Indemnification Clause Disputes: Who Pays When Something Goes Wrong?

What an indemnity clause does, and the three duties inside it

An indemnity clause is a promise by one party (the indemnitor) to bear a loss that the other party (the indemnitee) would otherwise carry. In commercial contracts it most often covers claims brought by third parties: a customer injured by a product, a subcontractor's employee hurt on site, a licensee sued for infringement. The clause may contain up to three separate duties, and a dispute often turns on which one is in play.

• Duty to defend. An obligation to pay for, or take over, the defense of a claim as soon as it is asserted. In contracts that include it, the duty to defend is usually triggered by the allegations in the claim, before anyone knows whether they are true.
• Duty to indemnify. An obligation to pay the loss itself: a judgment, a settlement, and often the fees and costs of defense. It is usually decided by the facts actually established, not by the allegations.
• Hold harmless. Language that the indemnitor will not hold the indemnitee responsible for the covered loss; Texas courts generally read it alongside the indemnity promise.

The first fight is almost always about scope

Indemnity clauses are read like any other contract term, by their words, and the words that cause disputes are predictable.

• The trigger. "Arising out of" the indemnitor's work is broad and usually requires only a causal connection; "caused by" the indemnitor's negligence is narrow and requires fault; "to the extent caused by" divides the loss in proportion to fault. Which phrase the parties used decides most cases.
• Who is covered. The indemnitee's officers, employees, affiliates and agents are covered only if the clause names them.
• What losses are covered. Judgments and settlements usually; attorney's fees and defense costs only if stated; the indemnitee's own first-party losses only if the clause clearly reaches them, since Texas courts tend to read indemnity as directed at third-party claims unless the language says otherwise.
• Settlements. Many clauses require the indemnitor's consent before a settlement is binding on it, and an indemnitee that settles without consent may have to prove the settlement was reasonable and that it was actually liable.

Indemnity for the other party's own negligence: the fair notice rules

Texas treats one kind of indemnity with suspicion: a promise to pay for losses caused by the indemnitee's own negligence. Two Texas Supreme Court decisions set the rules. In Ethyl Corp. v. Daniel Construction Co. in 1987 the court adopted the express negligence doctrine: a party that wants indemnity for the consequences of its own negligence must say so in specific terms within the four corners of the contract. General language such as "any and all claims" is not enough, however broad. In Dresser Industries v. Page Petroleum in 1993 the court added the conspicuousness requirement and confirmed that the two together form the fair notice test: the clause must be written so that a reasonable person would notice it, through placement, headings, type size, capitals or contrasting print, and the intent to cover the indemnitee's negligence must be stated expressly. Whether a clause meets fair notice is a question of law for the court.

The consequence of failing the test is not that the whole clause falls. The clause simply does not reach the indemnitee's own negligence. It still covers losses caused by the indemnitor and losses the clause otherwise describes. Fair notice is also excused where the indemnitor had actual knowledge of the clause, though that exception is narrow and the burden is on the party invoking it. The same fair notice rules govern releases of future negligence, covered in limitation of liability clauses in Texas.

Construction contracts: the anti-indemnity statute

For construction, the Legislature went further. Insurance Code chapter 151, which applies to construction contracts for commercial and public projects, makes void and unenforceable, as against public policy, any provision that requires an indemnitor to indemnify, hold harmless or defend a party against a claim caused by the negligence or fault, the statutory or regulatory violation, or the breach of contract of the indemnitee or its agents, employees or others under its control. Section 151.102 states the rule; a conspicuous, express clause does not save it, because the problem is no longer notice but policy.

The statute has exceptions and exclusions that matter in practice:

• Section 151.103 preserves indemnity for claims for the bodily injury or death of the indemnitor's own employees or the employees of its subcontractors of any tier, so a subcontractor may still agree to indemnify the general contractor for a claim by the subcontractor's injured worker, even if the general contractor was negligent.
• Section 151.104 applies the same limit to additional insured requirements, so a contractor cannot be required to buy insurance covering the indemnitee's own negligence beyond what the statute allows.
• Section 151.105 excludes, among other things, indemnity provisions relating to a single-family house, townhouse, duplex or related land development, public works projects of a municipality, agreements subject to the oilfield anti-indemnity rules in Civil Practice and Remedies Code chapter 127, surety indemnity agreements, and joint defense agreements entered after a claim is made.

A construction indemnity dispute therefore starts with a different question than a commercial one: not whether the clause is conspicuous, but whether the loss was caused by the indemnitee's own fault at all. Construction payment and defect disputes more broadly are covered on the construction litigation page.

Example

Suppose a Dallas general contractor subcontracts the electrical work on an office building. The subcontract says the electrical subcontractor will "indemnify, defend and hold harmless the Contractor from any and all claims arising out of or related to the Subcontractor's work, including claims caused in whole or in part by the negligence of the Contractor," in bold capitals in its own numbered section. A visiting consultant is injured when a ceiling panel installed by the general contractor's own crew falls near the electrical work, and he sues both. The general contractor tenders the claim to the subcontractor. Under the fair notice rules the clause would have reached the general contractor's own negligence: it is express and conspicuous. But this is a construction contract under Insurance Code chapter 151, and to the extent the claim was caused by the general contractor's own negligence, the indemnity and defense obligation is void. The subcontractor remains liable to indemnify to the extent the claim arose from its own work. Had the injured person been the subcontractor's own electrician, section 151.103 would have allowed the clause to operate as written.

Notice, tender and timing

Most clauses require the indemnitee to give prompt written notice of a claim and to tender its defense. Late notice does not automatically forfeit indemnity in Texas, but it gives the indemnitor an argument that it was prejudiced, and a contract that makes timely notice a condition will be enforced that way. Tender should be in writing, should attach the claim, and should state what is demanded: defense, indemnity or both.

Timing also affects limitations. A claim for indemnity generally accrues when the indemnitee's liability becomes fixed, by judgment or settlement, not when the underlying incident occurred, and a claim for breach of a duty to defend accrues when the defense is refused. These are contract claims, so the four-year period applies, as explained in how long you have to sue for breach of contract in Texas.

Insurance sits behind most indemnity clauses

An indemnity clause is often paired with a requirement that the indemnitor carry liability insurance and name the indemnitee as an additional insured. The two should be read together. Where the insurance exists, the practical dispute is between the insurer and the indemnitee over coverage, and the contractual indemnity becomes the backstop. Where the insurance was never bought, the failure to procure it is a separate breach with its own damages, and it often matters more than the indemnity itself because an uninsured indemnitor may be unable to pay.

If you are on either side of a tender

• Read the clause for the trigger phrase, the covered parties, the covered losses and any consent-to-settle requirement, and compare each with the claim as pleaded.
• Decide whether the fair notice rules or Insurance Code chapter 151 limit what the clause can do, and whether any exception applies.
• Respond to a tender in writing, accepting, rejecting or accepting under a reservation of rights, and say why. Silence is read against the silent party.
• Put the insurer on notice at the same time, under every policy that might respond.
• Keep the indemnity dispute separate from the defense of the underlying claim. Admissions made to win the indemnity fight can hurt the defense, and the reverse.

Indemnity disputes are decided on the text of the clause and a handful of Texas rules, so an early reading by a litigator usually produces a clear view of who will end up paying. Tina Wysk represents Dallas businesses, contractors and owners in disputes over indemnity, defense and insurance obligations in state and federal court and in arbitration.