fees is relevant because of the strong presumption imposed by the “American Rule,” which states that in the absence of a “specific and explicit” provision in a contract or statute requiring a party to pay the attorneys’ fees of the other party, each party is responsible for their own attorneys’ fees.  Indeed, the American Rule’s presumption is so strong that the United States Supreme Court recently held (unanimously) that a statute requiring one party to pay “all expenses of the proceedings” was not sufficiently clear and explicit to rebut the American Rule’s presumption that each party was required to pay their own attorney’s fees.  Peter v. Nantkwest, Inc., No. 18-801, 589 U.S. __ (Dec. 11, 2019, Sotomayor, J.).  Thus, it may be that it is the American Rule’s presumption that is sometimes at work more than the presumption that the word “indemnify” ordinarily only applies to third party claims.
  3. Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 1, Weil’s Global Private Equity Watch, June 9, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 2, Weil’s Global Private Equity Watch, June 14, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 3, Weil’s Global Private Equity Watch, June 23, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 4, Weil’s Global Private Equity Watch, July 7, 2016, available here.
  4. Such terms may include “pay, compensate, and reimburse for,” in addition to “defend, indemnify, and hold harmless from and against.”
  5. TranSched Sys. Ltd. v. Versyss Transit Sols., LLC, 2012 WL 1415466, at *3 (Del. Super. Mar. 29, 2012).  I suspect contract drafting guru, Ken Adams, would agree with those sentiments.  See  Kenneth A. Adams, A Manual of Style for Contract Drafting, “Introduction,”  xxxvi-xxxvii (4th Ed. 2017).

“Slow and Steady Doesn’t Always Win the Race” – Applicability of a Statute of Repose on Indemnity/Contribution Claims in New Hampshire

Rahul Gogineni | White and Williams | September 3, 2019

In Rankin v. South Street Downtown Holdings, Inc.2019 N.H. LEXIS 165, the Supreme Court of New Hampshire considered, pursuant to a question transferred by the trial court, whether RSA 508:4-b, the statute of repose for improvements to real property, applies to indemnity and contribution claims. The court concluded that based upon the plain reading of the statute, it applies to indemnity and contribution claims. As noted by the court, a holding to the contrary would violate the intent of a statute of repose, which is to establish a time limit for when a party is exposed to liability.

In Rankin, after falling and injuring himself while leaving a building, John Rankin and his wife brought an action against the property owner, South Street Downtown Holding, Inc. (South Street) in 2017. South Street subsequently filed a third-party complaint against multiple parties including an architectural company, Wagner Hodgson, Inc. (Wagner), who was involved in a renovation project at the property. The project was substantially complete in 2009. Wagner responded by moving to dismiss the action, arguing that South Street’s indemnification and contribution claims were barred by the applicable statute of repose.

RSA 508:4-b specifically states,

Except as otherwise provided in this section, all actions to recover damages for injury to property, injury to the person, wrongful death or economic loss arising out of any deficiency in the creation of an improvement to real property, including without limitation the design, labor, materials, engineering, planning, surveying, construction, observation, supervision or inspection of that improvement, shall be brought within 8 years from the date of substantial completion of the improvement, and not thereafter. (Emphasis added).

After reviewing the basis of South Street’s claims against Wagner, the court concluded that South Street’s indemnification and contribution claims specifically fell within the statute of repose. In so doing, the court reaffirmed its prior holdings that indemnity and contribution actions are actions to recover economic loss. It then concluded that because there was no exception in the section for indemnity and contribution actions, they both fell squarely within the meaning of the phrase “all actions.” Having found that the statute of repose was applicable to South Street’s claims, the court answered the transferred question in the affirmative.

This case serves as a good reminder that contribution and/or indemnification claims may be governed not only by a different subset of laws within respective jurisdictions but also by the terms of any applicable time limitation statutes. As such, practitioners should be aware that merely because an indemnity or contribution statute does not discuss either a statute of limitation or a statute of repose, such limitations may still apply to their claims. Moreover, just because a statute of limitations and/or repose does not specifically mention indemnity or contribution claims, does not mean they are exempt from the statute.

A Milestone Construction-Defect Case at New Hampshire Supreme Court

Boston Real Estate Times | August 16, 2019

Morrison Mahoney LLP, one of the northeast region’s leading litigation firms, announced that William A. Staar, a Partner in the firm’s Construction Litigation Practice, prevailed in a case before the New Hampshire Supreme Court (NHSC) on behalf of landscape architect, Wagner Hodgson, Inc.

At issue was whether New Hampshire’s eight-year statute of repose, which protects building professionals from direct claims, also protects those professionals from contribution and indemnity claims. Staar argued that the statute does offer that additional protection. The NHSC agreed, and this landmark decision will provide additional protection for building professionals operating within the state of New Hampshire.

Background

John C. Rankin & A. v. South Street Downtown Holdings, Inc.

South Street Downtown Holdings, Inc. v. Truexcullins and Partners Architects, et al.

The plaintiff is an older man who allegedly fell on a short set of exterior stairs and ramp that are part of a commercial property in Hanover, New Hampshire.  As a result, he purportedly suffered severe facial injuries.  The plaintiff sued the property owner, i.e., South Street, arguing that a defective design plagued the stairs and ramp and that such design caused him to fall.  South Street filed contribution and indemnity claims against several building professionals, including Wagner Hodgson, Inc., that allegedly designed and/or constructed the stairs and ramp approximately a decade before the subject accident.

Legal Argument

The Morrison Mahoney legal team, including Staar and firm associate Nicholas D. Meunier, moved to dismiss, arguing the following:

  1. A New Hampshire statute of repose, i.e., RSA 508:4-b (1990), bars all claims against building professionals “arising out of” allegedly defective construction that are over eight years post the date of substantial completion of a project, and
  2. South Street brought its third-party claims against Wagner Hodgson 8.5 years after the Town of Hanover issued a certificate of substantial completion.

South Street conceded that the third-party claims were late, but argued that the statute of repose (1) only barred direct claims against building professionals and (2) did not bar indemnity nor contribution claims.  It principally relied on the fact that the pre-1990 version of the statute did specifically bar indemnity and contribution claims and that the current version of the statute does not.  The trial court did not rule on the motion and, instead, passed the issue to the NHSC.

NHSC Ruling

The NHSC found that the current version of the statute bars both indemnity and contribution claims.  Its principal reasons were as follows:

  1. Although the current version of the statute does not explicitly bar indemnity and contribution claims as the prior one did, it contains broader language that does encompass such claims.  Specifically, the current statute bars “all actions” older than eight years against building professionals “to recover damages for . . . economic loss arising out of any deficiency in the creation of an improvement to real property.”  The Court found that a successful claim by the plaintiff against South Street would constitute an “economic loss” that “arose out of” such an alleged deficiency; and
  2. Excepting contribution and indemnity claims from the statute fundamentally would frustrate the central purpose of the statute, i.e., to allow building professionals to be free and clear from lawsuits pertaining to their work on a particular project eight years after the completion of such work.  As made clear by the legislative record for the statute, the goal of the statute was to protect such professionals from all claims arising out of their work.  The genesis of the statute was that, prior to its enactment, many building professionals operating in New Hampshire suffered severe financial strain by having to maintain liability insurance for their work sometimes decades after they had completed such work, including well into retirement.

The case was argued in the chamber of the New Hampshire House of Representatives on Tuesday, June 4, 2019, in celebration of the bicentennial anniversary of the state house, and the Court decision was released on August 6, 2019. The Court videotaped both oral argument and the Q&A, which is available here.

Developer is not Indemnified for its own Conduct Without an Express Agreement in the Indemnification Clause

Sunu M. Pilai | Construction Industry Counselor | August 22, 2019

In a case where the jury found both the Architect and the Developer separately responsible for Plaintiff’s damages, an Appellate Division of the New Jersey Superior Court recently held that the Developer is not entitled to be indemnified by the Architect.  See Grandview at Riverwalk Port Imperial Condo. Ass’n, Inc. v. K. Hovnanian at Port Imperial Urban Renewal II, LLC, No. A-2308-17T2, 2019 WL 3798427 (N.J. Super. Ct. App. Div. Aug. 13, 2019)(unpublished decision). The appellate court agreed with the Developer’s argument that the Developer’s breach of warranty would not have occurred but-for the Architect’s negligence. However, the appellate court denied the Developer’ demand for indemnification because the indemnification clause in the Developer-Architect contract did not unequivocally express an intention for the Architect to indemnify the Developer against losses resulting from the Developer’s own negligence.

This case involved a residential project containing 132 units, categorized as a Type 2B building that required fire-retardant-treated wood. By the time the Architect realized that the plans called for untreated plywood in floor assemblies and therefore did not meet Type-2B requirements, more than half the plywood was installed and Developer was not willing to consider solutions that would disrupt the schedule.  Following discussions, the Architect drafted plans to revise the building classification to Type 3A that would allow the untreated wood to remain. However, the Town never approved the revised plans, and the Developer never ensured that the revised plans were approved for a Type 3A Building.  The jury determined that the Developer breached its warranty to buyers of the residential units because it never disclosed to the buyers that the building’s classification was never approved, and, according to Plaintiff’s expert, the building would not meet Type 3A requirements either.  The jury found the Architect to be negligent in the design, and that the Developer breached an express promise that the Building’s common elements would be fit for their intended purpose.  The jury assessed damages of $1 Million against the Architects for its negligence and $3 Million against the Developer for its breach of an express warranty, which was trebled to $9 Million due to a finding of consumer fraud.

In the appeal, the Developer argued that the Architect was contractually obligated to indemnify it for the damages because the damages arose out of the Architect’s negligence in designing a building contrary to code requirements. The appellate court noted that, though public policy does not preclude such indemnification, a contract will not be construed to provide indemnification for losses resulting from a party’s own negligence unless such an intention is expressed in unequivocal terms.  The appellate court found that the indemnification clause only provides that the Architect will indemnify the Developer for Architect’s own negligence, and hence the clause cannot be construed to indemnify the Developer for its own conduct (when it breached its express warranty to residential buyers).

The decision, though non-precedential, highlights the importance of careful and effective drafting of indemnification clauses.

A Second Level of Protection to Indemnitees

Thomas L. Oliver III | Bradley Arant Boulg Cummings | July 31, 2019

Construction and Procurement Law News, Q2 2019

It is not uncommon for indemnitees to attempt to add language to indemnification provisions providing additional liability protections from the indemnitor. And courts and legislators are wary of language in indemnity agreements that create obligations on the indemnitor to indemnify the indemnitee for its own acts or omissions and create restrictions on the indemnitee’s rights to do so. A recent Florida court attempted to strike a balance between an indemnitee’s right to indemnification generally and protecting an indemnitor from indemnifying the indemnitee for its own fault.

In CB Contractors, LLC v. Allens Steel Products, Inc., a general contractor of a condominium project brought a contractual and common law indemnification action against its subcontractors arising out of a construction defect action brought against the contractor by the condominium association.

The subcontract’s indemnity clause stated: “Subcontractor’s indemnity obligations hereunder shall apply regardless of whether or not the claims, damages, losses, and expenses or causes of actions are caused in part by a party indemnified hereunder […].” In essence, the subcontract, on its face, allowed the general contractor to seek indemnity for claims, damages, and losses as a result of its own fault.

Florida Statute § 725.06 (2004), which applies to construction of buildings, states that “[a]ny portion of any agreement […] promis[ing] to indemnify or hold harmless the other party to the agreement […] for damages to persons or property caused in whole or in part by an act, omission, or default of the indemnitee […] shall be void and unenforceable unless the contract contains a monetary limitation on the extent of the indemnification that bears a reasonable commercial relationship to the contract […].”

Applying this statute, the lower court found that the entire indemnity clause was void and unenforceable. The general contractor appealed the trial court’s decision.

On appeal, the appellate court disagreed and found that the entire indemnity clause was not void and unenforceable, but instead concluded that only the specific portion of the indemnity clause purporting to impose indemnity obligations for the contractor’s own acts or omissions was unenforceable.

This ruling, which reflects the same middle-of-the-road approach followed by many jurisdictions, provides protection to the indemnitor without completely voiding the parties’ indemnification agreement. This decision could have been different under a different state’s stricter law regarding indemnity. Contracting parties should carefully consider the extent of indemnity included in their contracts, especially in light of the relevant jurisdiction’s law regarding those protections.