Construction & Public Contract Law Section Blog: Indemnity on Offense:

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  • Construction & Public Contract Law Section Blog
    January
    22
    2021

    Indemnity on Offense

    Matthew R. McClean

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    Most commercial contracts will contain an indemnity clause. But how are they being used? Turns out, you can use them not just for protection. Matthew McClean discusses the various uses of the clause – and case law surrounding its use.

    Indemnity clauses are common in commercial contracts.

    Typically, one party (the indemnitor) agrees to “indemnify, defend, and hold harmless” another party (the indemnitee) from any and all claims or losses, or perhaps certain defined ones.

    In the construction context, such a provision may, for example, provide indemnity protection to an owner for any claims, losses, or damages – including attorneys’ fees – arising out of a contractor’s work.1 At its base level, such language protects owners from exposure arising from a construction project.

    But is the value solely in its protection? The lawyer answer is – it depends!

    Generally, indemnity provisions apply only to third-party claims (the “protection” context), and cannot then be used by the indemnitee to pursue first-party claims.2 Not surprisingly, however, the words used in drafting an indemnity provision matter, potentially expanding the scope.

    Legal Interpretation of Indemnity Provisions – Business Park Dev. Co.

    Wisconsin case law interpreting indemnity clauses – specifically whether an indemnity clause applies to both third-party and first-party claims – is sparse.

    Matthew R. McClean Matthew R. McClean, Marquette 2002, is shareholder at Davis & Kuelthau in Milwaukee, where he serves as the chair of the litigation team and has considerable experience in all aspects of construction law.

    In an unpublished opinion, Business Park Dev. Co., LLC v. Molecular Biology Resources, Inc.,3 the court of appeals analyzed the language of the contract’s indemnification clause to determine whether a lease agreement clearly and unambiguously required the parties to indemnify each other for attorneys’ fees, in the event that one party brought a direct action against another party to the contract. In its analysis, the court pointed to other sections of the contract that discussed payments between the contracting parties, where language such as “pay” or “reimburse” was used.

    The court distinguished this language from the concept of “indemnity” based on the then-current Black’s Law Dictionary definition of indemnify, which provided “payment for a loss necessarily tied to a third-party.”4

    Ultimately, the court concluded that the prevailing plaintiff was not entitled to recover attorneys’ fees from the indemnifying party/defendant under the contract’s terms because the defendant was not a third party.

    Other Wisconsin Case Law

    But other cases help draw distinctions and suggest opportunities for broader indemnity coverage.

    For example, the Western District of Wisconsin distinguished Business Park Dev. Co., LLC finding a contract’s indemnity language to be ambiguous (as to whether it applied to third-party or first-party claims), and leaving the issue to be determined by a jury.

    In AVL Powertrain Engineering, Inc. v. Fairbanks Morse Engine,5 the court noted that the 1999 Black’s Law Dictionary definition of indemnity relied on by the Wisconsin state court in the Business Park decision had since been modified, and that the new Black’s volume more broadly defined indemnity, “to provide for payment to another for damage incurred whether by the fault of the paying party or a third-party.”

    The AVL Powertrain court also found significant that the indemnity clause at issue omitted the term “defend” from the typical clause “indemnify, defend, and hold harmless.” This omission rendered the language distinct from other circumstances where the term “defend” was interpreted to imply third-party claims.6

    Legal Interpretation of Indemnity Provisions – Outside Wisconsin

    In several instances outside of Wisconsin, courts have found indemnification clauses to include first-party claims based on the language of the contract.

    In American National Bank & Trust Company of Chicago v. Regional Transportation Authority,7 the court determined that an indemnification provision concerning “any claim” was sufficiently broad such that the jury could find that the provision was not limited to third-party claims.

    Additionally, in Zalkind v. Ceradyne, Inc.,8 an indemnification agreement was found to include first-party claims, because it stated that the indemnitor “shall indemnify ‘any and all’ damages and losses that arise from any breach of the agreement.”

    The Seventh Circuit interpreted an indemnity clause in Balcor Real Estate Holdings, Inc. v. Walentas-Phoenix Corporation,9 finding that the party’s agreement to indemnify and hold harmless the plaintiff in the event of a default had to include payment of the plaintiff’s attorneys’ fees and costs incurred in seeking collection to truly be a “hold harmless.”

    More compelling and relevant to our construction focus, the Fifth Circuit, applying Mississippi law in a design and construction case, found first-party indemnity based on this language in the party’s agreement:

    The Testing and Inspection Firm [Qore] further agrees to indemnify and hold Wal-Mart free and harmless from any claim, demand, loss, damage, or injury (including Attorneys’ fees) caused by any negligent act or omission by the Testing Inspection Firm, its agents, servants or employees.10

    Wal-Mart brought suit against the design professionals and contractor involved in the construction of a new store in an area with difficult soil conditions. After it opened, the building and parking lot started to stress and fail. The general contractor was found 90 percent at fault, the geotechnical company (Qore) 10 percent, and the civil engineer was deemed to have no fault. Wal-Mart sought 100 percent of its attorney fees from Qore under the indemnity clause above, and the trial court agreed with minor reductions.

    Analyzing the provision, the Fifth Circuit determined that Qore had agreed to “indemnify Wal-Mart, inter alia, for any loss, including attorneys’ fees, caused by Qore’s negligence in performing work under the contract.”

    Because the jury found that Qore was negligent in the performance of its work and that its negligence caused a loss “on the threshold question of whether attorney’s fees were permitted in this first-party dispute we find, like the district court, that the Testing and Inspection contract’s plain language allowed for recovery of attorney’s fees here.”11

    Indemnity as a Sword?

    Utilizing the case analysis, a compelling argument develops that an indemnity provision may be used as a sword and not just a shield.

    Assume that a contractor’s negligent work causes an owner to incur a loss – damages get repaired or a building’s use is lost for some period – and his construction contract contains an indemnity clause. Assume further the clause’s scope is arguable because it provides for the owner to be “held harmless” for “any and all losses, claims … including attorney’s fees … caused by the contractor’s negligent work” and does not include an obligation to “defend.” The owner sues.

    Now consider the legal issues that often arise in a construction case. By agreeing to cover all losses arising from one’s defective work, has the contractor taken on an expanded risk?12 Could such bargained-for language in the contract be precisely the type of provision, contemplated by 1325 N. Van Buren v. T-3 Grp. Ltd.,13 to be a “tailor-made” agreement shifting responsibility for economic losses to the contractor?

    And where a party has a right to first-party indemnity, when does the relevant time bar on the claim expire? If seven years after substantial completion, for instance, the owner incurs a loss, and then seeks recovery and incurs attorneys’ fees doing so, has this indemnity claim only just arisen?14

    Such an interpretation could extend a six-year statute of limitations for contract claims well beyond the normal time window and create a much longer tail of liability than a contractor previously assumed.

    Finally, whereas the American rule traditionally provides that each party pays for their own legal costs and fees to pursue litigation, there is an exception where the parties agree to fee-shifting in a contract.15 An indemnity clause mandating a “hold harmless” creates an argument for recovery of fees,16 whereas an indemnity clause that explicitly provides for the recovery of attorneys’ fees leaves little doubt.

    Under these circumstances, the balance of risks has shifted significantly in the owner’s favor. The scope and length of the claim may be greater, plus the leverage of fee-shifting can be powerful.

    Conclusion: Care Is Needed

    Indemnification clauses should be carefully crafted and reviewed to ensure that they reflect the parties’ agreement and create the intended balance of risk contemplated. Arguing in court whether they do or don’t is unpredictable and dangerous.

    This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section web pages to learn more about the benefits of section membership.

    Endnotes

    1 See, for example, AIA document A201 2007 Sec. 3.18: “To the fullest extent permitted by law the Contractor shall indemnify and hold harmless the Owner … [and] its employees … from and against claims, damages, losses and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work. …”

    2 See Bruner and O’Connor on Construction Law, Vol. 3, Sec. 10.39.

    3 Business Park Dev. Co., LLC v. Molecular Biology Resources, Inc., 2004 WI App 167, 276 Wis.2d 310.

    4 Id. at ¶20 (citing Black’s Law Dictionary, 7th Ed. 1999).

    5 AVL Powertrain Engineering, Inc. v. Fairbanks Morse Engine, 170 F. Supp. 3d 765 (2016).

    6 See AVL Powertrain, citing Travelers Indemnity Co. v. Dammann & Co., 594 F. 3d 238, 255 (3d Cir. 2010).

    7 American National Bank & Trust Company of Chicago v. Regional Transportation Authority, 125 F.3d 420 (7th Cir. 1997).

    8 Zalkind v. Ceradyne, Inc., 194 Cal.App.4th 1010 (2011).

    9 Balcor Real Estate Holdings, Inc. v. Walentas-Phoenix Corporation, 73 F.3d 150 (7th Cir. 1996) (applying Illinois law).

    10 Wal-Mart Stores, Inc. v. Qore, 647 F.3d 237, 243 (5th Cir. 2011).

    11 The case was remanded on the proper amount of the fees, which should have been limited to those incurred due to Qore’s work and not inclusive of the claims against the other defendants.

    12 Under the Economic Loss Doctrine, tort recovery for purely economic losses associated with a contractual relationship are barred. Tietsworth v. Harley Davidson, Inc., 2004 WI 32, ¶23, 270 Wis.2d 146, 677 N.W.2d 233. The Economic Loss Doctrine seeks to protect parties’ freedom to contract. Kaloti Enterprises, Inc. v. Kellogg Sales Company, 2005 WI 111, ¶28, 283 Wis.2d 555, 699 N.W.2d. Cases involving detailed construction contracts, sophisticated and experienced parties, commercial development, participation of counsel and negotiated warranties are “tailor-made for the application of traditional contract law.” 1325 N. Van Buren., 2006 WI 94 at ¶ 28, 293 Wis.2d at 429-430, 761 N.W.2d at 832, citing to Van Lare v. Vogt, Inc., 2004 WI 110, ¶ 21, 274 Wis.2d 631, 683 N.W.2d 46.

    13 1325 N. Van Buren v. T-3 Grp. Ltd., 2006 WI 94, 293 Wis.2d 410, 761 N.W.2d 822.

    14 See Peter v. Sprinkmann Sons Corp., 2015 WI App 17, ¶ 13 (finding the operative date to be the date is not when the plaintiff actually sustained its injury, but rather the date the plaintiff first had a claim).

    15 Borchardt v. Wilk,156 Wis. 2d 420, 456 N.W.2d 653 (Ct. App. 1990).

    16 See Balcor Real Estate Holdings, Inc. 73 F.3d at 153. But also see Hunzinger Const. Co. v. Granite Resources Corp., 196 Wis. 2d 327, 538 N.W.2d 804 (Ct. App. 1995) (finding that a contract must clearly and ambiguously provide for attorneys’ fees).

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