Professional liability insurance for architects and engineers.

Negotiating Indemnity Provisions

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By on Jan 1, 2014 in All Topics, Contracts, Newsletters |

Professional Liability insurance companies have long highlighted the risks to design professionals regarding language in the indemnity provision requiring the design professional to defend the client and have stressed the importance of ensuring the provision is negligence-based. The indemnity obligation should be limited “to the extent damages are caused by the design professional’s negligence.”

Now more than ever, clients are requesting design professionals to agree to overly broad indemnity obligations and are refusing to modify these provisions. Clients are emboldened by the current economy and more inclined to have a “take it or leave it” attitude when it comes to contract negotiations. Nevertheless, it is important for design professionals to maintain diligent risk management practices to ensure their professional services agreements are acceptable (or, at a minimum, to fully understand the risks associated with onerously drafted provisions).

This article addresses the following issues faced by design professionals:

  • Indemnifying the client for “breach of contract”
  • Indemnifying the client for “recklessness, wrongful acts, intentional misconduct, willful misconduct and gross negligence” and
  • Limiting the definition of “Indemnitees” (i.e., the parties the design professional will agree to indemnify) to the client, the client’s employees, officers, and directors.

Indemnifying for Breach of Contract
These days, clients are including “breach of contract” among the laundry list of circumstances under which the design professional is required to contractually assume a duty to indemnify.

From a risk management and professional liability standpoint, language requiring the design professional to indemnify for its breach of contract creates a significant additional exposure. Arguably, most third-party claims will arise out of a performance-based issue by the design professional and will boil down to assertions that because the design professional breached the contract, the design professional failed to meet the applicable standard of care and was negligent, thus triggering the professional liability insurance policy. Further, from a business standpoint, asserting during contract negotiations that the design professional has no obligation to indemnify the client if it breaches (or certainly if it “materially breaches”) its contract may not pass the “laugh test” and a design professional will be hard pressed to convince the client that it has no indemnity obligation to the client under a breach of contract scenario.
That being said, if a breach of contract claim does not arise out of the design professional’s performance, the design professional’s contractual obligation to indemnify the client for breach of contract may be beyond the coverage provided by a negligence-based professional liability insurance policy.

Indemnifying for Intent-Based Actions
It is critically important to ensure the indemnity provision is negligence-based. If the indemnity provision is not negligence-based, the design professional may be exposed to liability beyond that for which it is insured. Including language requiring the design professional to indemnify for its “recklessness, wrongful acts, intentional misconduct, willful misconduct and gross negligence” (or some combination thereof) potentially exposes a design professional to a liability beyond that for which it is insured.

These words are problematic because they have an element of intent and are not negligence-based. Including language requiring the design professional to indemnify for its “gross negligence” may be particularly troublesome since “negligence” is referenced, but keep in mind that Black’s Law Dictionary defines “gross negligence” as the “intentional failure to perform” a duty, thus clearly establishing an element of intent which is beyond coverage contemplated by professional liability insurance.

Limiting the Definition of “Indemnitees”
It is prudent for design professionals to limit the indemnified parties to the design professional’s client, and the client’s employees, officers, and directors. We typically delete broad and undefined terms such as the client’s “agents”; “attorneys”; “insurers”; “parent company”; “subsidiaries”; “related and affiliated companies”; “assigns”; “lenders”; “contractors”; and “subcontractors” from the “Indemnitees” definition since it may be impossible to determine with any degree of certainty who would fall into those categories at the time of contract negotiations.

Jurisdictions vary in their interpretation of whether a design professional owes a duty of care to another party with whom the design professional has no contract, based in large part on the application of the economic loss doctrine, which is why design professionals commonly seek to negotiate language in the agreement expressly stating there are no third party beneficiaries. In addition to negotiating a “No Third Party Beneficiaries” provision, design professionals commonly seek to delete third parties (such as the client’s contractors, consultants, lenders, insurers, attorneys, etc.) from the “Indemnitees” definition in any indemnity provision. These third parties are not directly part of the client entity and the design professional does not (and should not) owe them the same duties it owes its client with whom the design professional has a contract. In the event any of these third parties are damaged by the design professional (including damages caused by the design professional’s negligence) they can seek remedies to the extent any remedies are available at law.

By specifically including third parties in the “Indemnitees” definition, these parties may establish a third-party beneficiary status, at least with respect to the indemnity provision. In fact, lately we have seen “Third Party Beneficiaries” provisions in agreements that have language along the lines of, “Except with respect to the indemnity obligations, there are no third party beneficiaries to this agreement.” By including the third parties in the “Indemnitees” definition in the indemnity provision, combined with the Third Party Beneficiary language as noted above, any protections afforded under the economic loss doctrine may be lost and the design professional could owe these parties an indemnity obligation.

In the event the design professional is called upon to indemnify these third parties, there may be a coverage issue with the design professional’s professional liability insurance because, absent the contract language, there may be no obligation for the design professional to indemnify those parties.

This article was originally prepared by Colleen Palmer with Beazley Insurance. This article first appeared in the Beazley A&E Reporter. The opinions of the authors are solely those of the authors. The Beazley A&E Reporter is published and distributed by Beazley Group with the understanding that neither it nor the editors or authors is responsible for inaccurate information. The information set forth in the Beazley A&E Reporter should not be construed nor relied upon as legal advice and is not intended as a substitute for consultation with counsel.