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Does a typical indemnification clause that requires a party such as a contractor or design professional to indemnify its client for damages the client sustains due to the actions of Indemnitor apply only to damages resulting from third party claims against the client, or does it apply even if there is no third party claim but the client suffers a loss due to the Indemnitor’s actions?  Historically, it was generally understood that indemnification was only to apply to damages resulting from third party claims against the indemnified party.  But several recent cases around the country are concluding that indemnification is broader than that.  They are interpreting contracts to require indemnification for damages and losses the Owner sustains even if there is no third party claim involved.  The decision in Central Brown County Water Authority v. Consoer, Townsend, Envirodyne, 2013 WL 501419 (E.D. Wis. 2013), is a striking example of this.

Central Brown County Water Authority v. Consoer, Townsend, Envirodyne

The Authority filed suit against its engineering firm alleging that various deficiencies in its services caused the Authority to incur costs of having to dig up and investigate pipelines installed by its contractor, and also to incur costs in repairing the contractors work, and other related costs.  The court rejected the engineer’s argument that the damages sought were barred by the language of the contract that provided the engineer would perform in accordance with the generally accepted standard of care, and “If during the two year period following the completion of all Services covered by this Agreement, it is shown that [Engineer] failed to meet those standards [Engineer] shall indemnify [the Authority] from and against any and all damages, loss, or costs if and to the extent arising from [Engineer’s failure to meet generally accepted professional engineering standards….”

Rather than applying the narrow definition of Black’s law dictionary that indemnity is “to reimburse (another) for a loss suffered because of a third party’s or one’s own act of default,” the court cited the broader Webster’s Dictionary that indemnity is “to make compensation to (another) for incurred hurt, loss, or damage.”

Applying what the court said was a general principle of Wisconsin law that indemnity agreements “are liberally construed when they deal with the negligence of the indemnitor,” the court concluded “[Engineer’s] liability is not limited to reimbursement of the Authority for payments it has been required to make to others.  Instead, CTE agreed to pay the Authority for any and all damages, loss, or costs arising out of CTE’s failure to property perform its duties….”

Attorneys fees

Another interesting aspect of the decision is that the Authority demanded that the engineer reimburse the Authority’s attorneys fees incurred suing its construction contractors for faulty work.  The Authority alleged that the work did not comply with the plans and specifications, and that the engineer should have detected and prevented such non-compliance during site observation.

The court dismissed that aspect of the Authority’s claim, holding that to allow recovery upon an allegation of mere negligence would contravene the “American Rule” that holds attorneys fees are to be paid by each party regardless of who wins and loses.

In this case, the Authority did not persuade the court it had established facts sufficient to demonstrate that the litigation costs it incurred in suing the contractors were caused by the engineer’s conduct.  Nor the did the Authority demonstrate that the engineer’s alleged conduct was sufficiently “wrongful” as to constitute a basis for making an exception to the American Rule and thereby allow the Authority to recover its legal fees incurred in pursuing its claims against the contractors.

Sample Indemnification Clause

CommentLimit indemnity to third party claims. When drafting indemnification clauses, a good risk management practice is to very specifically state that the indemnity is only as to damages arising out of third party claims against the indemnitee to the extent caused by the negligent performance of the indemnitor.  An example of a clause I sometimes recommend is the following:

“Consultant shall indemnify and hold harmless the Client, its officers, directors, employees and agents from and against those damages and costs that Client is legally obligated to pay as a result of a third party claim concerning the death or bodily injury to any person or the destruction or damage to any property, to the extent caused by the negligent act, error or omission of the Consultant or anyone for whom the Consultant is legally responsible, subject to any limitations of liability contained in this Agreement.”

Attorneys fees may be excluded from insurance coverage. When it comes to drafting indemnification agreements, carefully consider the significance of this court’s decision, that as a result of the “American Rule,” the Authority had no common law right to recover its attorneys fees from the engineer.

If an indemnification clause states that the indemnitor will indemnify the indemnitee for all damages caused by the indemnitor’s negligence, “including reasonable attorneys fees,” there may be no insurance coverage available under the indemnitor’s policy to pay for those attorneys’ fees.  This is because the only basis for having to pay those attorneys fees would be contractual agreement to do so (such as the indemnity agreement).

The contractual liability exclusion of the policy may be applied to deny coverage for the attorneys fees that the indemnitor incurs on behalf of the indemnitee solely as a result of having agreed to pay the fees pursuant to the indemnification agreement.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 15, No. 7 (July 2013).

Copyright 2013, ConstructionRisk, LLC