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Case Study on Indemnification
Most
outsourcing contracts include indemnification provisions. In
drafting such provisions, as well as in following the procedures to make a claim
for indemnification, the party who is likely to make the claim for
indemnification (as "indemnitee") should learn the lessons of others.
What is
Indemnification? In general, indemnification is the
contractual obligation of a party to "hold harmless" another party
from losses that are described in the contract.
Enforceability.
To be enforceable, the indemnification must be sufficiently clear as to its
scope and nature.
Procedures.
Where the indemnification clause fails to specify the procedure for being
invoked, a well-drafted indemnification clause will contain some provisions
relating to the procedures. But, even without a specifically defined
procedure, common law will require, at a minimum, certain procedures in order to
avoid unfairness to the indemnitor.
What
Procedures Must be Followed to Obtain Indemnification. In
general, an indemnitee must follow certain basic procedures in asserting a claim
to get paid for indemnified losses.
Nature of
Indemnitee's Notice to the Indemnitor. The type of notice that an
indemnitee must give is simple.
Where the
indemnitor is subject to an express duty to defend against the claim or the
anticipated loss, the indemnitee's notice must be "sufficient to give the
indemnitor a meaningful opportunity to defend" against the loss, or the
notice must show that the indemnitor is actually liable to pay the indemnity..
Atlantic Richfield Co. v. Interstate Oil Transport Co., 784 F. 2d 106
(113) (2d Cir. 1986). And the indemnitee must not make a
separate settlement with the claimant and then seek to recover under the
indemnification, since a separate settlement would deprive the indemnitor of the
right to defend and defeat the claim without any liability for settlement
payments.
Indemnitee's
Duty of Good Faith. To give effect to this notification
requirement, the indemnitee must exercise good faith in responding in sufficient
detail to the indemnitor's request for an explanation of the claim.
Example: In
transferring a factory from one owner to another upon termination of a joint
venture, the buyer asked local governmental officials for a permit to close a
waste treatment facility that the seller had managed. But the buyer
did not notify local officials it requested such a permit in order to close a
waste treatment facility that the buyer knew was violating local law.
So when the seller asked for more details, the buyer refused to give access to
its tech
Indemnification
Problems involving Joint and Several Liability. Indemnification
by a service provider is not a clear-cut privilege for the customer when the
customer's own activities make it jointly liable to third parties.
Similarly, if the service provider is at fault to a third party and the customer
shares in some or all of the fault, indemnification might not be appropriate.
Indemnification
for Violation of Law. When a service provider manages a
facility, it frequently agrees that its services will not result in a violation
of applicable law relating to the operations.
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What Types
of Authority Is Competent to Declare "Indemnified" Violations Have
Occurred? Normally, any violation of law should be covered
if it is within the service provider's control. In defining such
potential violations of law, the parties should identify whether the scope
includes any foreign or domestic law, whether the law is embodied in a
statute or other form of legislative or administrative authority, and
whether it includes judicial acts, writs, orders, judgments and decrees, as
well as pre-trial procedures such as discovery, subpoenas and other interim
or procedural measures.
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Pre-existing
Violations. If a service provider takes over an existing
facility or business process, the parties need to allocate indemnifications
for violations before, during and after the service provider takes such
control.
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Specific
Acts. Certain indemnities cover any non-compliance with a type of
law. Others specify the acts of either indemnitor or indemnitee that
are indemnified like, for example, "storing or disposing of" a
substance, data or the other item.
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Due
Diligence. The indemnitee (the customer) is expected to
exercise a modicum of due diligence concerning the history of any prior
legal violations pertaining to the premises under the indemnitor's (service
provider's) management. The indemnitee (customer) has no excuse
if it fails to make any attempt to ascertain any information regarding the
existence, or not, of any governmental permits that would have exonerated
the indemnitor (service provider). See Rutgerswerke AG v.
Abex Corp., ____ NYS2d ____, NYLJ June 26, 2002, p. 26, col. 4 (SDNY
2002).
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Timeliness
of Due Diligence. The indemnitee cannot wait an
unreasonably long time to begin investigation of the relevant facts after
making its demand for indemnification. In a case involving
environmental violations, a delay of 18 months before the indemnitee hired
an attorney for investigation was an element of proof of the indemnitee's
bad faith and failure to comply with even the most minimal efforts to
support and protect the indemnitor's rights to defend against liability as a
violator of local laws.
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Timeliness
of Minimally Supportive Activities against Governmental Claims.
The indemnitee cannot wait indefinitely, when a governmental violation
notice is anticipated or has been received, before taking reasonable action
to protect the indemnitor's interests. If the indemnitee waits
two years to notify the indemnitor of the alleged statutory violation, at
the very least the indemnitee should take steps to oppose the governmental
assertion of the violation. In the Rutgerswerke case, the
indemnitee did the opposite: it assisted the government in drafting the
order that declared the violation of the statute and it failed to contest
the governmental sanction. The indemnittee tried to create the
"violation of law" so that it could create an indemnity claim.
The Rutgerswerke court found that this type of bad faith would not
support a claim for indemnification.
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Regulatory
Estoppel. Under the doctrine of regulatory estoppel, a party that
signs a statement submitted to a government cannot allege facts contrary to
the facts set forth in that statement. See Rutgerswerke case.
So if a customer had certified a fact to a government official, it cannot
later argue that the service provider owes a duty to indemnify for liability
arising from any situation that is contradicted in the customer's prior
regulatory filings. This doctrine is applied only in extremely
narrow cases, where the statements were submitted to government in an
administrative or regulatory proceeding analogous to a judicial proceeding,
and the statements were under oath.
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Spoliation
of Evidence. Testimony of a party's witnesses may be denied
in cases where the party intentionally destroyed documents that might be
contrary to the witnesses' testimony, and the other party would be severely
prejudiced. For example, if the customer had records of the
service provider's performance that measured the service level requirements,
and the customer destroyed those records and instead relied on testimony of
witnesses, the service provider would be unable to use the destroyed records
as an admission of the customer. Where the service provider can
show inferential evidence of the contents of the destroyed documents (such
as from other documents that were drafts or analogous), the court will
probably sanction the customer by depriving it of the testimony of the
witnesses due to the customer's spoliation of evidence. In a digital
world of innumerable archival copies of corporate records, this doctrine
should be moribund.
Duty to
Defend. Under a contractual duty to defend, the
indemnitor (or insurer) has a duty to defend teh claims as measured by the
allegations of the pleadings, but the duty to pay is measured against the actual
loss. Hugo Boss
Duty to Pay the
Loss.
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