BY MARK COHEN
This article offers practitioners guidance on drafting indemnification provisions in commercial contracts.
This article provides an overview of Colorado law governing indemnification provisions in commercial contracts and offers drafting guidance. Indemnity provisions in insurance contracts are beyond this article's scope, but the article cites cases decided in the insurance context where they provide the best available Colorado authority for a proposition.
The Duty to Indemnify
Lawyers use indemnification provisions to allocate inherent risks in transactions. Put simply, indemnification is the right of a party that is legally liable for a loss (the indemnitee) to shift that liability to another party (the indemnitor).1 The goal is usually to shift responsibility for any damages that occur from the party that is sued to the party that caused the harm. The Colorado Supreme Court has defined an indemnity agreement as "[a]n agreement by one person to hold another person harmless from such loss or damage as may be specified in the agreement."2
Third-Party and First-Party Claims
Indemnity provisions traditionally addressed only claims by third parties (third-party claims).3 However, an indemnity provision may apply to claims between the parties (first-party claims or direct claims) if the provision clearly applies to first-party claims or is written so broadly that a court interprets it that way. This is atypical, and in practice parties often limit indemnification to third-party claims and address liability for first-party claims elsewhere (e.g., the limitation of liability, insurance, and attorney fees provisions).
An indemnity provision should clearly state whether it applies to first-party claims. Poor drafting can cause an unintended result, and this danger is magnified when lawyers cut and paste provisions from other documents. In Hot Rods, LLC v. Northrop Grumman Systems Corp., Northrup sold an environmentally compromised property to Hot Rods.5 The sales contract addressed environmental indemnity by stating:
Seller hereby agrees to indemnify, defend by legal counsel ... and hold the Buyer... harmless from and against any claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses including, without limitation, reasonable environmental consulting fees and reasonable attorney fees arising out of (a) any Environmental Action(s) and/or Remediation involving an environmental condition or liability involving the Real Property caused by an act or omission of Seller . . . .6 (Emphasis added.)
When Hot Rods subsequently sued Northrop for failing to reimburse its losses from remediation activities, Northrup argued it was not responsible because the agreement covered only third-party claims. The court disagreed, holding that the phrase "any claims" was broad enough to encompass first-party claims.
To eliminate ambiguity, drafters should address the issue directly by including language stating the parties' intent; for example, "This indemnity provision applies only to third-party claims."
The Duty to Defend
An indemnity provision may include a duty to defend. A duty to defend, if specified, requires the indemnitor to defend the indemnitee in a legal action. This could be critical because the indemnitee may lack the resources to defend a suit, while the indemnitor may have significant resources. An indemnitee with significant resources sued by a third party may prefer to defend itself and seek reimbursement from the other party for costs and attorney fees after the matter is resolved. Conversely, the indemnitor may prefer to control the defense because the indemnitor will ultimately be liable for any losses the indemnitee suffers.
Although indemnification provisions often include a duty to defend, the duty to defend and the duty to indemnify are separate and distinct.7 Because the duties are distinct, and because the scope of a party's duty to indemnify may not be known until the dispute is resolved, the duty to defend is more easily triggered than the duty to indemnify.8 A party may have a duty to defend, but not a duty to indemnify.9A party's breach of the duty to defend does not preclude it from contesting its alleged duty to indemnify.10
When an indemnification provision includes a duty to defend, in the absence of a contrary provision, the indemnitor's duty to defend includes an implicit right to control the defense.'' This right includes the selection of counsel.12 Courts have applied these rules even when the duty to defend is contained in a commercial contract rather than an insurance contract.13
Although an indemnitor with a duty to defend normally has the right to control the defense, in the absence of a contrary provision, the indemnitor may not have the right to settle third-party claims against the indemnitee without the indemnitee's consent.14 Lawyers drafting indemnity provisions should address this issue to avoid uncertainty. A lawyer representing an indemnitor charged with a duty to defend...