Longtime readers of my blogging will know that I’m an unabashed fan of the work of Glenn West, a partner at Weil Gotshal. His articles on extra-contractual liability (click here for a copy) and on consequential damages (click here for a copy) are essential resources. And Glenn usefully chimed in on that burning issue, represents and warrants. (See this September 2009 AdamsDrafting blog post.)
So when I found myself at an impasse regarding my attempt to draft palatable indemnification language for Koncision’s confidentiality-agreement product, I knew whom to consult. I’ve copied our correspondence below, but to cut to the chase, here’s the revised indemnification language prompted by that correspondence, with the new language in bold italics:
Indemnification for Actions of Representatives. In addition to any other remedies available to the Disclosing Party, the Recipient shall indemnify the Disclosing Party against any reasonably foreseeable losses and reasonably foreseeable liabilities arising out of disclosure or use of any Confidential Information by any Representatives of the Recipient other than as authorized in this agreement, subject to the same defenses that the Recipient would be entitled to assert in an action for breach of contract.
I’d like to think that this language would address the concerns of anyone worried that indemnification claims are subject to a different regime than that applying to breach-of-contract claims, particularly as regards foreseeability.
No, on to my correspondence with Glenn, with the pleasantries edited out. Here’s my initial email:
Glenn: If you have the time and inclination, I’d be interested in your views on a matter that’s perplexing me.
I’m currently putting together a document-assembly confidentiality agreement. I had planned on including indemnification language to cover issues for which there’s no contract cause of action, but that prompted dissention—people are very leery of indemnification. I described the issue in the following blog post: https://www.adamsdrafting.com/indemnification-a-misunderstood-concept/. And below is a message in which one of my editorial board members explained his objections.
If you have any thoughts, I’d be delighted to hear them.
Here’s Glenn’s reply:
Thanks for reaching out. The only thing I can add to this discussion is that I extensively researched the issue of whether a claim for indemnification is broader than a claim for breach of contract in connection with my Reassessing the “Consequences” of Waivers of Consequential Damages in Acquisition Agreements, 63 Bus. Law. 777 (May 2008) article. [Click here for a copy.] The conclusion I reached is that an indemnification for a breach of an agreement is subject to the same rules as to foreseeability, etc. as are claims for damages for breach of that same agreement (thus, making the indemnification somewhat redundant except to the extent it limits those claims with caps, etc.). However, an indemnification for something other than a breach of the underlying agreement in which that indemnification obligation appears is different. In that case the right to indemnification is a right to be paid for all losses arising from the specified event unrelated to any underlying breach of the agreement other than the failure to pay the indemnified amount itself. That type of indemnification is not subject to contract’s rules of reasonableness. If you look at pages 785-788 of my Consequential Damages article there is a complete discussion of this subject along with some citations to cases and secondary sources.
Here’s my reply to his reply:
I knew I was asking the right guy!
I’m thinking that some “specific events” indemnification invites application of the rule of reasonableness. If a contract calls for indemnification for destruction of widgets, then presumably one doesn’t get into a discussion of whether destruction of the widgets was foreseeable. But often “specific events” indemnification refers to losses “arising out of” something or other. (The indemnification language that prompted my blog post says that “the Recipient shall indemnify the Disclosing Party against any losses and liabilities arising out of disclosure or use of any Confidential Information by any Representatives of the Recipient other than as authorized in this agreement.”) And “arising out of” necessarily raises issues of foreseeability.
But as always, the issue ultimately isn’t what interpretation makes most sense—it’s how can I avoid contract uncertainty? I propose saying “the Recipient shall indemnify the Disclosing Party against any reasonably foreseeable losses and reasonably foreseeable liabilities arising out of disclosure or use of any Confidential Information by any Representatives of the Recipient other than as authorized in this agreement, subject to the same defenses that the Recipient would be entitled to assert in an action for breach of contract.” The reason for adding “reasonably foreseeable” is self-evident; the language added at the end would be to mollify those who are concerned that a claim for indemnification is immune from defenses based on, for example, estoppel or notions of public policy.
Glenn’s reply:
Your modifications do the trick for me. But I am not sure I agree that, without those modifications, your “arising out of” is in anyway limiting or necessarily raises issues of foreseeability. In fact I think it’s quite expansive. But with your proposed changes, I think you have removed any question as to the intent and made clear that indemnified losses must be those that the reasonably foreseeable result of the event being indemnified. As I noted in the last two bullet points of my suggested guidelines on pages 806-807 of my Consequential Damages article, the issue of how indemnification provisions work against the back drop of normal contract rules is less than clear. Accordingly, I suggested there that one should always attempt to modify the “losses” concept in all indemnification provisions so that indemnifiable “losses” were limited to those that were the “probable and reasonable foreseeable” result of the indemnifiable event.
I had a follow-up question:
I certainly consulted those bullet points! But I was uncertain what “probable” added, other than uncertainty regarding how it relates to “reasonably foreseeable.”
Glenn brought our exchange to a close:
Not sure the word “probable” adds a lot; I was just borrowing from Hadley, as in: “[T]he damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally . . . from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.”
But, I am more than happy with your language.
When I first read the title of this blog post quickly in my RSS feed I saw the title as “Indemnification: Glenn Beck Weighs In!”
He does seem to have an opinion on most subjects. Why not indemnification?
That’s hilarious. Thanks for sharing your illiteracy with us!
Is it clear that “defenses” would be understood to cover remoteness and other rules on damages, if that is the intent? Also, if it does refer to the contractual remoteness test, how does it relate to the use of “reasonably forseeable” earlier in the clause, which is also a (different) remoteness test? Do both tests need to be satisfied?
My other thought is that, in English law at any rate, “reasonably foreseeable” is the tortious test of remoteness rather than the contractual test. The tortious test is deliberately broader, as in contract improbable losses are not recoverable even if reasonably foreseeable*. For that reason, the clause may (depending on how the “defenses” wording operates) allow recovery for more remote damages caused by third party disclosure than would be allowed for disclosure by the party to the contract. In practice the difference may only matter in limited circumstances and so I think the term is fairly acceptable here, but it seems hard to rationalise the principle.
I think this kind of issue may explain why many practitioners either use (i) the ‘legal fiction’ approach (that disclosure by a third party will be deemed to be disclosure by the recipient that gave them the information) or (ii) a term that the recipient party will ensure that the information is not disclosed by the third parties to which they pass the information. These were of course discussed in earlier blog posts – the latter at length! Both these approaches have the advantage of treating disclosure by third parties in the same way as disclosure by the recipient, and I think for many this outweighs the disadvantages which (I hesitate to say, for fear of Ken biting my head off) are mainly cosmetic. For what it’s worth, I prefer the legal fiction.
* The ‘probability’ concept from Hadley v Baxendale is explained to some extent in The Heron II (a 1967 English case), as follows: “He [i.e. the judge in HvB] clearly meant that a result which will happen in the great majority of cases should fairly and reasonably be regarded as having been in the contemplation of the parties, but that a result which, though foreseeable as a substantial possibility, would happen only in a small minority of cases should not be regarded as having been in their contemplation.”
Apologies for the long post!
Westmorlandia: No apologies required–I’m obviously obsession by this stuff. I’ll ponder your suggestions shortly. And I can’t remember the last time I bit any commenter’s head off! Ken
Thank you for reminding me as to why “probability” was included in my original language. You are correct that “reasonably foreseeable” is a broader concept than “naturally arising” or otherwise “in contemplation of both parties;” and those concepts are the limits of “contract” as opposed to “tort” damages. What I think Ken is trying to do here is limit claims under an indemnification provision so they are no broader than a claim for an underlying breach of contract. The issue I think everyone is struggling with is that a breach of the nondisclosure obligations by a Representative (particularly if the party to the NDA did everything it was required to do to prevent disclosure by such Representative) may not be a breach of the NDA; hence the need to create an indemnity obligating the contracting party to pay for the actions of the Representatives that would have been breaches of the NDA had the Representatives been parties to the NDA. As I wrote in my Consequential Damages article at pages 786-77, the problem with indemnification provisions is that certain courts and secondary authorities believe that, unlike a breach of contract claim where the court is determining the proper amount to compensate a nonbreaching party for the non-performance of a contract by the breaching party, an indemnification provision (particularly one that is not related to an underlying breach of a contract by a contracting party) is actually an obligation to pay an amount of money if certain specified events occur, and thus not the type of agreement as to which the Hadley damage limitation rules apply. So, based on your really helpful thoughts that triggered my memory on the underlying research I had previously done, I think a better approach to this issue may be to revise the language to eliminate the concept of indemnity and just say what we mean:
Liability for Actions of Representatives. In addition to any other remedies available to the Disclosing Party for a breach of this agreement by the Recipient, the Recipient shall be liable to the Disclosing Party for disclosure or use of any Confidential Information by any Representatives of the Recipient, other than as authorized in this agreement, to the same extent if the Recipient had directly breached this agreement in using or disclosing such Confidential Information.
Glenn: What you’ve done is taken the gist of my “legal fiction” language, as found in my update to this post, and put it in the language I proposed above. I think that represents good progress, but I have one important caveat: In my view, “the Recipient will be liable” and “the Recipient shall indemnify” are simply alternative ways of creating a claim that otherwise wouldn’t arise out of the contract, with the nature of that cause of action being as stated. To attribute any other significance to “shall indemnify” would be to treat “indemnify” as a magic word; to regard “will be liable” as being immune from the trappings of indemnification would be to treat “liable,” too, as a magic word. I can’t do that. So I propose using “indemnify” in your language, as it’s the most established word for creating claims, with the extent of that obligation being limited as stated. What say you? Ken
I know you hate “magic” words and, with the other limitations, I can live with your approach and use of “indemnify.” But in this case I actually think the words have different connotations and are not simply synonyms. “Indemnify” carries a connotation of “compensate for”, “pay,” “reimburse,” or “make whole” regardless of any underlying contractual liability for the harm that gave rise to the loss. And that connotation is the basis for the conclusions reached by some courts and commentators (both in the US and UK) that an obligation to indemnify is simply an obligation to pay a sum of money; not a contract to perform an obligation the breach of which can give rise to damages that are subject to Hadley’s rules. “Liability” is more of an acknowledgement of contractual responsibility for the underlying harm and not an agreement to pay a sum of money for such harm; and therefore, at least to me, I derive more comfort from using an acknowledgment of liability rather than an obligation to indemnify in order to further strengthen the position that I am only subjected myself to a contract based determination of damages for the resulting harm caused by the Representatives disclosure of confidential information. But again, I do not feel strongly about it and think I am now ready to go back to work.
Maybe it’s time to scrap “indemnify” entirely, given that it’s fraught with such baggage, and given that you don’t need such a fancy word to articulate the notion of an obligation to pay a sum of money. In any event, thank you for taking part in this discussion; I’ve found it very valuable.
In favor of scrapping “indemnify” entirely in this context is the fact that some courts restrict it to third-party claims, absent a contrary intent. See, e.g., Nevadacare, Inc. v. Dept. of Human Services, 783 N.W.2d 459, 470 (IA 2010) (“Currently, there is a split of authority as to whether an indemnification provision applies to claims between the parties to the agreement or only to third-party claims.”) This makes it prudent for a drafter to specify that an indemnity provision applies to both direct-damages and third-party claims, unless this intent is otherwise very clear.
Ken – You state say that the alternative language is a way of “creating a claim that otherwise wouldn’t arise out of the contract…”
Are we sure this is true? As a disclosing party, wouldn’t the designation of a “Representative” by the recipient look a lot like an appointment of an agent? It seems to me that if the Disclosing Party was seeking be compensated for a Representative’s breach, the easiest thing to do is allege breach of principal contract and that any acts of the Rep are merely acts of the Recipient.
Mike: Do I have a contract claim against the other party if it complies with the contract by putting in place reasonable measures to protect confidential information and an rogue associate at its outside law firm nevertheless discloses CI? I don’t know. I’d rather give the parties the opportunity to spell out how that situation should be handled. Ken