Understanding Indemnification Clauses in Management Agreements
Most agreements for providing a homeowners’ association with management services are standard form documents that have been prepared by the management company. As such, they typically contain language that has been drafted in a manner that is most protective of the manager and not the homeowners’ association. These agreements are then presented to an association’s board of directors for approval and signing. In the typical scenario, one or two members of the association’s board review the document without the assistance of legal counsel, and then present it to the full board of directors for discussion and approval in accordance with their recommendations. In reviewing the proposed agreement, the provisions that are most frequently scrutinized are those that relate to the scope of the services being provided and the cost of those services.
Virtually every management agreement contains clauses that are rarely analyzed or fully understood by the person who is reviewing the document on behalf of the association. This person is generally a volunteer board member that lacks the requisite expertise to understand the implications of particular language contained in the management agreement. One such clause is known as an “indemnification clause.” The indemnification clause has the potential to result in drastic consequences for an unwary association by causing it to become responsible for improper acts committed by the property manager. As such, an association’s board of directors should never enter into a property management agreement without fully comprehending and accepting the provisions in the document that relate to indemnification.
Indemnification involves the assumption of responsibility and liability for particular acts. Most people understand the concept of indemnification in an insurance context where, in exchange for the payment of a premium, an insurance company agrees to indemnify an insured in the event of a covered loss by paying for the damage. When a homeowners association agrees to indemnify its property manager, it is becoming an insurer of the manger’s losses. Thus, when an association accepts that responsibility it is crucial that it is fully aware of the full nature and extent of the losses for which it is accepting responsibility.
The following undesirable indemnification clause has been extracted from a commonly used standard form property management agreement that favors the property manager:
Indemnification:
The Association shall indemnify, defend at its sole cost (with counsel selected by Company) and hold Company and its employees, agents, representatives, officers, directors, and shareholders harmless from and against any and all claims, demands, actions, liabilities, losses, damages, injuries, costs and expenses (including, without limitation, actual attorney’s fees and defense costs) arising directly or indirectly out of, or in connection with or related to, this Agreement or in connection with the management, operation, or condition of the Association, including any and all claims and damages and liability for injuries suffered or death or property damage incurred relating to the Property, except to the extent any such liability is due to the sole willful misconduct or gross negligence of Company and/or its employees.
This provision to indemnify Manager and its employees, agents, representatives, officers, directors, and shareholders also relates to any and all acts, errors, or omissions, statements or representations made by Company in the performance and/or non-performance of this Agreement, Manager’s duties, and relating to any and all contractual liabilities and non-contractual liabilities which may be alleged or imposed against Company or Association.
The obligation of Association to indemnify, defend and hold harmless includes but is not limited to the obligation to pay for, on a current basis, all costs of defense of Company in any action, which costs include but are not limited to the payment of all fees and expenses for legal, expert, accounting or other professional services needed to defend any action brought by any person or entity for which indemnification and defense of Company is called for hereunder.
Notwithstanding any other provision of this Agreement to the contrary, the Association’s obligations under this Section shall survive the expiration and/or termination of this Agreement for any reason whatsoever and shall bind any and all of the heirs, successors, assigns and/or transferees of the Association. Further, this provision shall not be limited by any applicable insurance coverage available to the Association or Company hereunder.
Company will be responsible only for any willful misconduct and gross negligence where such liability is due to the sole conduct of Company and/or its employees in the performance of its duties under this agreement.
The following dissection of the first paragraph in the above clause will demonstrate the undesirability of that clause from the perspective of a homeowners’ association:
a. “The Association shall indemnify, defend at its sole cost (with counsel selected by Company) and hold Company and its employees, agents, representatives, officers, directors, and shareholders harmless from and against any and all claims, demands, actions, liabilities, losses, damages, injuries, costs and expenses (including, without limitation, actual attorney’s fees and defense costs).”
This language: (i) obligates the association to pay all costs, including legal fees, court costs, expert witness fees etc. incurred by the management company and any of its employees, agents, representatives, officers, directors and shareholders in connection with “claims, demands, actions, liabilities; (ii) allows for the retention of multiple lawyers by the parties covered by the indemnification; (iii) the selection of the lawyers by the indemnified parties and thus, the “actual” cost of those lawyers– even if they are unreasonable.
b. “arising directly or indirectly out of, or in connection with or related to, this Agreement or in connection with the management, operation, or condition of the Association including any and all claims and damages and liability for injuries suffered or death or property damage incurred relating to the Property, ”
This language extends the indemnification to essentially cover all types of claims, demands, actions etc. that may be asserted against the indemnified parties.
c. “except to the extent any such liability is due to the sole willful misconduct or gross negligence of Company and/or its employees.”
This language, which is the only language that limits the extent of the indemnification, provides that the association is not indemnifying against liability that results from either “the sole willful misconduct,” or the “gross negligence” of the manager and/or its employees. Use of the language, “sole willful misconduct” protects the manager when the damage in question resulted from acts that were partially, or mostly, caused by the manager’s and/or its employees’ negligence and from all acts that resulted from ordinary negligence (acts that were not due to “willful misconduct” or “gross negligence” .
An indemnification clause should include coverage relative to ordinary negligence and an association’s indemnification of its property manager and/or its employees etc. should only apply to damages that are caused to the manager and/or its employees by the association’s negligence. An association retains a property manager to do the right things for the association and it should not be responsible for the negligent acts of its manager or the manager’s employees. Fundamental rules of fairness dictate that each party should be held responsible for damages that are suffered by others due to their negligence. Thus, a balanced indemnification clause in a property management agreement should provide for reciprocal liability on a property manager and indemnification of the association when the negligent acts of the manager and/or its employees have caused damage to the association.
Associations should also be aware of the extent to which their insurance coverage will cover the acts of its property manager and the property manager’s employees. Insurance coverage does not cover any and all obligations that may be assumed by a homeowners’ association in their property management agreement. Typical insurance policies limit coverage to liability for damages to the extent caused by the insured’s negligence and do not provide coverage for reckless or intentional acts.
Because indemnity clauses contained in management agreements provided by property managers tend to contain provisions that are more favorable to the property manager, it is critical for an association’s board of directors to thoroughly review the proposed agreement and be aware of the exact language used. Considering the potential adverse ramifications that can come from one-sided provisions, it would be a prudent investment to have legal counsel review and counsel an association regarding a proposed management agreement before it is entered into.
Associations that are currently bound by management agreements that contain undesirable provisions should plan to renegotiate and rewrite unfavorable clauses prior to a renewal of the agreement or upon entering into a new agreement. When it comes to the indemnification provisions, an association’s board of directors should be aware of: (i) the scope and terms of the indemnification language in the contract; (ii) the extent of insurance coverage in the association’s insurance policies for acts of the property manager; and (iii) the existence and extent of insurance coverage provided for the association by the manager’s insurance policies. Being aware of these items and properly addressing them will greatly reduce the association’s exposure to liability for actions of its property manager.