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).

A Practical Approach to Resolving Mechanics Liens in Illinois: Just Deal With It.

Elizabeth J. Boddy | Taft Stettinius & Hollister

Owners of property encumbered by a mechanics lien often find themselves in violation of loan covenants and under pressure from their lenders. Liens are also a significant hindrance to the sale of the property to an otherwise willing buyer. How best to deal with a mechanics lien depends upon the circumstances, but here is a look at some options.

1. Bonding Over the Claim. In 2016, via amendment of the Illinois Mechanics Lien Act[1], Illinois joined most other states in providing a statutory process for bonding over a mechanics lien. Essentially, once a claim for a mechanics lien has been asserted, an owner or other eligible person having an interest in the subject property may petition the local court to substitute a surety bond in lieu of the property as security for payment of the lien. If the petition is timely filed, and no objection is presented and sustained by the court, an order will issue (1) substituting the surety bond for the property securing the lien claim, and (2) substituting the lien claimant’s right to recover on the bond for claims that could otherwise be asserted by the claimant under the Mechanics Lien Act. The order discharges the lien, and once recorded effectively releases the claimant’s encumbrance on the property. Litigation then proceeds among the claimant, surety and bond principal only. Other persons having an interest in the property who would otherwise be joined in the action are excused.

Some of the intended benefits of this process include (1) earlier release of the lien encumbering owner’s title; (2) simplifying litigation; and (3) providing a source of cash recovery to a successful claimant.

But there are downsides to consider. First: the size of the claim and bond. The bond must, in addition to other requirements, be in an amount equal to at least 175% of the sum claimed. Often, the bond principal is a general contractor constructing improvements to the property for the owner’s benefit, bound by the terms of its contract to permit no liens by subcontractors or suppliers. Unless a private project is very large, the owner may not have required the contractor to post a payment bond up front. Once the dispute arises, the financial burden on the contractor/principal to obtain a bond in the proper amount may be substantial. The same is true for an owner/principal whose budget for the project did not contemplate the need for a bond.

Second: the principal is jointly and severally liable with the surety for any judgment awarded to the successful claimant – including some or all of the claimant’s attorneys’ fees. A prevailing party clause in the statute provides that if the claimant is awarded at least 75% of the amount claimed, it is entitled to recover reasonable attorneys’ fees up to the penal sum of the bond remaining after payment of the award plus interest. The bond principal, on the other hand, becomes the prevailing party only if the claimant is awarded less than 25% of its claim, in which case the principal may recover attorneys’ fees up to 50% of the claim – if it is collectible. Unless the principal is very sure of its position, challenging the claim presents material risk beyond its own legal expenses.

2. Title Insurance. As an alternative to statutory bonding and litigation, an owner/seller can try negotiating for a title policy insurance over the lien (depending on size and other factors), but title companies are under no obligation to offer such coverage and will typically require the seller’s personal undertaking for all related losses in an amount up to two-and-one-half times the size of the claim. Even where this is a viable option for the seller, it may not be acceptable to the buyer, who will generally prefer to take a clean title.

3. Negotiate a Release. Liens arise because the claimant hasn’t been paid. More often than not, the claimant will prefer cash in hand, even at a discount, over taking its chances in court. The tried and true method of making a deal to exchange cash for the claimant’s release is typically more cost-effective, less disruptive and less risky than litigation – for both sides.

The relative contributions of the parties to the bargain will depend on the circumstances. Did the owner satisfy its obligation to pay the contractor? Even if true, payment to the contractor is not necessarily a complete defense to the claims of subcontractors. If the claimant is a subcontractor, the owner may have the incentive to chip in to a settlement and pursue other remedies against the contractor. Did the contractor make errors that increased the cost of a subcontractor claimant’s work? In that case, the contractor may be taking a haircut. Did the claimant fail to fully perform? If so, a reduction of the claim is in order.

When settlement is reached, the owner benefits by clearing title to the property; the would-be bond principal, whether owner or contractor, will avoid costs for the bond; all parties will save legal expenses; everybody avoids judgment; and generally speaking, an outcome the parties agree on themselves is better than one imposed upon them by a court. So, when weighing the options, consider taking the practical approach: just deal with it.

Once Again: Contract Terms Matter

Christopher G. Hill | Construction Law Musings

I know, you’ve heard this over and over again here at Construction Law Musings: courts in Virginia will interpret a contract strictly and in a manner that gives meaning to its unambiguous terms.

A recent case out of the Eastern District of Virginia federal court, White Oak Power Constructors v. Mitsubishi Hitachi Power Systems, reinforces this point.  The basic facts of the case relevant to this discussion and the Court’s opinion are these.  Old Dominion Electric Cooperative (ODEC) hired White Oak Power Constructors (White Oak) to build a natural gas power plant.  The contract between ODEC and White Oak provided for liquidated damages for delay and also contained a risk of loss provision making ODEC responsible for certain losses or damages due to property damage at the plant.  I highly recommend that you read the facts of the case in full to get the details of the terms of these clauses.

Needless to say (or this case wouldn’t be the subject of a construction law blog), the project ran past completion date and liquidated damages were assessed to the tune of more than $50,000,000.00.  The delay was alleged to have been caused in substantial part by property damage due to weather, fire, and ice among other causes.

In a creative piece of lawyering, Whlte Oak argued that because the delay was due to property damage, ODEC, and not White Oak, was responsible for any delay related costs (including liquidated damages) that were linked to the property damage.  Of course ODEC did not agree.

After going through several cannons of Virginia contract interpretation, the Court determined among other things, that to have a liquidated damages provision in a contract that would then essentially be cancelled out by a risk of loss provision would be absurd. The Court also determined that the context and entirety of the contract rendered White Oak’s argument untenable, stating:

There is only one reasonable interpretation of the risk of loss provision: that Old Dominion’s liability for property damage under the risk of loss provision does not include corresponding “delay-related losses, damages, and costs.” Accordingly, the provision is unambiguous, and the court may enforce its interpretation as a matter of law. Because the language of the contract is unambiguous, the court does not need to consider extrinsic evidence.

In sum, the Court looked at the contract and enforced its unambiguous provisions despite some wonderfully creative arguments from White Oak.  This case further cements the maxim that Virginia law will not seek to go beyond the contract where the terms are unambiguous.  Further, you should always seek counsel from an experienced construction attorney when analyzing the terms of a construction contract, hopefully prior to entering into that contract.

South Carolina Supreme Court’s Quiet Erosion of Insurers’ Attorney-Client Privilege Rights

Roben West | Property Casualty Focus

One decision that flew under the radar in 2019 continues the recent trend of courts to dispense, under among other things the previously discussed “at-issue” waiver doctrine, with insurers’ fundamental rights to confidentiality with respect to legal advice. In the June 2019 decision In re Mt. Hawley Insurance Co., No. 2018-001170 (S.C. June 12, 2019), South Carolina directed, in response to a certified question from the Fourth Circuit Court of Appeals, the circumstances under which it decided that an insurer no longer has a right to confidential attorney-client communications in bad faith cases.

The insurance dispute stemmed from various alleged construction defects plaguing a residential development. The insurer issued an excess commercial liability policy to the construction company that was responsible for constructing the residential development. Upon the discovery of alleged construction defects, the development’s homeowners association sued the construction company. Eventually, the construction company settled with the homeowners association and assigned its interest in the excess policy to the homeowners association.

In response to the insurer’s coverage denial, both the insured and the construction company filed a bad faith action in state court, which was removed to federal court shortly thereafter. During discovery, the insurer relied on the attorney-client privilege to withhold several documents from the plaintiffs. Arguing that the insurer’s denial of bad faith implicated the “at-issue” exception and established the insurer’s waiver of the attorney-client privilege, the plaintiffs filed several motions to compel, resulting in in-camera inspection of the documents. The insurer sought a writ of mandamus to avoid the production, and the Fourth Circuit certified the following question to the South Carolina Supreme Court:

Does South Carolina law support application of the “at issue” exception to attorney-client privilege such that a party may waive the privilege by denying liability in its answer?

The court began its analysis by surveying South Carolina bad faith law and the various approaches surrounding the implied attorney-client privilege waiver in the bad faith context. The court adopted a “middle-ground” case-by-case approach, finding the rule less harsh than establishing a per se waiver every time an insurer defends a bad faith action by denying bad faith or asserting good faith but more stringent than an absolute application of the privilege.

The court acknowledged that as it relates to implied waiver and the at-issue exception to the attorney-client privilege, insurers are often stuck between “Scylla and Charybdis” because it is difficult to respond or otherwise defend a bad faith action without asserting that it investigated the claim in good faith and evaluated the applicable law. The court clarified that it is when the insurer affirmatively alleges that its actions were based on its reasonable good faith belief and its subjective belief — which was informed by advice of counsel — that the court found that the privilege must give way.

The court did not comment on the potential policy implications of a rule that encourages insurers and their counsel to reduce the scope of what they are willing to commit to paper.

Does a No-Damage-for-Delay Clause Also Preclude Acceleration Damages?

Christine Fan and Ted Gropman | Pepper Hamilton

Construction contracts often include a “no damage for delay” clause that denies a contractor the right to recover delay-related costs and limits the contractor’s remedy to an extension of time for noncontractor-caused delays to a project’s completion date. Depending on the nature of the delay and the jurisdiction where the project is located, the contractual prohibition against delay damages may well be enforceable. This article will explore whether an enforceable no-damage-for-delay clause is also a bar to recovery of “acceleration” damages, i.e., the costs incurred by the contractor in its attempt to overcome delays to the project’s completion date.

Courts are split as to whether damages for a contractor’s “acceleration” efforts are distinguishable from “delay” damages such that they may be recovered under an enforceable no-damage-for-delay clause. See, e.g., Siefford v. Hous. Auth. of Humboldt, 223 N.W.2d 816 (Neb. 1974) (disallowing the recovery of acceleration damages under a no-damage-for-delay clause); but see Watson Elec. Constr. Co. v. Winston-Salem, 109 N.C. App. 194 (1993) (allowing the recovery of acceleration damages despite a no-damage-for-delay clause). The scope and effect of a no-damage-for-delay clause depend on the specific laws of the jurisdiction and the factual circumstances involved.

There are a few ways for a contractor to circumvent an enforceable no-damage-for-delay clause to recover acceleration damages. First, the contractor may invoke one of the state’s enumerated exceptions to the enforceability of the clause. It is helpful to keep in mind that most jurisdictions strictly construe a no-damage-for-delay clause to limit its application. This means that, regardless of delay or acceleration, courts will nonetheless permit the contractor to recover damages if the delay is, for example, of a kind not contemplated by the parties, due to an unreasonable delay, or a result of the owner’s fraud, bad faith, gross negligence, active interference or abandonment of the contract. See Tricon Kent Co. v. Lafarge N. Am., Inc., 186 P.3d 155, 160 (Colo. App. 2008); United States Steel Corp. v. Mo. P. R. Co., 668 F.2d 435, 438 (8th Cir. 1982); Peter Kiewit Sons’ Co. v. Iowa S. Utils. Co., 355 F. Supp. 376, 396 (S.D. Iowa 1973).

Second, a contractor may recover acceleration damages despite a no-damage-for-delay clause if the owner or general contractor denies the contractor’s valid request for a time extension. No-damage-for-delay clauses typically provide that the only remedy for a contractor is an extension of time. Should the contractor be deprived of this sole remedy under the clause, the owner and/or general contractor’s denial of the request would constitute a material breach of contract, thus allowing the contractor to recover damages. Multiple courts have allowed the recovery of damages in these instances. See, e.g., Cent. Ceilings, Inc. v. Suffolk Constr. Co., Inc., 91 Mass. App. Ct. 231, 237 (2017) (precluding the general contractor from invoking the no-damage-for-delay clause where it failed to grant an extension of time to the subcontractor); Watson Elec. Constr. Co., 109 N.C. App. at 199 (holding that damages for breach of contract are recoverable despite a no-damage-for-delay clause if the owner fails to properly grant an extension of time for its delay).

Finally, acceleration damages that do not flow as a consequence of delays may also be recoverable. Contractors may try to characterize the costs incurred as costs arising solely from impacts or disruptions to their performance, and not acceleration efforts to recover project delays. This approach has received inconsistent results across jurisdictions. For example, the U.S. Court of Appeals for the District of Columbia Circuit recognized the distinction between claims for delay versus disruption and awarded disruption damages to a contractor despite the presence of a no-damage-for-delay clause. United States Indus. v. Blake Constr. Co., 217 U.S. App. D.C. 33 (1982). Similarly in Massachusetts, a court found that a no-damage-for-delay clause precluded only damages that are attributable to delay and did not bar damages that would have been incurred even if performance had been timely. Paul Hardeman, Inc. v. United States, 406 F.2d 1357, 1362 (U.S. Ct. Cl. 1969). Yet, a separate court in Massachusetts found that working piecemeal, out of sequence, and in winter weather constituted delays, and thus any damages incurred were still precluded under a no-damage-for-delay clause. B.J. Harland Elec. Co. v. Granger Bros., Inc., 510 N.E.2d 765, 767 (Mass. App. Ct. 1987). As acceleration is often closely linked to delays on a project, using this approach to bypass the no-damage-for-delay clause is certainly far from perfect.

In conclusion, contractors could face hurdles in trying to recover acceleration damages under a valid no-damage-for-delay clause. Some of the methods available to bypass the clause include invoking any of the recognized exceptions to the clause or pursuing breach of contract damages for the owner or general contractor’s denial of a time extension. However, based on the inconsistent rulings across the courts, the results of these efforts are largely jurisdiction-specific.