In the last article we discussed how indemnification clauses in contracts seek to protect one party from damages caused by another party. This picks up where the last one left off. Indemnification is basically a fancy wordy for reimbursement.
For instance, Party A Retailer sells a product made by Party B Manufacturer, that blows up in the face of Consumer C. C sues A & B. What happens if Party B Manufacturer “indemnified” Party A Retailer in the contract? Well, “indemnification” usually means the indemnifying party is covering (reimbursing) the losses of the indemnified party.
So Party B Manufacturer is indemnifying Party A Retailer. If Consumer C wins $1M from each party for a total of $2M, then Party B Manufacturer should pay $2M (one million for themselves and one million for Party A Retailer).
But it’s not always that simple. Last time we talked about legal fees of Party A, and if they are covered. Today, let’s talk about other ways you can get … an unpleasant result, depending on how your indemnification contract is drafted.
Disclaimer: The following information does NOT constitute legal advice and is only for general educational purposes. Each situation is different and specific legal issues usually require additional research and investigation, so do not rely on this article to address a particular legal issue; use this as a starting point to gain a general understanding.
Most indemnification clauses will have lots of qualifying language. Sort of, “Party B indemnifies Party A, from any negligent conduct by Party B that results in a loss to Party A.
What is negligence? Usually it is defined as some form of “reasonable” care that a person “ordinarily” would show when doing whatever it is they are doing. A legal claim for Negligence has four elements: (1) Duty (2) Breach (3) Cause (4) Harm. The party held liable must have a Duty, must have Breached that Duty, *that specific breach* must have Caused the Harm that to the injured party. The case law on each of these elements varies industry to industry, and can fill several books a piece.
For instance, the Manufacturer may have had a duty to use good materials so that their pressure cooker did not explode, and if they breached that duty, did their use of poor materials cause the explosion? If not, they might not be negligent. Finally, did the explosion actually cause the harm to Consumer C? If not then again, no negligence. No negligence, no indemnification to Retailer.
If the Manufacturer can show it was not negligent then it probably does not have to indemnify Retailer Party A! Did you see this? *If* Manufacturer didn’t do anything wrong, Party A might have to cover its own million dollars to Consumer A. Even though Manufacturer made the product that exploded.
Actually, it’s far worse than that. If Manufacturer Party B were to refuse to indemnify Retailer A, guess what? The Retailer then has to prove that the Manufacturer was negligent. That’s a big deal. A very big deal. Depending on the parties involved this could cost $10,000, $100,000 or several millions of dollars in legal fees. No kidding.
So, the point is, although the indemnification clause above is not only reasonable and standard across the board, but it is not nearly the type of protection Party A believes it to be. A lot of it depends on the goodwill of the Party B. Obviously, if Party B is clearly negligent, eventually if Party A sues Party B for indemnification coverage, Party B will have to cover Party A; however, Party A will be out the legal fees to sue Party B. I would bet the parties will settle out of court, likely for much less than for which Party A originally was entitled.
So are indemnification clauses worth it? Yes. However, people imagine they will get the full bargain of everything they have down in a contract. Practically speaking this does not always work out.
5. Gross Negligence
Then there’s the gross negligence standard. In New York, “Gross Negligence” usually means reckless indifference to the rights of others. This is a way higher standard than negligence, which means it’s even harder to prove. Much harder. So, if the indemnification clause in your contract says that, if you are the one expecting to be reimbursed for your losses, don’t be too hopeful. An example of gross negligence would be using materials generally known to be unstable and that may or may not suffice to protect someone. The nice thing about this is if you do win on these grounds, courts might also apply punitive damages (more than you were hoping to get) in such case because the conduct of the grossly negligent party is so egregious.
6. Willful Misconduct
Willful misconduct essentially means someone has purposefully failed to act or acted in a way they know probably will result in injury or damage. For instance, purposely using materials in the pressure cooker that they *know* will explode upon use in a normal way. Court often will apply punitive damages in such situations as well. Willful misconduct can also mean when someone just does something criminal or wrong, such as setting fire to their own building on purpose.
With respect to indemnification provisions that are dependent on the negligence of the person reimbursing another party, some form of negligence is usually standard in such contracts. Depending on the negotiation power of the parties, this need not always be true , so that the party expecting potential reimbursement might demand the right to indemnification whether or not there was negligence on the party of the reimbursing party. If there is a standard of negligence, it’s easier to prove negligence as opposed to gross negligence. If gross negligence is proved the party seeking reimbursement might recover additional punitive damages.
Do you have the right to be reimbursed for your losses caused by the other party? How strong is your contract to guarantee your rights? In every relationship you have with a merchant, a manufacturer, a software developers, a client, these are good things to figure out.