Client Alerts

Language Trumps Logic in Indemnification Clauses

Client Alerts | August 10, 2010

A recent decision by New York’s Appellate Division for the First Department, Gotham Partners, L.P. v. High River Limited Partnership, 2010 NY Slip Op. 6149, 2010 N.Y. App. Div. LEXIS 6223 (1st Dept. 2010), confirms that the wording of an indemnification provision must be very specific in order to
afford indemnified parties the full protection for which they logically believe they have bargained. The way these agreements are drafted can have major practical implications.

Enforcing an Indemnification Agreement

Consider the following scenario: You are party to a contract and your counterparty agrees to indemnify you for the counterparty’s breach of the agreement. The indemnification language is typically broad and holds you harmless from any losses, damages, suits, costs, charges, expenses and the like, including reasonable fees and expenses of counsel, as a result of your counterparty’s breach. Your counterparty breaches, and you sue the counterparty for your damages, as well as your counsel’s fees and expenses. What is the result?

Or this one: Your counterparty represents and warrants that the product your counterparty sold you does not violate anyone else’s intellectual property rights, but you get sued by a third party for infringement. Your counterparty denies any obligation to defend, claiming that there was no infringement and therefore no breach of representation or warranty. You defend the third-party claim, spending legal fees to do so, and lose. Your indemnitor declines to make you whole for the judgment due the third party or the legal fees you paid to defend the third-party claim. So you sue your counterparty for both, as well as for your counsel’s fees and expenses in the suit against your counterparty. What is the result?

Although logic would tell you otherwise, in each case the language of the indemnification provision does not cover your fees and expenses of suing your counterparty and enforcing the indemnification. In the first scenario, you may recover the damages resulting from your counterparty’s breach of the agreement ? just the same as if there were no indemnification provision ? but not for your costs, attorneys’ fees and expenses in suing your counterparty to enforce the indemnification. In the second scenario, you may recover from your indemnitor the judgment you paid to the third party and the fees and expenses you incurred in defending the third-party lawsuit ? but again not for your costs, attorneys’ fees and expenses in suing your counterparty to enforce the indemnification.

In order to be indemnified for the attorneys’ fees spent enforcing the agreement with your counterparty, the indemnification provision must make it “unmistakably clear” that those fees are covered. The provision must be “exclusively or unequivocally referable” to claims between the parties themselves. Hooper Assoc., Ltd. v. AGS Computers, Inc., 74 N.Y.2d 487, 481-492 (1989).

If the provision can be read as an indemnification for claims by third parties, it will not suffice to recover the attorneys’ fees incurred in litigating with your counterparty. The intention to award fees to the winner in litigation between the contracting parties themselves must be “virtually inescapable.” Gotham Partners, Slip Op. at 5, App. Div. LEXIS at 11.

Interim Indemnification

Another important practical consideration is interim indemnification. Unless the agreement states that you are entitled to be indemnified as costs are incurred, you may be forced to fund the matter until it is resolved and only then to seek to be indemnified. This arrangement can drastically impact the handling of the matter.

Contracting parties should consult with legal counsel to address the legal and practical issues relating to the language of their indemnification agreements. A relatively small investment in careful planning ? and careful drafting ? ahead of time can avoid a much larger and more costly problem later.