In purchase agreements and other contracts, parties commonly use indemnification provisions to allocate the costs of future claims, including attorneys’ fees and expenses. New York State and Federal courts applying New York law, however, construe contractual indemnification provisions very strictly, applying a presumption that such clauses only cover claims made by third-parties against one of the contracting parties – not claims by one contracting party against another (i.e. “direct claims”) – unless the contracting parties have made their intention to cover direct claims “unmistakably clear” in their agreement. This can be a huge issue because even a winning litigant in the U.S. typically cannot recover its attorneys’ fees and expenses – a principle known as the “American Rule.” Indemnification provisions typically reverse the American Rule by providing that the indemnified party can recover its attorneys’ fees and expenses from the indemnitor. Thus, whether an indemnification provision applies to claims between the contracting parties – say for breach of a representation or warranty – is often heavily litigated.
Given the foregoing, it is vitally important to understand not only the presumption against coverage of direct claims under indemnification agreements governed by New York law, but also how to draft indemnification agreements clearly enough to ensure that direct claims are or are not covered – depending on your intent. In this first post, we discuss the New York presumption; in subsequent posts, we will discuss the types of language likely to be found to cover, and not to cover, direct claims, respectively.
The presumption against coverage of direct claims
The presumption against coverage of direct claims was first articulated by the New York Court of Appeals, New York’s highest court, in Hooper Associates, Ltd. v. AGS Computers, Inc. Under Hooper and its progeny, a court evaluating an indemnification provision governed by New York law will construe the agreement to apply solely to claims brought by a third-party against a contracting party – unless the agreement is “unmistakably clear” that the parties intended the indemnification provision to apply to direct claims. The presumption exists, in part, because of the strong policy underlying the American Rule that litigants bear their own expenses and are not ordinarily entitled to recover their attorneys’ fees and costs from their adversary, even when they are successful in the litigation.
In order to determine whether the parties to the agreement intended for direct claims to be covered by the indemnification provision, the court will examine (i) the contractual language; (ii) any additional, relevant provisions of the contract surrounding or referring to the indemnification provision and, in certain instances, other agreements executed or drafted contemporaneously with the indemnification provision; and (iii) the circumstances in which the contracting parties entered into the contract and what types of claims were foreseeable at the time of contracting. In other words, unlike most contractual disputes, it is not just merely the language used but also the circumstances in which the parties were contracting that will be determinative of whether direct claims are covered by the indemnity (and thus whether there will be reimbursement of legal fees).