Weil, Gotshal & Manges LLP

Indemnification Between Contracting Parties

Levine, Richard L.

(October 2000, Business & Securities Litigator)


By Richard L. Levine and S. Christian Wickwire

When negotiating or litigating the terms of a contractual indemnity governed by New York law, it is important to recognize that indemnities are construed very strictly.  Indeed, as a general rule, indemnities will be held to cover only claims by third-parties, not claims between the parties to the indemnity – absent express language in the indemnity so providing.  For example, in a recent case discussed more fully below, even though the court found that the defendant was obligated to indemnify the claimant/indemnitee for legal fees that the claimant had incurred in defending an underlying third-party lawsuit, it held that the claimant could not recover the fees incurred in suing to enforce the indemnity (so-called “fees-on-fees”) because the indemnity did not expressly cover claims between the parties to the indemnity.  Drafters and litigants, therefore, should be aware that courts applying New York law will not find that an indemnity covers claims between the parties to the indemnity, including costs incurred in enforcing the indemnity, unless the indemnity expressly and unambiguously covers such claims and/or costs.

Indemnities Generally Cover Only Third-Party Claims

In the seminal case of Hooper Assocs., Ltd. v. AGS Computers, Inc.,1 the New York Court of Appeals reversed both the trial court and the Appellate Division on the ground that, under New York law, indemnities presumptively cover only third-party claims.  In Hooper, plaintiff sued for breach of contract, breach of express and implied warranties, and fraud in the inducement, and sought indemnification for legal fees incurred in prosecuting such claims.  The indemnification clause at issue obligated the defendant to “‘indemnify and hold harmless [plaintiff] *** from any and all claims, damages, liabilities, costs and expenses, including reasonable counsel fees’ arising out of breach of warranty claims [or] the performance of any service to be performed . . . and the like.”2  The trial court severed the claim for indemnification and, after trial, the jury held for the plaintiff on the remaining claims but found that it had not suffered any damages.  The trial court then granted plaintiff’s motion for summary judgment on its claim for indemnification of its attorneys’ fees incurred in the litigation on the grounds that the contract “was clear and unambiguous in its terms *** in providing for indemnification of all claims, including reasonable attorney’s fees.”3  The Appellate Division affirmed without opinion.4  

The Court of Appeals, in a decision written by Judge Simons, reversed.  It held that although an indemnification clause might “seem to admit of a larger sense,” it must be “strictly construed to avoid reading into it a duty which the parties did not intend to be assumed.”5  Moreover, because “a promise by one party to a contract to indemnify the other for attorneys’ fees incurred in litigation between them is contrary to the well-understood rule that parties are responsible for their own attorney’s fees, the court should not infer a party’s intention to waive the benefit of the rule unless the intention to do so is unmistakably clear from the language of the promise.”6  


The court then observed that the language of the indemnity there at issue was “typical of those which contemplate reimbursement when the indemnitee is required to pay damages on a third-party claim.”7  The court emphasized that even though the indemnity covered “counsel fees arising out of breach of warranty claims,” since a breach of warranty could result in a third-party claim, the indemnity was susceptible to a construction that it covered third-party claims; as a result, the indemnity was not exclusively and unequivocally referable to claims between the parties themselves, which was the standard for an indemnity to reach inter-party claims.8  Thus, the court ruled that the plaintiff could not recover the counsel fees incurred in its action against the indemnitor.  


Decisions Construing Hooper
What contractual language satisfies the Hooper standard that an indemnity must exclusively and unequivocally refer to inter-party claims to cover such claims has been addressed in a number of decisions.

For example, Bridgestone/Firestone, Inc. v. Recovery Credit Servs., Inc.,9 arose out of defendants’ alleged breach of an agreement governed by New York law under which defendants were responsible for collecting delinquencies on credit card accounts.  The district court found that defendants had failed to remit monies collected for plaintiff and had destroyed records evidencing such collections and awarded damages.10  The district court also awarded plaintiff the full amount of its attorneys’ fees incurred in prosecuting the lawsuit.11  


On appeal, the Second Circuit reversed the award of counsel fees, finding that even though the indemnity covered “‘all claims, demands or causes of action, any and all costs or expenses, including attorney fees, that may be asserted due or arising out of the [defendant’s] collection activity’ . . . [t]his language is not an unmistakably clear statement that such damages were intended.”12  Rather, because the language “may easily be read as limited to third party actions,” under Hooper it did not cover inter-party claims.13


Similarly, in Bonnie & Co. Fashions, Inc. v. Bankers Trust Co.,14 the indemnity covered “‘[a]ll costs and expenses incurred by [Bankers Trust] in protecting, maintaining, preserving or enforcing’ [its] rights and interests acquired under the Factoring Agreement.”  The court held that because such language could “easily be read to protect [Bankers Trust] from claims to its rights and interests by third parties,” the language was not “exclusively or unequivocally referable to claims between the parties themselves” and thus the indemnity only covered third party claims.15  Bankers Trust then moved to reargue, relying on a separate clause in the indemnity which provided for the indemnification of its expenses incurred “defending or prosecuting any actions or proceedings out of or in any way related to [the Factoring] Agreement.”16  The court held that even this broad language “cannot be read as an expression of the parties’ unmistakably clear intention that plaintiffs would pay for [Bankers Trust’s] litigation costs arising from litigation between the parties.”17  The court reasoned that “at least as plausible an interpretation . . . is that plaintiffs agreed to indemnify [Bankers Trust] for its costs in prosecuting or defending actions related to the Factoring Agreement against third parties.”18  Therefore, “[b]ecause both of these interpretations are possible, [Bankers Trust’s] reading cannot be as ‘unmistakably clear’ as it must be to render plaintiffs liable for all of [Bankers Trust’s] litigation expenses in this action.”19  

In Bourne Co. v. MPL Communications, Inc.,20 the dispute involved competing claims between a publisher and a composer to ownership interests arising from the extended renewal term in the copyright of a musical composition.  The court held that because “[t]he Agreement at issue requires indemnification of plaintiff when plaintiff must take steps to protect its right, title and interest in the composition and allows plaintiff to ‘dispose of any matter, claim, action or proceeding’” (emphasis supplied), the language of the indemnity, “as in Hooper, is typical of the type which contemplates indemnification for third-party claims.”21  The court rejected plaintiff’s argument that the indemnity, which explicitly referenced claims arising from breaches of covenants, warranties or representations in the contract, could to such extent only be referring to claims between the parties.22  The court observed that the indemnity in Hooper also contained such language and that Hooper nevertheless concluded that “none of these subjects are exclusively or unequivocally referable to claims between the parties themselves or support an inference that defendant promised to indemnify plaintiff for counsel fees in an action on the contract.”23


The decision in Promuto v. Waste Management, Inc.,24 however, was that the indemnity did cover claims between the parties to the indemnity.  Promuto involved a claim for breach of warranty in connection with the sale of a family business.  The court granted plaintiffs’ motion for summary judgment on liability, finding that defendants had breached express warranties.25  The court also granted plaintiffs’ motion for summary judgment on its entitlement to indemnification; the court ruled that there was indemnification for inter-party claims because the indemnity contained two clauses and the second clause repeated the language of the first but added language apparently referring to claims between the contracting parties.26  The court held that the presence of this second clause made it clear that there was indemnification for inter-party claims because otherwise the first clause would have had no purpose.27


Finally, given Hooper’s holding that the intent to cover inter-party claims must be exclusive, unambiguous, and unmistakable, several courts have looked to whether an indemnity which arguably is referencing inter-party claims could have included additional language which would have made such intent even more clear.  For example, in Frater v. Tigerpack Capital, Ltd.,28 plaintiff sought indemnification from defendant for his fees incurred in prosecuting a wrongful termination claim.  Plaintiff based his claim for indemnification on the indemnities in his Employment Agreement, a separate Shareholders’ Agreement, and the company’s by-laws.  The court found that the indemnification clauses applied only to actions brought by third-parties because of “[t]he strong presumption against reading into a contract a condition which could easily have been explicitly included.”29  

Rules Of Contract Construction Apply

Courts have relied on traditional rules of contract construction when determining whether an indemnity covers inter-party claims under the stringent Hooper standards.  In Hooper itself, the Court of Appeals referenced the hoary principles that “[w]ords in a contract are to be construed to achieve the apparent purpose of the parties” and the need to “afford[ ] a fair meaning to all of the language employed by the parties in the contract and [to adopt a construction that] leaves no provisions without force and effect.”  The court then concluded that because the notice and opportunity to defend provisions in the indemnity required plaintiff to “promptly notify” defendant of “any claim or litigation to which the indemnity . . . shall apply” (emphasis supplied) and provided that defendant “may assume the defense of any such claim or litigation with counsel satisfactory to [plaintiff]” (emphasis supplied), the indemnity covered only third-party claims in that such provisions could have “no logical application to a suit between the parties.”30

A similar analysis was applied in Sequa Corp. v. Gelmin.31  There, co-plaintiff Sequa Capital Corp (“SCC”) and defendants Gelmin and GBJ Corporation (“GBJ”) had entered into both a consulting agreement, whereby defendants agreed to perform services for SCC, and an indemnity agreement, pursuant to which SCC “[i]ndemnified GBJ and Gelmin against ‘claims’ of any kind and nature, including reasonable legal fees and expenses that might be incurred in defending against suits imposed on, incurred by, or asserted against GBJ or Gelmin due to the performance of their duties under the Consulting Agreement.”32  


SCC and its parent Sequa Corp. later sued defendants for violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”).  Defendants counterclaimed, alleging that even if they were held liable to plaintiffs, plaintiffs must indemnify them and reimburse their reasonable legal expenses pursuant to the indemnity.  In its decision, the court first examined the language of the indemnity, finding that “the agreement’s broad language – ‘any and all’ claims ‘of any kind and nature’ – refers solely to the type of claims that are covered, not the identification of parties who may assert those claims.”33  The court then held that the indemnity did not cover actions between the contracting parties because the provisions setting forth procedures for notification of all claims and the right of the indemnitor to assume the defense of all claims could have no logical application to a suit between the parties.  Moreover, the indemnification agreement contained a clause which provided that SCC “shall be subrogated to the rights of GBJ and Gelmin whenever SCC pays any amount pursuant to the Agreement.”  The Sequa court emphasized that this clause could not be applied to claims asserted by plaintiffs against the defendants.


Interestingly, the rule of contract construction that a court should not interpret a contract so as to leave any provision of the contract without force and effect was central to a pre-Hooper decision which the Hooper court took great care to distinguish.  In Breed, Abbott & Morgan v. Hulko,34 the Breed, Abbott law firm had acted as an escrow agent for defendant Hulko in connection with his contract to purchase a house.  Under the terms of the escrow agreement, Breed, Abbott was obligated to deliver the down payment to the sellers in the event of a default by Hulko.  When Hulko defaulted, Breed, Abbott duly delivered the down payment.  Hulko then sued the firm for wrongfully releasing the escrow fund to the sellers.  A trial on the merits resulted in a judgment for the firm.  


Breed, Abbott then sued Hulko for indemnification of its legal fees incurred in defending Hulko’s failed claim.  That indemnity in the escrow agreement (as quoted in the First Department’s decision under appeal to the Court of Appeals) provided that “the parties hereby indemnify the escrowee and hold the escrowee harmless from any claims, damages, losses or expenses arising in connection herewith.”35  The trial court dismissed Breed, Abbott’s claim for its legal fees; the First Department, however, reversed and the Court of Appeals affirmed.  The Court of Appeals reasoned that if the broadly phrased indemnity did not include “legal expenses incurred [by the escrowee] in defending against an action by one of the parties alleging misconduct by the escrowee which resulted in a determination in favor of the escrowee, it is difficult, if not impossible, to ascertain for what it was that the parties had agreed to indemnify the escrowee.”36    


Hooper distinguished Breed, Abbott on the grounds that in Breed, Abbott, the “intent of the parties [to cover inter-party claims] was manifest,” while in Hooper, “the potential existed for third-party actions seeking lost profits, personal injury or property damages from plaintiff,” so an intent to cover claims between the parties could not be assumed.37  
In a post-Hooper case finding that an indemnification provision did cover claims between the contracting parties, Sagittarius Broad. Corp. v. Evergreen Media Corp.,38 the First Department relied on the same rule of contract interpretation.  The court determined that, as in the Promuto case discussed above, the indemnification provision must be read to apply to actions between the parties because otherwise a different subsection of the indemnity “which clearly pertains to third-party actions” would be rendered “mere surplusage.”39  


In Re Health Management Systems

As noted in the introduction, a recent decision demonstrated the continuing viability of the Hooper rule.  In In re Health Management Sys., Inc. Sec. Litig.,40 the court followed certain earlier precedent and held that the claimant/indemnitee was not entitled to recover the costs it had incurred in suing to enforce the indemnity, even though it held the claimant was entitled to indemnification for the underlying third-party claim.  Health Management involved a dispute over whether § 722(a) of the New York Business Corporation Law (the “BCL”) and/or the indemnification provisions of the by-laws of Health Management Systems, Inc. (“HMS”) required HMS to indemnify the claimant, a director of the corporation, for costs he incurred in defending himself in a third-partysecurities class action and for the attorneys’ fees he incurred in trying to enforce the indemnity.  The facts of the case are fairly simple.  While the claimant had been named as a defendant in the underlying class action in his capacity as a director of HMS, the class action plaintiffs ultimately stipulated to his dismissal.  HMS, however, refused to reimburse him for his attorneys’ fees and expenses, claiming that such fees were excessive and thus neither reasonable nor necessarily incurred – preconditions for indemnification under the company’s by-laws.  The claimant then filed a motion for an order requiring HMS to indemnify him for his defense costs.  

The court referred the motion to a Magistrate Judge, who issued a Report and Recommendation that HMS be required to indemnify the claimant for $67,636.73 in attorneys’ fees and expenses incurred in defending the class action but disallowing the $17,147.64 sought for costs incurred in enforcing the indemnity.  In so ruling, the Magistrate Judge declined to follow Sierra Rutile Ltd. v. Katz,41 and Professional Ins. Co. of New York v. Barry,42 both of which granted the movant costs incurred in enforcing an indemnity.  The Magistrate Judge observed that the Sierra Rutile decision contained no analysis of the issue and the Barry court’s conclusion that “fees on fees” were “necessary” in connection with the defense of the underlying action was a “strained interpretation of the B.C.L. [which] has not been adopted by any other court and is inconsistent with the New York rule that an attempt to shift fees must be clearly stated.”43  The Magistrate Judge noted that while “it is unfair for someone promised complete indemnification to have to incur substantial costs to secure that right, . . . [f]ees on fees ‘are not a part of defending the indemnified claim, but instead fall within the ordinary rule that each party bears its own expenses.’”44


The Magistrate Judge’s recommendation in Health Management was adopted by the district court.  The court began by noting that the general rule is that parties are responsible for their own attorney’s fees and that under Hooper, courts considering an indemnity should not “infer a party’s intention to waive the benefit of the rule unless the intention to do so is unmistakably clear from the language of the promise.”  Id. at 230 (quoting Hooper).  The district court then noted its agreement with the Magistrate Judge “that there may be an element of illogic in denying fees on fees.  After all, the purpose of indemnity is to make someone whole.”45  The district court, however, also agreed with the Magistrate Judge that there was no “unmistakably clear” language in the BCL or HMS’s by-laws to support an award of fees on fees, concluding that in light of existing precedents, “the appropriate resolution of this problem is to amend the applicable instrument, be it a contract or a corporate by-law, explicitly to authorize fees on fees, rather than to conclude that language which is ambiguous is, actually, ‘unmistakably clear.’”46  


Conclusion

This review of the case law leads to one very obvious conclusion:  when drafting or negotiating an indemnity, the question of whether it is to cover claims between the parties, or at least fees-on-fees, needs to be addressed directly.  Mere broad verbiage – such as language that the indemnity is to apply to “any and all actions arising out of the contract” – will not be construed as sufficient to cover claims between the parties.  Indeed, if the parties intend to provide for indemnification for inter-party claims and for claims brought by third parties, the prudent practice is to include distinct clauses with express language spelling out the circumstances under which each indemnity is to apply.  Further, it is important that any notice and opportunity to defend provision be tailored to reflect the intent of the parties with regard to inter-party claims.  In the case of indemnification of officers and directors, since they no longer can rely on the BCL for protection, the intent to provide for fees on fees must be expressly stated in the company’s by-laws or in a separate indemnification agreement.  

1.        74 N.Y.2d 487, 548 N.E.2d 903, 549 N.Y.S.2d 365 (1989).
2.        Id. at 492, 548 N.E.2d at 905, 549 N.Y.S.2d at 367.  
3.        Id. at 490, 548 N.E.2d at 904, 549 N.Y.S.2d at 366.
4.        Id.
5.        Id. at 491, 548 N.E.2d at 905, 549 N.Y.S.2d at 367.  
6.        Id. at 492, 548 N.E.2d at 905, 549 N.Y.S.2d at 367 (emphasis supplied).
7.        Id.  
8.        Id.  
9.        98 F.3d 13 (2d Cir. 1996).
10.        Id. at 17.  
11.        Id.
12.        Id. at 21.  
13.        Id.
14.        955 F. Supp. 203, 217-19 (S.D.N.Y. 1997).
15.        Id.
16.        Bonnie Co. Fashions, Inc. v. Bankers Trust Co., 171 F.R.D. 79, 84 (S.D.N.Y. 1997).  
17.        Id.
18.        Id.
19.        Id.
20,.        751 F. Supp. 55 (S.D.N.Y. 1990).
21.        Id. at 57.  
22.        Id.
23.        Id. (citing Hooper).
24.        44 F. Supp. 2d 628 (S.D.N.Y. 1999).
25.        Id. at 650.  
26.        See id. at 650-51.  
27.        Id. at 652.
28.        1998 WL 851591, *3 (S.D.N.Y. Dec. 9, 1998).
29.        See generally Szalkowski v. Asbestospray Corp., 259 A.D.2d 867, 686 N.Y.S.2d 243 (3d Dep’t 1999) (indemnity did not cover third party claim which was the result of claimants’ own negligence, in part because the drafter “had the expertise to include language therein to insure protection from its own negligence . . . [and] failed to do so”).

30.        74 N.Y.2d at 491-93, 548 N.E.2d at 905, 549 N.Y.S.2d at 367.  The court Promuto v. Waste Management, Inc., discussed above, distinguished the notice and opportunity to defend provision there from the one at issue in Hooper on the basis that the provision in Promuto expressly limited its application to third-party claims:  “(b) In the event that any third party asserts a claim against any [Seller Indemnitee] which may result in a claim for indemnification against the Purchaser, then such Seller Indemnitee shall promptly give written notice to the Purchaser of such claim.”  44 F. Supp.2d at 651 (emphasis added).  The Promuto court held that such language “evinces a clear intent to distinguish between inter-party claims and third-party claims, with the notice and assumption of defense provisions applying exclusively to the latter.”  Id.
31.        851 F. Supp. 106, 111 (S.D.N.Y. 1994).
32.        Id. at 108.  
33.        Id. at 110.  
34.        74 N.Y.2d 686, 541 N.E.2d 402, 543 N.Y.S.2d 373 (1989).
35.        Breed, Abbott & Morgan v. Hulko, 139 A.D.2d 71, 72, 531 N.Y.S.2d 240, 241 (1st Dep’t 1988) (affirmed by the case cited immediately above).  

36.        Breed, Abbott, 74 N.Y.2d at 687, 541 N.E.2d at 403, 543 N.Y.S.2d at 374 (quoting the First Department).
37.        74 N.Y.2d at 493-94, 548 N.E.2d at 906, 549  N.Y.S.2d at 368.
38.        293 A.D.2d 325, 663 N.Y.S.2d 160 (1st Dep’t 1997).
39.        243 A.D.2d at 326, 663 N.Y.S.2d at 161.  
40.        82 F. Supp. 2d 227 (S.D.N.Y. 2000).
41.        1997 WL 431119 (S.D.N.Y. July 31, 1997).
42.        60 Misc. 2d 424, 303 N.Y.S.2d 556 (Sup. Ct. N.Y. Cty.), aff’d, 32 A.D.2d 898, 302 N.Y.S.2d 722 (1st Dep’t 1969).
43.        Health Management Sys., 82 F. Supp.2d at 236 (citing Hooper and its progeny); see also id. (Sierra Rutile and Barry “cannot be reconciled with the general rule in New York that attorneys’ fees may not be awarded unless there is specific statutory or contractual authorization”).  A line of Delaware cases interpreting Delaware General Corporation Law § 145, the directors and officers indemnification provisions, has concluded that the language therein also is not specific enough to allow for “fees on fees.”  See, e.g., MCI Telecomm. Corp. v. Wanzer, 1990 WL 91100 (Del. Super. Ct. June 19, 1990) (acknowledging that the court in Barry allowed for fees on fees under the New York BCL, but holding that the Delaware statute did not permit such fees and “refus[ing] to depart from the general ‘American’ rule that each party to a litigation will be responsible for the costs associated with bringing claims in the absence of specific statutory authorization for such costs”); Cochran v. Stifel Fin. Corp., 2000 WL 28672

2 (Del. Ch. Mar. 8, 2000) (holding that neither §145 nor the company’s by-laws allow for fees on fees).  Indeed, in Mayer v. Executive Telecard, Ltd., 705 A.2d 220 (Del. Ch. 1997), another decision construing §145 as not providing for fees on fees, the court reasoned that ‘[t]he [Delaware] Legislature could also have included language explicitly granting a successful claimants ‘fees for fees,’ as other states have done in their statutes,” and cited as examples Ga. Code Ann. §14-2-854(b) (1996); Ind. Code Ann. §23-1-37-11 (Burns 1996); and Model Business Corp. Act §8.54(b) (1993).  See also Davis & Cox v. Summa Corp., 751 F.2d 1507, 1528 (9th Cir. 1985) (applying Delaware law and affirming denial of fees on fees because “[t]he Delaware statute, unlike the California statute, does not provide for the recovery of attorneys’ fees and expenses incurred in establishing an indemnity claim”).  
44.        Id. (citing Thyssen, Inc. v. S/S Eurounity, 21 F.3d 533, 541 (2d Cir. 1994)).  But see Fleisher v. Fed. Deposit Ins. Corp., 70 F. Supp. 2d 1238, 1242 (D. Kan. 1999) (construing language in Kansas corporate indemnification statute and company’s by-laws indemnifying for fees “actually and reasonably incurred by such person in connection” with the defense of the underlying action to include fees on fees).

45.        Id. at 231.  Similar logic was applied by the Delaware Supreme Court to award fees on fees in Pike Creek Chiropractic Center, P.A. v. Robinson, D.C., 637 A.2d 418, 422-23 (Del. 1994).  Overruling the trial court, the Supreme Court construed an indemnification clause in an employment contract – which required defendant to hold harmless and indemnify plaintiff against “any liabilities and expenses, including attorney’s fees” resulting from plaintiff’s acts or omissions — to provide for fees on fees “because [plaintiff] will not be held harmless from [defendant’s] acts or omissions unless it receives all legal expenses and attorneys’ fees it has incurred, including those incurred in enforcing the Indemnification Clause.”  Id.; but see Jackson v. Turnbull, No. 13042, at 10 (Del. Ch. May 22, 1995) (“The argument that the director would not be made whole if that director were required to pay the costs of this motion out of his own pocket has a certain appeal;” however, this argument “has appeal in every case in
 which a plaintiff has to go to court in order to vindicate a right, even a clear right, whether it’s a right that arises under the corporation law, contract law or tort law”).
46.        Id.
   
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