Risks of Client Indemnification Agreements
Professional consultation doesn’t always go as intended. Despite good intentions, there are always risks facing professionals that the representation will turn sour and lead to a malpractice claim. Clients also face risks and some sophisticated clients take steps to reduce exposure. For example, more corporate clients are attempting to reduce exposure by requiring counsel to sign indemnification clauses within the engagement agreement. Many firms agree to represent clients pursuant to such clauses in order to develop or maintain business relationships, notwithstanding the additional risk. However, experts warn that doing so may make firms personally responsible for unforeseen liability, and that long term risk may not justify the short term gain.
An indemnity agreement, also known as a hold harmless agreement, is a contractual mechanism that allows a party to transfer the risk of loss to another party. In an indemnity agreement, one party will agree to hold the other harmless for specific damage to the other party. If a third-party suit arises, the indemnifying party will be required to pay any damages obtained in suit.
Clients are increasingly demanding that counsel sign engagement letters that protect the client from possible legal outcomes. In some cases, the indemnity clauses cover such a broad array of outcomes that they have the effect of making the firm act as an insurer of its legal advice, even where the advice was reasonable under the circumstances. Thus, any time a client’s customers, government agency or third party files a claim, the law firm may be placed on the hook for any financial damages.
Worse yet, the broad risk under indemnity agreements may give rise to claims that fall outside of the scope of the law firm’s professional liability insurance policy. For instance, a client may request indemnification from a law firm for a legal outcome that would not ordinarily be covered under the firm’s malpractice policy. If the firm pays out on the claim, they may not be entitled to recovery from their own carrier.
Given these uncertainties, experts caution that firms should be hesitant to enter into engagements that include broad indemnity clauses. Wherever possible, firms should attempt to negotiate more limited indemnity language. Further, when client indemnity clauses are invoked, firms should be sure to first contact their carriers or broker to discuss any coverage concerns.