Contract Clues: Leveraging Indemnity to Transfer Contractual Risk

An indemnity clause is a form of contractual risk transfer that shares similarities with the hold harmless provision, but with some crucial differences.

By definition, an indemnity clause is between two or more parties, where one party agrees to cover the other party’s losses. A simple analogy for a contractual indemnity agreement is an insurance policy. Insurers agree to compensate and reimburse losses and damages suffered by policyholders.

Housing organizations can leverage indemnity clauses in contracts to help shift risk to another contractual party. The indemnitor agrees to indemnify (i.e., compensate for harm or loss) the indemnitee, to whom the promise of indemnification is made.

Contract Clue: Indemnity vs. hold harmless

In a hold harmless clause, which we’ve covered in this series, a party assumes liability for certain acts, circumstances, and events as defined in the scope of the contract.

Say your housing organization hires a general contractor to renovate several units. Your organization can negotiate a hold harmless clause in the contract to prevent your organization from being held liable for any injury or property damage resulting from the renovation project.

Meanwhile, an indemnity clause protects one party to a contract from paying for losses related to certain acts, omissions, or occurrences specified in a contract. What an indemnity clause doesn’t do is remove liability. With indemnity, your organization may still be legally liable for a loss, even if it doesn’t have to pay for that loss directly. But liability can certainly harm your organization’s reputation.

In contracts, hold harmless and indemnity clauses are often combined using language like “Party A agrees to hold harmless and indemnify Party B,” similar to the example below.

Contract Clue: Seek indemnity to avoid paying for another party’s negligence

Without a well-executed indemnity clause, your housing organization could end up paying for another party’s negligence.

“[The indemnitee] is not required to put money upfront for a loss or defense of a claim,” said Martin Ween, senior counsel with Wilson Elser. “What you don’t want is to have to front money for a defense and chase after another party for indemnity.”

For example, a housing organization works with a contractor whose negligence results in an injury to a resident. The resident sues the housing organization and the contractor. Without an indemnity clause with the contractor, the housing organization could be required to pay for its defense costs and any losses arising from the contractor’s negligence.

Stephen Brown, a partner with Wilson Elser, said defense costs alone could add up quickly for a housing organization if an indemnity clause isn’t in place.

“Sometimes, the defense of matter can be more expensive than the underlying action at the heart of the matter, especially in construction matters when there could be a dozen or more parties involved,” Brown said.

An indemnity clause written into the housing organization’s contract with the contractor could help avoid this situation. If the contractor is deemed negligent, their indemnification obligations would be triggered, meaning the housing organization wouldn’t be on the hook to pay any damages or defense costs.

Contract Clue: Indemnity isn’t guaranteed, even when written into a contract

Let’s revisit the insurance analogy (why not, we’re an insurance company). If a policyholder files a claim, the payout from the insurer to the policyholder isn’t automatic. The insurer must accept its obligation to indemnify a claim based on the facts of the incident.

In a contractual indemnity clause, the indemnitor must accept its obligation to indemnify for a particular claim. If the contractor in our previous example doesn’t accept their indemnification obligations, arguing that they weren’t negligent, a court or arbitration panel may make the final determination.

Working with your housing organization’s legal counsel is vital to ensure indemnity agreements are written as clearly as possible. Any misinterpretations could lead to legal issues, noted Stephen Brown, a partner with Wilson Elser.

“If the contract is worth the paper it’s written in, [the indemnity agreement] is enumerated and spelled out in its own section, bolded and clear for all parties to see in the contract,” Brown said.

Contract Clue: Seek the broadest form of indemnity

Indemnification isn’t a one-size-fits-all provision in a contract. There are three levels of indemnification: broad form, intermediate form, and limited form.

Broad form indemnification transfers the most risk, as it requires the indemnitor (e.g., a contractor you hired) to cover all losses, regardless of who is deemed negligent.

Intermediate form indemnification requires the indemnitor to cover all costs unless the indemnitee (e.g., your housing organization) is found to be 100 percent negligent. Meanwhile, limited form indemnification requires the indemnitor and indemnitee only to cover the costs for which they’re deemed negligent. For example, if a contractor is 30 percent negligent and a housing organization is 70 percent negligent, the contractor covers 30 percent of costs, while the housing organization covers 70 percent.

Your housing organization likely enters into contracts for products or services, such as lawn mowing or asbestos removal. Ween said that in these situations when your organization is on the receiving end of a contract, indemnity agreements should be “as broad as possible.”

Risk transfer provisions like indemnity and hold harmless agreements should be hammered out between contractual parties during the contract negotiation phase, which we discussed earlier in this series.

Ween and Brown both stressed that indemnity agreements aren’t universally accepted across the U.S. Many states ban broad and intermediate forms of indemnity to prevent corporate abuse of such provisions, so it’s critical to loop in your legal and risk management teams for review before a contract is signed.

Editor’s Note: This is part three of a nine-part series exploring contract best practices from a public and affordable housing perspective. A contract is a legal agreement involving two or more parties who agree to mutual rights and responsibilities. Contracts are necessary to protect your rights when entering into an agreement with another party. A best practice is to seek legal counsel regarding contract questions and recommendations.

Includes copyrighted material from a company under the HAI Group family, with its permission. This post is for informational purposes only and is not intended to provide legal advice, and shall not be relied on as such. We strongly recommend consulting with legal counsel or an appropriate subject matter expert.