Belt and Suspenders or Gordian Knot: Insurance and Indemnity Provisions in Commercial Contracts

1. Belt and Suspenders or Gordian Knot: Insurance and Indemnity Provisions in Commercial Contracts John S. Vishneski III Emily Garrison Reed Smith LLP

2. Themes • An indemnity agreement in a private sales contract is the worst mechanism for allocating losses. • “Off the rack law” (common law and statutory law) and insurance already contain provisions for allocating loss for products claims. • An indemnity agreement should not be entered unless its effect on off-the-rack law and insurance is clearly understood.

3. Our Simple Case

4. What is the worst that could happen?

5. The Baby Extreme Sports Contract • We R’Screws Co. salesperson has just landed a $20 million per year contract for screws with Baby Extreme Sports Company. • The salesperson is going over the contract with a representative for Baby Extreme Sports Company. • And now time for a short skit…

6. Baby Sports Indemnity Provision We R’Screws agrees to defend, indemnify and hold harmless Baby Sports and its agents from and against any and all claims or suits for: (i) bodily injury to all persons whether employees of Baby Sports or otherwise, and (ii) damage to property -- arising out of the Screws, and all other damage, direct or indirect, of whatsoever nature, resulting from Baby Sports’ use, sale or distribution of the Screws, however caused including Baby Sports’ sole or partial negligence. It is expressly agreed that this provision shall survive the performance of this Agreement.

7. Baby Sports Insurance Provision We R’Screws shall obtain and maintain in full force during the performance of this Contract and six months thereafter: (a) Commercial General Liability Insurance endorsed to include products/completed operations, independent contractors, contractual liability (covering We R’Screws indemnity obligations in this contract), broad form property damage and fire liability coverage with a combined single limit of $1,000,000 per occurrence and $2,000,000 in the aggregate. All such policies shall name Baby Sports and its agents as additional insureds. We R’Screws shall furnish a Certificate of Insurance evidencing such coverage.

8. Kitty Hawk Catastrophe • Baby Sports sponsored a toddler hang-gliding demonstration in Kitty Hawk, NC. Over 200 three and four year-olds participated. • After a large gust of wind, toddlers starting falling out of the sky. • Baby Sports and We R’Screws are facing numerous lawsuits.

9. “Off The Rack” Law… …allocates losses based on actual facts.

10. What happens if both are at fault?

11. Michigan: Several Liability • Michigan has abolished joint and several liability in most instances. Michigan tortfeasors are only liable for their percentage of fault. • “Except as provided in section 6304, in an action based on tort or another legal theory seeking damages for personal injury, property damage, or wrongful death, the liability of each defendant for damages is several only and is not joint. However, this section does not abolish an employer’s vicarious liability for an act or omission of the employer’s employee.” M.C.L.A. 600.2956; see also, M.C.L.A. 600.6304 and M.C.L.A. 600.6312. • Michigan provides for contribution where persons are jointly or severally liable. M.C.L.A. 600.2925a.

12. Other Jurisdictions: Joint and Several Liability • California: Joint tortfeasors are jointly and severally liable for economic damages (“objectively verifiable monetary losses”). Joint tortfeasors are severally liable for non-economic damages. Cal. Civ. Code § 1431 and § 1431.2. • Illinois: Defendants are jointly and severally liable for (1) medical expenses and (2) all other damages if the defendant is more than 25% at fault. 735 Ill. Comp. Stat. 5/2-1117. • Texas: Defendant is jointly and severally liable for damages if (1) “the percentage of responsibility attributed to the defendant with respect to a cause of action is greater than 50%” or (2) where the damage was caused by the defendant and another who, acting in concert, engaged in conduct described in certain provisions of the Texas Penal Code. Tex. Civ. Prac. & Rem. Code § 33.013. • New York: A tortfeasor is only jointly liable for non-economic loss if it is more than 50% liable. N.Y. C.P.L.R. 1601.

13. Contribution Law Applies • Generally, if on the actual facts there is a division of fault for a common injury, there is a right of contribution among the tortfeasors. • A tortfeasor may seek the excess it paid from a joint tortfeasor. • No contributing tortfeasor is liable for more than its pro rata share. • Each tortfeasor is responsible for its own attorney’s fees. • Contribution law is generally statutory and there can be differences between states. • See M.C.L.A. 600.2925a; Cal. Civ. Code § 1432; Cal. Civ. Proc. Code § 875; 740 Ill. Comp. Stat. 100/2; Tex. Civ. Prac. & Rem. Code § 33.015 and § 33.015; N.Y. C.P.L.R. 1401; and Miss. Code Ann. § 85-5-7.

14. What happens if the manufacturer is solely at fault?

15. Indemnity Law Applies • Generally, when manufacturer is 100% at fault, distributor has right to recover any judgment or settlement that the distributor paid. • Many states’ indemnity laws require a relationship which would make the indemnitee vicariously, constructively, derivatively or technically liable for the indemnitor’s torts.

16. Indemnity Law Applies • In many states, including Michigan, Illinois, New York, Mississippi and Texas, after the enactment of contribution and comparative fault statutes, common law indemnity was limited to shifting the entire loss from an innocent indemnitee to a negligent indemnitor. Langly v. Harris Corp., 321 N.W.2d 662 (Mich. 1982); Dixon v. Chicago & Northwestern Trans. Co., 601 N.E. 2d 704 (Ill. 1992); Glaser v. M. Fortunoff of Westbury Corp., 524 N.E. 2d 413 (NY 1988); Brewer Const. Co., Inc. v. David Brewer Inc., 940 So.2d 921 (Miss. 2006); EquitableRecovery, L.P. v. Heath Ins. Brokers of Tx. L.P., 235 S.W.3d 376 (Tex. App. 2007). • Some states, including California, continue to recognize a common law partial comparative indemnity doctrine. American Motorcycle Assoc.v.Superior Ct. of Los Angeles Cty., 578 P.2d 899 (Cal. 1978); Stonegate Homeowners Assoc. v. Staben, 50 Cal. Rptr. 3d 709 (Cal. App. 2 Dist. 2006). • Some states have enacted statutes permitting a seller or distributor to seek indemnity from a manufacturer in products liability situations. Miss. Code Ann. Section 11-1-63 and Tex. Civ. Prac. & Rem. Code § 82.002.

17. Indemnity Law Applies • Some states allow the distributor to recover its reasonable attorney’s fees. • Mississippi: Product liability statute requires reimbursement of defense costs if the manufacturer is found liable and the seller must be found innocent. No duty to defend. Miss. Code Ann. Section 11-1-63. • California permits an award of attorney’s fees to an innocent person who has prevailed on a claim for implied indemnity. Cal. Civ. Proc. Code § 1021.6.

18. Contractual Loss Allocation • Indemnity Agreements • Insurance

19. Indemnity Agreements • Manufacturer enters the insurance business • Without training or expertise • Without pooled loss knowledge • Without a clue

20. What do purchasers and distributors ask for in an indemnity agreement? • Coverage without dollar or time limits. • Broad scope of coverage for indemnity (i.e. any loss arising in the course of the use or sale of We R’Screws’ product). • Broad duty to defend (which puts We R’Screws in the business of defending against the purchaser/distributor’s negligence). • Attorney’s fees provision (i.e. attorney’s fees for enforcing the indemnity agreement against We R'Screws).

21. What to do? • Create a company-wide policy: • We R’Screws personnel should avoid indemnity agreements where possible. • When it is necessary to enter an indemnity agreement, We R’Screws should have standard terms to which it will typically agree. • Exceptions to the standard terms should require approval at a high level of management (e.g. Risk Manager).

22. Standard Terms • There should be set dollar limits applicable to the total of defense and indemnity costs. • There should be a time limit on how long the indemnity agreement continues in effect after sales cease (e.g. six months). • Indemnity Agreements should be narrow in scope to cover only the risk about which We R'Screws is knowledgeable – the risk that its product will cause injury or damage.

23. Standard Terms • No broad duty to defend should ever be included. • Indemnity for defense costs can be included but must be a duty to pay defense costs only if the actual facts demonstrate We R'Screws’ product was at fault. • This should be a duty to reimburse – not to advance defense costs. • The indemnity should not be triggered unless and until all other available insurance has been exhausted or held inapplicable by a court.

24. We R’Screws Proposed Indemnity We R’Screws agrees to indemnify [Purchaser] for sums [Purchaser] becomes legally obligated to pay as damages for bodily injury or properly damage caused by “We R’Screws’ fault.” “We R’Screws’ fault” means: a manufacturing defect, design defect or negligent failure to warn with respect to products designed by We R’Screws and supplied to [Purchaser] by We R’Screws. We R’Screws further agrees to indemnify [Purchaser] for reasonable legal expenses it incurs defending itself against any suits seeking such damages. We R’Screws shall have no obligation to indemnify [Purchaser] for any damages caused by [Purchaser’s] fault or for any legal expenses incurred by [Purchasers] in defending itself against suits seeking damages caused by [Purchaser’s] fault. This provision is limited to $1,000,000 for both damages and defense costs for all claims. This provision expires 6 months after the termination of this contract or last sale of We R’Screws’ products pursuant to this contract whichever is earlier.

25. How Can We R’Screws Enact and Enforce Standard Terms? • In order to be fully embraced by the entire company, the Standard Terms must be supported by top management. • Gatekeepers of the Standard Terms must be Legal Department in conjunction with Risk Management. • Any deviation from the Guiding Principles must be signed off on by a Risk Manager.

26. What if We R’Screws is a Small Player: Unequal Bargaining Power

27. Unequal Bargaining Power • We R’Screws is unlikely to get its proposed indemnity • We R’Screws will have to determine whether the contract is valuable enough to undertake the risk • We R’Screws may be able to negotiate a slightly less onerous provision

28. Revised Indemnity We R’Screws agrees to indemnify and hold harmless Baby Sports and its agents from and against any and all claims or suits for: (i) bodily injury to all persons whether employees of Baby Sports or otherwise, and (ii) damage to property – arising out of the Screws, and all other damage, direct or indirect, of whatsoever nature, resulting from Baby Sports’ use of the Screws, however caused. It is expressly agreed that this provision shall survive the performance of this agreement. We R’Screws agrees to defend Baby Sports for any claim, suit or loss allegedly attributable to bodily injury or damage to property, arising out of Baby Sports’ use of the Screws, even if Baby Sports is partly at fault for such bodily injury or property damage.

29. Equal Bargaining Power

30. Reciprocal Indemnity Provision • (a) We R’Screws agrees to indemnify Baby Sports for sums Baby Sports becomes legally obligated to pay as damages for bodily injury or properly damage caused by solely by “We R’Screws’ negligence.” “We R’Screws’ negligence” means: a manufacturing defect, design defect or negligent failure to warn with respect to products designed by We R’Screws and supplied to Baby Sports by We R’Screws. We R’Screws further agrees to indemnify Baby Sports for reasonable legal expenses it incurs defending itself against any suits seeking such damages. We R’Screws shall have no obligation to indemnify Baby Sports for any damages caused by Baby Sports’ fault or for any legal expenses incurred by Baby Sports in defending itself against suits seeking damages caused by Baby Sports’ fault. We R’Screws shall also have no duty to indemnify Baby Sports, if its product is changed or altered in any way.

31. Reciprocal Indemnity Provision • (b) Baby Sports agrees to indemnify We R’Screws for sums We R’Screws becomes legally obligated to pay as damages for bodily injury or properly damage caused by solely by “Baby Sports’ negligence.” “Baby Sports’ negligence” means: any negligence by Baby Sports in the distribution, sale or use of We R’Screws’ products, including failure to warn and any change or alteration to We R’Screws’ product by Baby Sports. Baby Sports further agrees to indemnify We R’Screws for reasonable legal expenses it incurs defending itself against any suits seeking such damages. Baby Sports shall have no obligation to indemnify We R’Screws for any damages caused by We R’Screws’ fault or for any legal expenses incurred by We R’Screws in defending itself against suits seeking damages caused by We R’Screws fault.

32. Reciprocal Indemnity Provision • EFFECT OF PROVISIONS • Under the reciprocal indemnity, neither party indemnifies the other unless the suit is based on the sole negligence of one party for specific acts • Additionally, neither party has a duty to defend the other – at most each party must pay the other’s reasonable defense costs if a suit is based on its sole negligence

33. Insurance

34. Insurance provides a duty to defend based on allegations – not actual facts. • Under the off-the-rack law, a manufacturer should never have to defend a purchaser or distributor on the basis of allegations alone. • However, if the manufacturer’s insurer covers the purchaser or distributor, it may provide a defense based on allegations alone.

35. Provision of a duty to defend based on allegations is a bold risk to accept. • For example, the manufacturer’s policy may only cover the purchaser or distributor for its liability arising from a defect in the manufacturer’s product. • But, if the injured party alleges that the purchaser or distributor is liable both because the product was defective and because of the distributor’s negligence, the insurer has to defend the entire suit. • This means the insurer may sometimes be required to defend the purchaser/distributor for claims arising from its own negligence.

36. Provision of a duty to defend based on allegations is a bold risk to accept. • Provision of such a broad duty to defend is bold because the manufacturer’s insurer has no way to investigate the distributor’s bad habits. • Insurers can be this bold because they are professional risk takers and have pooled industry knowledge that helps assess such risks.

37. What insurance provisions do purchasers or distributors ask for?

38. Purchasers/Distributors Want First Dollar Coverage. • $1Million to $3 Million in indemnity limits. • Broad duty to defend with no limits.

39. They may ask for a “Vendors Endorsement.” • A vendors endorsement typically covers a purchaser or distributor (the vendor) for liability arising from its sale of the manufacturer’s products in the ordinary course of its business. • Exclusions make it clear that the coverage extends only to matters in which the vendor has not contributed to the injury or damage independently.

40. They may want to be made an “Additional Insured”… • Some distributors will ask to be named directly in the manufacturer’s policy as an “additional insured.” • This is broader coverage than the vendor’s endorsement because it makes the distributor an “insured” for all coverage provided by the policy – not just the narrow vendors coverage.

41. …or to be made a “Named Insured” • Insurers distinguish between “named insureds” and “insureds” (such as “additional insureds”). • “Named Insureds” get the broadest coverage under the policy, but also have more responsibility than “insureds.” • For example, many insurers require the “named insured” to give prompt notice of an accident or occurrence, but they do not require an “insured” to do so.

42. Purchasers may ask for Contractual Liability Coverage. • A purchaser/distributor may request a manufacturer to demonstrate that it has insurance to back any indemnity agreement the manufacturer signs. • Contractual liability coverage parallels the scope of any separate indemnity agreement. • Hence, contractual liability coverage may be broader or narrower than coverage provided by a vendors endorsement.

43. Proof of Insurance Coverage: Certificates of Insurance • Insurance Provisions often provide that a Certificate of Insurance will be furnished. • ACORD Standard Certificate of Insurance Forms, however, contain the following disclaimer: • “[t]his certificate is issued as a matter of information only and confers no rights upon the certificate holder. This certificate does not affirmatively or negatively amend, extend or alter the coverage afforded by the policies below” • Courts will enforce this disclaimer language. • Moral: As distributor/vendor, do not rely solely on Certificates of Insurance as proof of insurance.

44. Proof of Insurance Coverage: Conflicting Perspectives • Distributor: Given that a Certificate of Insurance is not sufficient proof of insurance, distributor will want certified copies of policies, and will want language in insurance provision requiring manufacturer to provide such copies. • Manufacturer: As provider, it could be an administrative nightmare to produce certified copies of insurance policies to every vendor/ distributor. Manufacturers may also want to avoid distributing insurance policies for privacy reasons.

45. Proof of Insurance Coverage: A Compromise • The following language can be used to satisfy both parties: • All such policies shall name Baby Sports and its agents as additional insureds. We R’Screws shall furnish to Baby Sports a Certificate of Insurance evidencing such coverage and shall continue to provide Baby Sports with subsequent Certificates of Insurance evidencing uninterrupted compliance with this insurance requirement until six months after termination of this Contract. We R’Screws shall provide Baby Sports with certified copies of the policies required herein upon Baby Sport’s request.

46. “Notice” Language in Certificates of Insurance • The “notice” language in ACORD Standard forms was recently changed to state: • “[s]hould any of the above described policies be cancelled before the expiration date thereof, notice will be delivered in accordance with policy provisions.” • Previous “notice” language provided for a “good faith” attempt by the insurer to “endeavor” to notify a certificate holder of cancellation of a relevant insurance policy • Moral: Do not rely on insurer to provide notice of cancellation if policies do not require notice.

47. Change in “Notice” Language: Implications • As a manufacturer, if your contracts require notice of policy cancellation, you cannot rely on insurer to give such notice. • A smart distributor/vendor will require that insurance policy provides that insurer will give 30 days notice of cancellation, and that contracts reflect such agreement. For example: • All such policies shall name Baby Sports and its agents as additional insureds. Each policy shall provide that it may not be cancelled or changed without at least thirty (30) days prior written notice to Baby Sports. We R’Screws shall furnish to Baby Sports a Certificate of Insurance evidencing such coverage and shall continue to provide Baby Sports with subsequent Certificates of Insurance evidencing uninterrupted compliance with this insurance requirement until six months after termination of this Contract. We R’Screws shall provide Baby Sports with certified copies of the policies required herein upon Baby Sport’s request.

48. But What About The Purchaser’s/ Distributor’s Own Insurance? • Most purchasers and distributors will have their own products liability coverage. • Since the purchaser and distributor will almost always be a “named insured” under its own policy, it will have very broad coverage – typically including coverage for products it sells and for its own negligence. • The purchaser or distributor’s insurer usually will also have a broad duty to defend the entire suit even if only some allegations are covered.

49. So whose insurer pays first – the manufacturer’s or the purchaser/distributor’s? • It depends. • Almost all insurance policies have “other insurance” clauses. • Sometimes these clauses are compatible and determine who pays first. • But sometimes they conflict. (For example, both policies cannot be excess to all other policies.) • When other insurance clauses conflict, courts determine allocation. For example, one rule might be allocation in proportion to limits.

50. But which applies first – the insurance or the indemnity agreement? • The insurance policy won’t provide the answer. • Typically, the indemnity agreement itself won’t address the question – but it should. • There may be no clear answer.