Agreeing to Pay Reasonable Attorneys Fees as Part of Indemnification May Create Uninsurable Loss

 A question that is asked with increasing frequency is whether attorneys fees incurred pursuant to an indemnity clause are insurable where they are not incurred due to a duty to defend (i.e., paid on behalf of the indemnitee) but are instead paid after the litigation is complete and the indemnitor (e.g., engineer) is found liable for damages due to its negligence.  The short answer is that unless the court would have awarded the attorneys fees against the engineer in the absence of the contractual obligation to pay attorneys that was created by the indemnification provision, the attorneys fees will not be covered by the professional liability policy.  The contractual liability exclusion of the policy applies to such contractually created attorneys fees obligation.

A typical indemnification clause that includes payment of attorneys fees as part of indemnification rather than as part of a duty to defend is the following:

INDEMNIFICATION

The Consultant shall indemnify and hold harmless Owner, its  parent,  affiliates and their respective directors, officers and employees (“Indemnitees”) from and against any and all claims, suits, actions, judgments,  demands,  losses, costs, liability, damages, and expenses, of any kind (including reasonable attorneys fees)   for  injuries  to  persons  (including but not limited to death) or damage to property to the extent any  of the foregoing are caused by any negligent act, error, or omission of Consultant, its officers, employees, agents, representatives, and  persons  for  whom  Consultant  is  legally responsible in  the performance of the Services.

Although this clause may look innocuous in that the indemnification is limited to negligence, it may nevertheless create uninsurable loss by virtue of the attorneys fees that are included in the indemnification.  Under American Jurisprudence, the courts do not award attorneys fees to the prevailing party unless the contract creates such a duty or unless there is some legal basis such as a civil statute that would establish the basis for the award of attorneys fees.

An insurance broker was recently asked by his client (an engineering firm) to consider the insurance ramifications of an indemnification clause somewhat similar to what was quoted above.  Instead of containing the reference to reasonable attorneys fee within its text, however, the clause included an additional sentence that stated:  “Consultant shall not have  an  obligation  to defend any person under this indemnity; however, Subconsultant  shall  have  liability  for reasonable  and necessary defense costs incurred by persons indemnified to the extent caused by Subconsultant’s  negligence.”

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To avoid contractual liability for legal fees under the above-quoted clause that would not be covered by insurance, the broker recommended that the final sentence be revised to read as follows: “Consultant shall have liability for reasonable and necessary defense cost incurred by persons indemnified to the extent caused by Consultant’s negligence herein and recoverable under applicable law on account of negligence.”

I agree with the broker that, unless the award is limited to the sum “recoverable under applicable law on account of negligence,” the indemnity of legal costs is not fully insured. Specifically, an award of legal costs in favor of the indemnitee against the engineer that is based on the contractual indemnity alone is excluded from coverage by the contractual liability exclusion of the policy. The amount of the award that is made under applicable law respecting recovery of plaintiff’s legal costs, apart from the contractual indemnity, could be covered under the policy depending upon terms and conditions of the policy.

In other words, if a state has a law for recovery of plaintiff’s legal costs against the engineer, an award under that law based upon negligence  might be covered under the professional liability policy, but any part of an award of attorneys fees that results only from a contractual indemnity obligation to indemnify a plaintiff’s legal fees will run afoul of the contractual liability exclusion of the policy and, therefore, be excluded from coverage.

As previously stated, in the United States, the laws of the individual states do not provide, routinely, for an award of plaintiff’s legal costs. That is the genesis of contractual indemnity of legal costs. Contractual indemnity “fills in” what the law does not otherwise order. Likewise, that is the reason the engineer would limit the contractual indemnity to the sum that state law would award. The “fill in” to enforce the contractual indemnity is not a liability that would have attached to the “insured” in the absence of such contract, warranty, guaranty or promise, to quote from the contractual liability exclusion contained in one insurance carrier’s policy.  For the reasons explained in this article, a party that agrees to indemnify another should beware that agreeing to reimburse the indemnitee for attorneys fees will likely create an uninsurable risk where those fees would not have been awarded by a court in the absence of the contractual obligation.