The Blame Game: Supply Chain Indemnity Agreements
By Rebecca Cross, Esq.
The food product industry faces an escalating barrage of lawsuits—for both alleged mislabeling and safety violations. In response to these attacks, food product companies have increasingly sought to limit their risk by passing it up the supply chain to their copackers and suppliers through indemnification clauses. Not surprisingly, copackers and suppliers are pushing back. Oftentimes, without the help of experienced legal counsel, the parties end up negotiating and editing these indemnification clauses in such a way that the resulting provision is convoluted, ambiguous and challenging to enforce.
This article walks through the basic principles of indemnification provisions and how parties may structure a balanced and clear-cut provision that is valuable to both sides.
In supply agreements, indemnification clauses dictate the degree of each party’s liability and the extent that each takes on or shifts risk. The language in indemnification provisions can be confusing. The terms “indemnify,” “hold harmless” and “defend” are often used interchangeably, but actually have distinct and separate meanings:
Indemnify. Indemnification is a contractual obligation by one party (the indemnitor) to pay or compensate for the losses, damages or liabilities incurred by another party (the indemnitee).
Hold Harmless. In some states, this term only releases the indemnitee from liability to the indemnitor, not to third parties.
Defend. In many states, the obligation to indemnify does not occur until resolution of the case, when the indemnitee has had a judgment entered against it for damages, or has made payments or suffered actual loss—unless the contract requires such a defense. Also, in some states (like California and New York), the right to indemnify includes the reasonable costs of defense, but in other states (like Illinois), it does not, unless expressly stated.
To avoid ambiguity, the terms should be used purposefully. And for an indemnitee to obtain full protection, the three terms should be used collectively, for example, “A agrees to fully indemnify, hold harmless and defend (collectively, “indemnify”) B.…”
Delineating Areas of Control and Fault
Common types of losses subject to indemnification include breach of representation or warranty; breach of agreement; losses incurred under specified conditions; and third-party claims concerning product defects.
Parties should beware of overbroad or ambiguous indemnification clauses, which put the indemnitor on the hook even where it has not breached the contract or otherwise been at fault. For example:
• “any liability arising out of or connected with the services under this agreement”
• “any act or omission of X or any of its employees or agents in whole or in part, including but not limited to...”
• “any intentional act in connection with the production or distribution of the products”
In a balanced and clear-cut contract, parties should only warrant and indemnify for things under their control. Each party’s obligations should be clear in the supply agreement. Likewise, in the indemnification provision, the types of fault that could reasonably occur should be defined and spelled out as attributable to a certain party.
A party may not be in a position or want to take on certain responsibilities—suppliers may have riskier duties under a supply agreement, although the brand may have the deeper pocket. When reviewing indemnification language, each party should consider the worst possible scenario under the agreement and determine the associated level of risk.
Obviously, each party wants to minimize its risk. Factors to consider in allocating risk are as follows:
• Who would be at fault for the loss? Who is in the best position to control/mitigate the risk? If the indemnities are delineated by areas of control and fault, as a practical matter, they should be easy for each party to accept.
• What is the customary industry practice?
• Who has the bargaining power?
• Who is in the best position to insure against the risk?
Indemnification provisions should reflect the parties’ insurance coverage. In other words, the indemnitor for a type of loss should be the one to obtain insurance for that loss and should name the indemnitee as an additional insured. An indemnity may only be as strong as the insurance the party has to back it up—especially where the indemnitor is a small company with limited assets.
Additional insured status gives the indemnitee the right to claim directly against the indemnitor’s insurer, which can include the right to immediate defense and avoid a recovery dispute between the parties.
It is important to have legal counsel review the policy to make sure it covers the intended type of loss and includes sufficient limits. General liability policies provide coverage for claims by consumers alleging bodily injury or property damage. They will likely cover very few, if any, of the costs associated with a food recall.
A variety of specialty policies are available that will provide coverage for food recall-related losses, such as for the following insured events: actual contamination, product tampering and adverse publicity. These specialty policies should also be carefully reviewed by legal counsel—often there are exclusions that could render them virtually worthless. For example, a policy should cover instances not only where there is proof of actual contamination, but also where there is “reasonable cause to believe” that there may be contamination—as food product companies may be asked by the U.S. Food and Drug Administration to conduct a recall before there is proof of contamination.
Finally, for ease of enforceability, an indemnification section should include provisions (see “Top Considerations for Indemnification Provisions,” below) for how a claim will be handled, including notification, right to control the defense and the obligation to advance or reimburse legal fees and costs.
Rebecca Cross, Esq. is a partner with BraunHagey & Borden LLP, a San Francisco–based litigation boutique. She has served as outside general counsel to a number of food product clients, advising them on regulatory and litigation risk regarding labeling, advertising, supply chain management, product safety and recalls.