Indemnify the Other Party?
LOS ANGELES—“Many real estate agreements—particularly loan documents—contain language whereby one party agrees to ‘indemnify’ the other party. These provisions are increasingly sprinkled throughout agreements without, I believe, enough consideration of their effect.” That is according to Tom Muller, co-chair of land use and real estate practice at Manatt, Phelps & Phillips LLP.
According to Muller, who wrote in the exclusive commentary on the subject below, a typical provision might state that “Borrower hereby agrees to indemnify and hold harmless Lender from and against all losses, costs, claims, liabilities, fines, penalties and expenses, including reasonably attorneys’ and experts’ fees and expenses, in any way arising out of or related to the Loan.”
The views expressed in this column below are the author’s own.
What does all that actually mean?
As a practical matter, it means whatever the Lender’s litigator can persuade a judge it means. Clearly, it greatly expands the potential scope of the Borrower’s liability for virtually any misfortune that might befall the lender that is arguably somehow connected with the Loan.
What should it mean?
Indemnity is most appropriate to address potential third party claims against the indemnified party. For example, it’s entirely appropriate for a lender to require the borrower to deal with—i.e., indemnify lender against—personal injury claims from accidents on the mortgaged property. The lender is not in control of the property, can’t take steps to prevent accidents, and may well end up as a defendant in the law suit anyway.
Where indemnity is applied to mere breach of the contract in which it is contained, however, it is rarely appropriate. There is a well-developed body of law as to what are, and are not, appropriate damages for breach of contract. In most cases, those well-developed principles are fair and should suffice to compensate the other party for losses resulting from the breach. By adding an indemnity on top of those standard contract remedies, the parties invite the litigator for the indemnified party to indulge her creativity in imagining all kinds of remote misfortunes arising from the breach, well beyond even consequential damages. Rarely is that the other party’s intent, and so for the most part indemnities should be limited to third party claims.
One fairly standard market exception to this principle is the environmental indemnity required by most real estate lenders, which memorializes the understanding that the loan is made based on the assumption that the collateral is uncontaminated, and it is borrower’s responsibility to do what is necessary to protect this assumption, both by protecting the lender against governmental cleanup requirements and, if necessary, making up a shortfall in collateral value caused by contamination.
One other unintended consequence of indemnity language arises from lenders’ attempts to include them in loan documents as a carve-out from the limitation on recourse. Obviously, it does little good to limit recourse to losses resulting from a short, specific list of bad acts—and also anything else that can be fit into the incredibly broad language quoted above.
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