Associations and Management Companies Must Balance Competing Interests in Indemnification Clauses

Published on: April 22, 2005

Litigation having become something of a national pastime, the odds of being sued are now, if not quite as high as the likelihood of catching a cold, close enough to make risk reduction a major concern in the community association industry, as it is in virtually every other business sector. It is not surprising then, that community association managers and management companies almost always insist on including indemnification clauses in their contracts.

Because my firm represents community associations and works closely with management companies, we don’t get involved in negotiating management contracts. But we do understand the competing interests involved and can talk about indemnification clauses from that perspective, focusing on the issues that association boards and managers need to consider in determining the protections they want and are willing to offer. The most important point, and it applies equally to both parties, is that the indemnification or “hold harmless” language has potentially sweeping ramifications for both parties, and should be considered thoughtfully and reviewed thoroughly by legal counsel.

Competing Interests

Indemnification clauses have become something of an industry standard; we don’t see many contracts any more that don’t contain this language, which reflects a management company’s understandable desire to reduce its litigation risks. Managers are concerned both about suits resulting from errors they might make (or be accused of making) and about suits filed against the association in which managers might be named, even if they have no involvement, direct or indirect, in the complaint.

In an ideal world, management companies would like to be indemnified completely for everything, while community associations would prefer to offer no indemnification at all. Negotiations typically carve out a middle ground acceptable to both, but how the two sides balance their competing interests will vary, depending on the needs of the parties involved and the relative strength of their negotiating positions. Because no two negotiations will be exactly alike, there is no “standard” wording for hold harmless clauses, but the following example illustrates features common to many of them:

“The trust shall defend and indemnify and hold management harmless from all claims, actions, damages, costs, and reasonable attorneys’ fees incurred arising from the performance of its duties under this agreement, including, but not limited to, claims, actions, damages, costs and attorneys’ fees for personal injury, bodily damage or property damage relating to or arising out of any claim or action relating to mold, mildew, fungi or moisture or terrorist acts, unless management is adjudicated by a court of competent jurisdiction, and after all applicable appeal periods, to have acted with gross negligence, or to be guilty of criminal acts.”  This language makes two key points:

  • The management company will be on the hook only for damages resulting from “gross negligence” or criminal behavior. This sets a fairly high legal bar, making companies liable for blatant dereliction of their duties, but not for mistakes they might make in the course of doing their job. An example would be a “slip and fall” suit filed against the association and the manager. The manager’s delay in ordering snow removal and sanding after a snow storm would be deemed simple negligence, to which the indemnification would apply, while the failure to request snow removal service would probably qualify as “gross negligence” for which the manager should be responsible.
  • Except for situations involving gross negligence or criminal acts, the association will cover the cost of defending suits arising from the management company’s contractual relationship with the association. Additionally, this language makes it clear that the indemnification and the association’s responsibility for paying legal defense costs will apply until a court, following all appeals, finds the management company guilty of gross negligence or criminal wrongdoing. The logic here is that a manager accused of negligence or wrongdoing isn’t necessarily guilty and should not have to pay the defense costs unless the allegations are proven.

Insurance Overlay

The management company’s insistence on indemnification and the association’s questions about how much indemnification is necessary or appropriate, all come down to money – the cost of fighting law suits and the prospect of having to pay a large damage claim. The concerns on both sides largely disappear if the association has appropriate insurance coverage in place. Specifically, the association’s commercial general liability policy should include the manager as a named insured. This would cover the manager automatically for negligent acts resulting in personal injury or property damage.

The manager should be named as well on the association’s Directors’ and Officers’ liability policy, which will typically cover areas the liability policy excludes, such as discrimination claims or allegations that the manager acted improperly. The D&O policy actually creates the equivalent of errors and omissions coverage for the manager, which is a good thing, because many management companies find the cost of E&O coverage prohibitive and don’t carry that protection as a result.

The important point here is for associations to make sure the indemnification language they accept mirrors both the type and amount of insurance coverage they have in place. In that context, many associations may also want to review their coverage limits; the standard $1 million per claim cap is likely to prove less than adequate when you consider that multi-million dollar awards have become commonplace today. Although insurance addresses most indemnification concerns, it doesn’t cover all of them. For one thing, insurance policies vary – some may cover defense costs but exclude payment of a judgment, or vice versa; and there are some areas insurance companies won’t touch at all, mold and terrorism-related damages currently and prominently among them.

Management companies, which want no part of potential mold liability (and who does?), point out that mold problems sometimes begin inside owners’ units, for which management is not responsible and over which they nave no control. Associations, which are equally nervous about mold claims, often contend that the management company should be completely accountable for the quality of the maintenance service it provides. This is another negotiating point the parties will have to resolve.

What’s Good for the Goose

Some associations take the position that if they are going to indemnify their management company, the management company should indemnify the association as well. Turning the managers’ argument around, these associations say they shouldn’t have to assume the cost of defending suits in which the association is named simply because it happens to have a contract with the management company. An example might be a wrongful termination suit an employee files against the management company that names the association – a perceived potential “deep pocket” — as a defendant, too. Management companies, for their part, usually resist offering indemnification of any kind. How this question is resolved will depend, again, on how strongly the two sides feel about it and how much, or how little, each party is willing to concede.

The fact is, management companies and associations both have legitimate concerns about the indemnification language and an equally valid need to make sure their interests are protected. Unfortunately, in the honeymoon period that follows the decision to sign a contract, both sides can be so focused on getting the relationship going, they don’t pay as much attention to the indemnification wording and other contract details as they should.

If all goes well, as it often does, the contract, once drafted, will be stuffed in a drawer and no one will ever think about it again. But like marriages, management company-association relationships aren’t always smooth, and the indemnification details can have a dramatic effect on how potentially difficult and expensive problems are resolved. Indemnification clauses aren’t triggered very often, but when they are, you don’t want one side or the other to discover too late that they have given up a point on which they should he held firm, or accepted a provision they now wish they had rejected.