If your job includes reviewing, drafting or negotiating contracts, you’ve probably seen these provisions. Are they boilerplate that you spend little time on? Do you fully understand exactly what they do? Do you negotiate or revise them?
Allocation of Risk
Fundamentally, the purpose of insurance, indemnification, and limitation clauses is to allocate risks. In general, insurance transfers risk from the contracting parties to a third party—an insurance company. Indemnification usually transfers risk between the parties to the contract. Limitation of liability prevents or limits the transfer of risk between the parties.With those basic concepts in mind, think about the risks that arise out or relate to the contract. Take the time to imagine nightmare scenarios as well as other events that might be less devastating but more likely to occur. Then think about who should bear each of those risks. Do the insurance, indemnification, and limitation of liability provisions allocate the risks appropriately? If not, the parties should consider carefully negotiating to reach agreement on the risk allocation and then drafting or revising the provisions necessary to accomplish their mutual intentions. These issues can be as important as price and other material terms in the contract.
Clear Drafting
As with any contract provision, ambiguity can be bad for both parties. If you’re uncertain how the risk allocation provisions apply to one of the risk scenarios that concerns you, consider adding language that specifically addresses that situation. Make it as clear as you can, and consider not just who should bear the risk but how that should work. Should there be a deadline for one party to notify the other? Should the party bearing the risk be required or even permitted to control the defense of third-party litigation? If insurance covers only part of the problem, what happens to the rest? Whatever your answers to these questions, it may be important to address them specifically in the insurance, indemnification, or limitation of liability provisions of the contract.
Obstacles to Enforcement
The law governing the contract can make a big difference in whether a risk allocation provision will be enforceable. For example, many states have statutes limiting the extent to which a party can be indemnified for its own acts, especially in industries such as construction, transportation, oil and gas, and health care. Some courts also apply those anti-indemnity laws to limitation of liability provisions. States differ on the extent to which the contract between the parties may impact their common law rights and remedies. Insurance coverage may or may not hinge on the language of the insurance requirements in the contract or on the indemnity provision. All of these variables are worth considering.
Understanding Insurance
Contractual insurance requirements often describe the type of policies that one or both parties must carry, and they may even identify some terms and endorsem*nts that must be included. The parties dutifully purchase the specified policies but unfortunately may misunderstand the coverage.For example, Owner hires Contractor to erect a second building on Owner’s site, and their contract requires Owner to be an additional insured under Contractor’s commercial general liability policy. In the course of the project, Owner’s existing first building is damaged. Owner may think that its additional insured status allows it to submit a claim to Contractor’s CGL insurer and get paid for the damage. Probably not. It’s a commercial general liability policy, covering the insured’s liability to third parties. Being an additional insured can allow Owner to be covered against a third party’s claim for injury or damage, such as an injury suffered by a subcontractor’s employee. There may still be an avenue for Owner to have Contractor’s CGL policy pay for the damage to Owner’s property. If the facts support an allegation that the damage was caused by an act or omission of Contractor, Owner can demand or sue Contractor, and then the CGL carrier may pay for Contractor’s liability for damaging Owner’s first building. B
ut that has nothing to do with Owner’s status as an additional insured.If you’re not sure about something in the insurance provision of your contract, talk to coverage counsel or someone else who does. Regardless of which party(ies) must purchase insurance, make sure you understand the requirements and can verify compliance with them.This space is insufficient to address all the complexities or offer tips for drafting insurance, indemnification, and limitation of liability provisions in business contracts. If you take the time to think carefully about these issues, you’re already doing more for your business than someone who considers those provisions to be mere boilerplate not worth the effort.
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FAQs
Commonly, a party's indemnification obligations are carved-out from the limitations of liability – meaning a party has unlimited liability for indemnification obligations.
What is the limitation of liability clause limited to insurance coverage? ›
A limitation of liability is an agreed-upon cap on the amount one party has to pay the other if a loss is suffered due to the contract. The cap will apply regardless of what causes the loss, whether it is a breach, negligence, or some other cause. I like to see it near the indemnity and insurance clauses.
What is the limited liability indemnification clause? ›
The General Partner will not be liable to the Partnership or the Limited Partners for any act or omission by the General Partner pursuant to the authority granted to it by this Agreement, except by reason of willful misconduct, recklessness, or any act in breach of this Agreement.
What is the indemnification clause in an insurance contract? ›
4) Indemnification (also referred to as “hold harmless”) clauses require the other party to a contract to step in and pay for any liability for loss to a third party and to pay for defense costs in the event of a lawsuit over the substance of the agreement. These types of clauses in contracts must be very precise.
What is the difference between limit of indemnity and limit of liability insurance? ›
If your insurer does not add a limit to how much they can indemnify you, they could be held liable for unlimited amounts. A limit of indemnity allows insurers to quantify their maximum exposure by pricing the risk they are undertaking and to gauge their potential risk exposures.
Can you limit liability under an indemnity? ›
You can introduce limits to the scope of an indemnity to apply only to specific situations or types of claims. Consider a software supplier who sells software to a customer. The indemnity in the contract may indemnify the customer against any third-party intellectual property (IP) claims.
What is the difference between indemnity and insurance? ›
Both indemnification and insurance transfer risk and guard against financial losses, but they do so differently: Indemnification transfers risk between contracting parties through a non-insurance agreement. Insurance transfers risk from one party to another in exchange for payment.
What is the indemnification clause for an LLC operating agreement? ›
In the limited liability company (LLC) context, indemnification is an LLC's contractual obligation to reimburse defense expenses. Fee advancement is an LLC's contractual obligation to pay incurred litigation expenses, before the right to indemnification is established.
What's the difference between indemnification and liability? ›
The indemnifying party becomes responsible for a loss only after the indemnified party pays. Liabilities. Liabilities are composed of debts and other legal obligations. The indemnifying party becomes responsible for a liability when the liability is legally imposed, but before the money is paid.
Should I agree to an indemnification clause? ›
The indemnification clause is a crucial element in commercial contracts as it helps mitigate the risks and consequences associated with potential breaches of contracts. This clause also ensures that the parties are fairly compensated for their losses and helps maintain a stable and predictable business relationship.
The Principle of Indemnity
Indemnity is a guarantee to restore the insured to the position he or she was in before the uncertain incident that caused a loss for the insured. The insurer (provider) compensates the insured (policyholder).
What triggers an indemnification clause? ›
Triggering events are specific circ*mstances or occurrences that activate the indemnitor's obligation to indemnify the indemnitee. Triggering events are the catalysts that set the indemnification process in motion. Triggering events can vary based on the nature of the contract and the specific risk involved.
What is the difference between LoL and indemnification? ›
LoL is often used to limit direct financial exposure for various types of breaches. Indemnity is used to allocate responsibility for specific types of losses, including third-party claims. Liquidated Damages address quantifiable damages, often related to time-sensitive performance.
What does indemnification mean? ›
Indemnification is a legal agreement by one party to hold another party blameless – not liable – for potential losses or damages. It is similar to a liability waiver but is usually more specific, applicable only to particular items, circ*mstances, or situations, or in regard to a particular contract.
What does limitation of liability agreement mean? ›
What does Limitation of Liability mean? Limitation of liability means a contractual provision to reduce or exclude the types and amounts of liabilities one party may recover from another party relating to default or non-performance in connection with a contract.
