An indemnification agreement is a contractual way for parties to transfer risk of loss, damage, or liability from one party to another. When drafting indemnification agreements, parties usually envision third party losses but may, through oversight or sloppy drafting, fail to consider whether the agreement also covers first party (or direct) claims. To avoid this pitfall, you must understand the difference between third and first party claims and use precise language in your indemnification agreement.
Third Party v. First Party Indemnification
Third party claims occur when one party to the contract agrees to indemnify the other party from claims brought by a third party, or person not part of the agreement. First party claims, on the other hand, provide indemnification for claims resulting from the conduct of one of the parties to the agreement.
For example, under a third party claim, A agrees to indemnify B. Later, when B is sued by C, a third party, A reimburses B for C’s claims against B, provided the claims fall within A and B’s agreement. Under a first party claim, A agrees to indemnify B for loss or damage incurred as a result of the conduct of A, regardless of whether C exists or makes a claim against B. Essentially A indemnifies B for B’s own losses.
Failing to Distinguish Between Third and First Party Indemnification: Lessons Learned from Hot Rods, LLC v. Northrup Grumman Systems Corporation
A 2015 case provides an illustration of a party who thought its indemnification agreement covered only third party claims, but in actuality, it covered first party claims as well. In Hot Rods, Northrup sold an environmentally compromised property to Hot Rods. The contract for sale addressed environmental indemnity by stating
“Seller [Northrup] hereby agrees to indemnify, defend by legal counsel . . . , and hold the Buyer [Hot Rods]. . . harmless from and against any claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses including, without limitation, reasonable environmental consulting fees and reasonable attorney fees arising out of (a) any Environmental Action(s) and/or Remediation involving an environmental condition or liability involving the Real Property caused by an act or omission of Seller . . . .”
Later when Hot Rods sued Northrop for failing to reimburse its losses related to remediation activities, Northrup argued it was not responsible because the agreement covered only third party claims.
The court disagreed concluding the phrase “any claims” was broad enough to encompass both types of claims. Importantly, the court reached this conclusion despite (1) Northrup’s argument there must be “express language” in an indemnity clause before it can encompass first party claims; and (2) the general rule in California that “[i]ndemnity provisions typically refer to third party claims[.]”
Properly Limiting Your Agreement to Third Party Claims
If you want to avoid a mistake like Northrup’s, then clearly limit your claims to those made by a third party. Add the phrase “third party” to your general indemnification clause. Here is an example:
“Seller hereby agrees to indemnify, defend by legal counsel . . . , and hold the Buyer . . . harmless from and against all third party claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses . . . .”
Include specific language because, as stated above, while “[i]ndemnity provisions typically refer to third party claims, . . . if the parties so intend, such provisions may also encompass direct claims.” In other words, although the assumption is a third party claim, parties are free to contractually alter the rule, so make your intentions clear.
Plainly state what type of claims you want covered. Does your agreement generically provide indemnification for “claims” or “any claims?” Read your contract(s) to see whether your indemnification clause should include language like “third party claims,” “first party claims,” or whether it is fine as written. Your local attorney can provide guidance on drafting new and interpreting current indemnification agreements.