Coming to Terms

Contract Traps for the Unwary ©

The following is intended for informational use only, and is not intended as legal advice. Anyone seeking legal advice regarding the legal effects of the following issues, should consult an attorney.

Below are materials which discuss generally several types of contract clauses which can have unintended consequences. Generally there are no "magic words," to consider in reviewing a contract. However you should:

  1. Avoid broad or vague language. Non‑self‑defining terms will be construed against you.
  2. Limit the triggering event to a clearly defined set of circumstances. Provide certainty when you will be called on to answer for indemnity.
  3. Carefully negotiate what you are being held responsible for. Do not accept more risk than your company can reasonably assume.
  4. Discuss vague or ambivalent terms with your attorney.

A. Definitions

The following are terms which are commonly seen in contract language, that you should know about.

Indemnify. To indemnify means to stand in the shoes of someone else‑to assume a responsibility that would otherwise be theirs. An insurance contract is an indemnity agreement. In return for the payment of a premium, your insurance company agrees to stand in your shoes in the event of a covered loss.

When you agree to indemnify one of your clients, you become, within the scope of the indemnity provision you sign, an insurance company of your client's losses. Your own insurance may or may not respond to the obligations you assume. Knowing this, most architects and engineers approach indemnification agreements with great care.

Hold Harmless Agreement. A contractual arrangement whereby one party assumes the liability inherent in a situation, thereby relieving the other party of responsibility.

An indemnification agreement is often referred to as a "hold harmless" agreement. Regardless of its title, one party (the "indemnitor") agrees to indemnity the other party (the "indemnitee") from the liabilities that are associated with the business the parties are conducting. An indemnification agreement is, in effect, merely a contractual device to transfer the risk from one party to another.

Protect. "Protect," in an indemnity agreement, means that the indemnitor will provide protection to the indemnitee or the indemnitees' property by providing a legal defense to claims brought against the indemnitee.

Defend. "Defend," in an indemnity agreement, means to provide a legal defense to the indemnitee should a claim arise which is covered in the indemnity agreement. An agreement to hold harmless is generally held to include an obligation to defend, or to reimburse for costs of defense, when an action within the terms of the agreement is filed against the indemnitee. United States Fire Insurance Co. v. Chrysler Motors Corp., 274 Or 362 (1973).

Negligence. "Negligence" is the failure to use such care as a reasonably prudent and careful person would use under similar circumstances; it is the doing of some act which a person of ordinary prudence would not have done under similar circumstances or failure to do what a person of ordinary prudence would have done under similar circumstances. Conduct which falls below the standard established by law for the protection of others against unreasonable risk of harm; it is a departure from the conduct expectable of a reasonably prudent person under like circumstances.

Oregon courts apply a fairly standard test to a given set of facts to determine if there has been negligent behavior.

Additional Insured Endorsements. Agreements to procure insurance (APIs) are contractual arrangements in which one party to a contract agrees to procure insurance for another party's benefit. In the construction industry, the API is frequently satisfied through inclusion of an AIE in one party's insurance policy. Under the AIE, the party for whose benefit insurance is being obtained becomes insured under the promisor's policy (an "additional insured").

Additional Insured Clauses

An additional insured clause is one requiring the addition of a party as an additional named insured under the policy, and provides direct rights under the policy, including a right to defense from the insurance company and, sometimes, indemnification under the named insured's policy. Additional insured status, therefore, permits the additional insured to protect its defense and indemnification rights directly, rather than relying solely on the rights outlined in the indemnification clause of its own CGL( Comprehensive General Liability) policy.

In general, courts have engaged in an expansive interpretation of the scope of coverage afforded to an additional insured under standard endorsements. As long as there is a nexus between the loss and the work or operations of the insured, most courts uphold coverage, unless the particular additional insured endorsement before the court contains some limitation on coverage. The relative negligence of the named insured and the additional insured is not particularly relevant to the inquiry.

Indemnity Clause[1]

Sample Clause: To the fullest extent permitted by law, the Party shall hold harmless, indemnify, and defend the Owner, its officers, directors, representatives, designees, agents, and employees from and against any and all claims, demands, actions, suits, losses, liabilities, expenses, and costs, directly or indirectly caused by, connected with, attributable to, or alleged to be caused by, connected with, or attributable to:

  1. The performance of services under this Agreement by the Party, its officers, employees, agents, and consultants,
  2. Willful misconduct by any of them,
  3. Infringement of any copyright, trade secret, or patent,
  4. Breach of any term or condition of this Agreement, or
  5. Violation of any state, Federal or local law, code, ordinance, or regulation, including, but not limited to the Americans With Disabilities Act of 1990.

Excepted from the foregoing shall be only those claims, demands, actions, suits, losses, liabilities, expenses, and costs caused by the sole, active, negligence of the Owner.

Looking at the Language: What Does It Mean?

A. "To the fullest extent permitted by law. . ."

The problem here is that the law governing contracts in most states is more permissive than the coverage afforded by your insurance. The law generally permits indemnification which extends well beyond your negligence. Your legal liability and your insurance fence the field of your negligence, but the law may enforce a fence which encloses that and the field of harm caused by others, as well.

B. ". . . and defend . . ."

What does it really mean when you agree to defend as well as indemnify? It means that, long before any legal liability is established, you have an obligation to retain an attorney and mount a defense on your client's behalf. Under most circumstances, this is an obligation your insurance company will likely refuse to accommodate. Remember, contractual liability coverage may afford compensation for defense costs once negligence is established, but, absent negligence, there is no coverage.

Indemnify your client against costs of defense attributable to your negligence, if you must (and if your insurance stands behind it), but avoid agreeing to mount that defense if you can. That commitment is likely to be contrary to everyone's interests in the long run.

C. " . . . representatives, designees, agents . . ."

Delete these words, and all like them. If you encounter resistance, ask for a list of those representatives, designees, and agents your client believes to be appropriate recipients of your largesse. At the very least, you deserve to know who they might be. Nor is it stretching the limits of fairness for you to insist on the opportunity to evaluate, in each and every case, the appropriateness of extending the security of your indemnification to any of them.

This is not necessarily a "make or break" proposition, at least not in states where the protections of privity have long since been swept away. If the balance of your agreement to indemnify is limited to the consequences of your negligence, and if representatives, designees, or agents of the owner are damaged by your negligence, you are likely to have legal liability for those damages, and your insurance is likely to respond.

D. " ... any and all claims, demands, actions, suits..."

Overly inclusive language can be used against you to create a duty where none was contemplated. Losses, liabilities, expenses, and costs are damages for which you could be legally liable if the clause is construed against you, even if it was not intended. Even attorneys' fees may be construed to be damages in some states, and, where not, your limited contractual liability coverage may well respond. But claims, demands, actions, and suits, in and of themselves, are not damages, and the mere fact that they occur, may or may not have anything to do with your negligence.

This is not a make or break proposition, either, but clarity of intent finds offense in these words and the absolutes which precede them. Best they be deleted.

E. ". . . directly or indirectly . . ."

Your responsibility under the common law ends with the direct consequence of negligence. Your indemnification should end there too.

F. ". . . connected with, attributable to, or alleged to be caused by, connected with, or attributable to . . ."

You are not negligent until you are found by a court or forum of competent jurisdiction to have been negligent. It follows that you cannot insure against costs incurred by someone else as a result of mere allegations of negligence on your part

". . . the performance of services . . ."

There is a serious omission here, and by now you know what it is. The word "negligent" is missing. Without it you will find yourself responsible, not just for losses for which you are legally liable, but for losses arising out of anything that might be related to the services you, perform.

You can safely agree to accept responsibility for the consequences of your negligent performance. A broad reading of this provision requires indemnification and a defense for any loss which occurs on a job in which you are involved. Word the provision to require the indemnity be triggered by a finding of negligence.

What about your agents and consultants? By virtue of your position in the line of fire, you may well be legally liable for their negligent acts, errors, and omissions under a theory of vicarious liability--just as the owner may be liable for yours by virtue of having contracted with you in the first place. This explains the owner's interest in your indemnity agreement. It also explains your insurance company's interest in the Certificates of insurance you obtain from your consultants, and it argues for passing the obligations you assume under your contract through to them. If you keep those obligations within the maximum limits of fairness, there should be no problem with this.

G. ". . . Willful misconduct by any of them . . ."

Oregon law does not allow vicarious liability for the intentional (willful) wrong acts of an employee or agent, unless the employer exercised control over the conduct or was aware of it. If you agree to indemnify for intentional acts, you are signing on for liability you wouldn't otherwise have.

If you are willing to extend indemnification for your negligence (harm inadvertently caused), why is it unfair to extend indemnification for harm intentionally done? This is presumably something you can control, and the case from your client's point of view would seem more compelling for intentional harm than for negligence.

H. ". . . infringement of any copyright, trade secret, or patent . . ."

Claims for copyright infringement need no proof of intent, negligence, or any evil behavior save the infringement itself. So are trade secrets and patents. Owners can easily argue that, if there is infringement, the loss should not fall on them. They did not infringe -- you did. It is not a risk you can reasonably control, and it is not one you can reasonably be expected to assume. You will want to delete this obligation.

Indemnification for your legal liability arising out of your negligence is the most you can reasonably concede.

I. ". . . breach of any term or condition of this Agreement . . ."

This clause is problematic because the appropriate remedy for breach of contract is contract damages, not indemnification. If there was a contract breach the other side must still prove damages. By agreeing to indemnify (or make them whole), you are agreeing to assume responsibility for losses for in addition to those which are directly causally related to any breach.

J. ". . . violation of any ... law, code, ordinance, or regulation . . ."

This obligation has no place in an indemnity provision. Delete it here. If you must address it elsewhere in your agreement, well and good, but keep this in mind: the most you can reasonably concede is to agree to exercise usual and customary professional care in your efforts to comply with the law.

This applies to all laws, codes, ordinances, and regulations, but it is particularly applicable to the Americans with Disabilities Act and the regulations which have been drafted to implement it. Whether your interpretation of the requirements of this far reaching legislation are accurate or not will depend on legal battles not yet fought. They will be civil rights battles, and coup will be counted on the fields of others. You will have no safe place there unless your responsibility begins and ends with the consequences of your negligence.

K. ". . . excepting only ... the sole, active negligence of the Owner . . ."

Never mind that it may be permissible under the law in most states. You know by now that it is neither reasonable, nor insurable for you to assume 100% of the liability for losses for which you may be only partially responsible. Nor does the distinction between active and passive negligence fall within the boundaries of reason (for more on this, see "The Innocent Bystander" in Chapter III). You cannot insure against the risk that your client may contribute to a loss, regardless whether actively or passively, but your client can. Best you delete these words and leave this risk where it belongs.

Types of Indemnification Agreements

There are a few basic points to keep in mind regarding indemnification agreements. First, this transfer of risk is completely independent of any insurance coverage. Although a contract may specify in another section that liability insurance converge is mandatory, this is a separate obligation than that assumed in the indemnification agreement. An indemnitor generally will be obligated to respond if a claim is made, regardless of whether he is insured for the given accident. This is important because if there isn't sufficient insurance coverage to backup an indemnification agreement, the contractor likely will be responsible for settling the balance of the claim. Second, the indemnitee agreement does not relieve the indemnitee (for instance, the owner) of liability to an injured third party.

Through the use of an indemnification agreement, the manufacturer or owner of the product is not transferring a duty owed to the user or consumer, but rather, is simply transferring the liability that can arise out of the breach of such a duty. In effect, the manufacturer or owner remains liable, but the contractor has assumed the obligation to pay for any loss or damage that arises out of that liability.

There are three forms of indemnification agreements: broad, intermediate and limited. The main difference between the three is relative to the amount of liability accepted by the contractor (indemnitor).

Generally, indemnification agreements seeking to shift liability for an indemnitee's negligence have not been well accepted by the courts. It is believed such agreements are contrary to public policy, that is they conflict with the principle that each party should be responsible for its own negligence, which is supposed to deter future negligence conduct. In many states, indemnification is limited by anti‑indemnity statutes.

Enforcement of the Agreement

Indemnification is enforced, first, with a demand. When confronted with a claim or a loss believed to fall within the scope of your agreement to indemnify, the indemnitee (the party you signed up to protect) will demand that you undertake its defense and pay any eventual loss.

If the demand is unsuccessful, indemnity is enforced by legal action. In most states, the courts will enforce all forms of indemnification agreement. The courts will favor an agreement entered into by two parties who are aware of the facts and the consequences of the terms of the contract. The court will hold parties responsible for their contractual obligations pursuant to the indemnification agreement.

Whether or not a particular court will enforce such an indemnification agreement in favor of an indemnitee, depends, in part, on the following factors:

  1. Whether the clause addresses the liabilities for which the indemnitee claims indemnity (i.e. those obligations that the indemnitor has assumed under the indemnification agreement);
  2. Whether the indemnification agreement is written with clear language that clearly indicates that the parties intended the indemnitee to be indemnified for its sole negligence; and
  3. Whether the indemnity clause comports with any applicable anti‑indemnity statutes in effect.

If the indemnification clause meets these requirements, most courts will enforce the agreement in favor of the indemnitee. However, there must be a direct relationship between the injury, loss or damage that occurred and the risk indemnified against. Accordingly, the claim must be carefully examined by the indemnitor to make sure that it falls within the scope of the obligations imposed by the indemnification agreement.

Clearly, the best way to assure that the injury, loss or damage complained of falls within the scope of the risk that is covered by the indemnification clause, is for the parties to use "clear and unequivocal" language in the indemnification provisions. Many courts agree that in order to meet the "clear and unequivocal" standard, it is not necessary that the parties make any reference to the indemnitee's own negligence or even to use the work negligence in the indemnification provisions.

Thus, to ensure that the courts will interpret the indemnification agreement as a broad form agreement, the contract should clearly state that the indemnitor agrees to indemnify the indemnitee for all claims "resulting from or in any way connected with the services performed, even though contributed to or in any way connected with joint or concurrent fault or negligence on the part of" the indemnitee.

Oregon law appears to follow the clear and unequivocal approach. The Oregon Supreme Court has held "Indemnity provisions are construed against holding that coverage extends to the negligence of the indemnitee, unless a contrary intention clearly appears, expressly . . . or out of the circumstances of the parties and their relationship."

However, if the indemnity agreement is not clear, Oregon courts will construe the language of the agreement in the following way:

If the contractual "hold harmless" language is broad but indefinite, such as referring to "any and all claims" or "any and all liability" without reference to particular risks or to the putative indemnitee's own conduct, the court determines the scope and enforceability of that language after assessing certain broader contextual considerations.

The court is to consider at least the following factors: (1) parties' relative status; (2) extent to which putative indemnitor's activities exposed putative indemnitee to new or different liability; and (3) putative indemnitor's reasonably anticipated benefit under the agreement versus its concomitant potential exposure to liability for indemnitee's conduct. Blanchfill v. Better Builds, 160 Or.App. 527 (1999).

Indemnity agreements in Oregon must be written with very detailed descriptions of what risks are being transferred to the indemnitor.

"Take it or Leave it!"

This is a strong-arm tactic. It is usually adopted by parties prepared to press the advantage of a superior bargaining position. As you negotiate, you must carefully weigh the benefit of accepting terms of a potentially profitable contract, which may ultimately prove financially ruinous. A profitable contract with a "big client," which contains language shifting the risk for unforeseen events onto you may end up being disastrous to you, if the project goes south. Consider the following if you are confronted with a take or leave it situation:

  1. The potential profit in the contract. Be realistic, and recognize the likelihood of unforeseen problems.
  2. Research the track record of the other party. Do they deliver problem‑free projects, are they known for organization, efficiency and problem solving, or for beating up on their subs.
  3. Assume there may be problems on the project.
  4. Analyze the flexibility of your organization to absorb the downside of the project if it goes south.

Limitations on Liability / Clauses Limiting Liability

Many contracts contain limitation of liability provisions which limit the exposure to the value of the contract, i.e., a contract price of $150,000, for the design and construction of a huge municipal project. These provisions in Oregon are problematic.

A limitation of liability clause that has not been negotiated or is not conspicuous in the contract may not afford the contractor the protection it expects.

In 1996, the Oregon Supreme Court held that a limitation clause was not enforceable by an engineer against the homeowners' negligence claim.

The case arose in October 1990, when the plaintiffs were considering purchasing their "dream home," which was built on a hillside. As it turned out, the house had been built on uncompacted fill. Soon after the purchase, the house began to settle significantly, causing extensive cracking and damage to the house. To stabilize the house, the plaintiffs were forced to spend an estimated $340,000 in repairs.

To recoup their damages, the plaintiffs sued their engineer for negligence, negligent misrepresentation, and breach of contract. The engineer defended on the basis of a limitation‑of‑liability clause contained on a single‑page, preprinted contract form that plaintiffs signed. The clause stated: "The liability of MEI and the liability of its employees are limited to the Contract Sum." In the contract, the "Contract Sum" was estimated to be a mere $200.

The Oregon Supreme Court granted review of the case. The court ruled narrowly that the specific language of the clause under the circumstances of the case failed to "clearly and unequivocally" express an intent to limit the engineer's liability for its own negligence. In determining the intent of the clause, the court analyzed both the actual language of the clause and the Plaintiffs' expectations concerning the effect of the clause. The court held the language of a limitation clause must be bold, and specifically identify the fact the clause limits the engineer's own negligence. The effect of the clauses and whether they are enforceable, is certainly not a closed issue.

Conclusion

The above material sets forth general rules regarding indemnity, hold harmless clauses, and limitations of liability. Do not overlook the "boilerplate" because it may have language that will come back to haunt you, and you may end up "buying the farm."


[1] Excerpted from: Indemnification: "How to Identify Unacceptable Risks and Get Them out of Your Agreements," by F. David Shipley and David W. LaKemp.