What Constitutes a Deductible Indemnity Agreement?
Although not commonly used, a deductible indemnity agreement ("DIA"), also referred to as a deductible reimbursement agreement, is what it sounds like: an agreement by which the indemnitor agrees to pay the indemnified party’s deductible(s) up to a specified maximum amount. For example, if the indemnified party’s insured incurs $2 million in covered loss and is subject to a $1.5 million deductible, a deductible indemnity agreement would require the indemnitor to reimburse the first $1.5 million to the indemnified party, with the indemnified party being responsible for any amounts above its deductible. As drafted , DIAs generally are reciprocal and would require both parties to reimburse the other parties’ deductible.
DIAs are not unique but rather resemble the retained risk provisions found in many claims-made-and-reported insurance policies, whereby the insured, as in the DIA example above, is expected to pay some or all of its deductible before turning to its insurer for coverage. In context of liability policies, the liability insurer often pays all of the indemnified party’s covered losses above the policy retention and then pursues its insured for the amount of the retention. The primary difference is that indemnity agreements are not typically insurance. As a result, they do not evoke the same duties, rights, and obligations as an insurance policy might impose.
The Main Aspects of Deductible Indemnity Agreements
The first critical element in the deductibles analysis is of course the unexpected death of an insured or the incurred expense of defending indemnified parties. Then it is essential to determine and understand 1) the relationship between the parties; 2) the terms of the arrangement; and 3) the most common requirements relating to the deductible and the indemnity.
Parties
Most commonly, there are three (3) parties: the indemnitor, the indemnitee, and the credit company. In most cases, the party who is providing the funds to cover the costs associated with a loss, also indemnifies the other parties to the agreement.
In general, the liability imposed on the indemnitor to provide funds or to indemnify any party to the agreement is limited to the amount of the deductible or the liability for which the indemnifying party assumes responsibility. In some cases, the liability has no limit.
There are also common exclusions included in these agreements. These exclusions can include, but are not limited to, costs associated with defense and/or primary insurance, punitive damages, and claims made outside of the specific term of the contract.
Terms
Areas of focus for the terms of the agreement include:
Insuring Agreement
Deductible
Monetary Limits
Duties
Indemnities
Exclusions
Each "term" will define how the parties relate to each other.
Indemnification and Indemnities
Although there may not be a definition of "indemnification" in a particular agreement, the legal meaning defined by Black’s Law Dictionary as "[the] appropriate relationship that exists between a third-party wrongdoer and a party injured by that wrongdoers act or omission, or between an insurer and the insured," might still apply.
Indemnities are typically defined in the agreement between the parties as a "[c]ontractual obligation (often contained in an insurance policy) of one party to compensate another for the latter’s actual losses." Indemnities apparently appear in every business deal or agreement and allow a party to "provide [] protection against the actions of a third party."
Disclaimer
This article discusses Supreme Court of California findings. The findings are not specific to your deductible indemnity agreement and are not specific to California’s laws.
The Advantages of Deductible Indemnity Agreements
Commonly referred to as a "deductible," an indemnity agreement in an insurance policy may be beneficial for both insurers and insureds, at first blush. A deductible is an amount paid by an insured before insurance coverage sins in. Deductible indemnity agreements are beneficial to both insurers and insureds because they are generally less costly than traditional policies. In fact, insurers often charge less for deductible indemnity agreements because it is generally less likely that an insured will file a claim, as opposed to a policy where the insurer deducts the cost of the claim from its general funds.
Many property damage and personal injury claims can be quite costly. An insured is responsible for the cost of claim or an agreed upon portion of the claim that is subject to the provisions of the deductible indemnity agreement. An insured may control the cost of coverage by insightfully negotiating a deductible that is manageable for its business.
Deductibles are designed to create an incentive for insureds to control loss. Where a deductible indemnity agreement is structured correctly, it will protect insureds from overzealous use of insurance. Thus, although at first blush, deductible indemnity agreements may not appear to be attainable, both insurers and insureds find them beneficial because they prevent over-engagement from either party.
Potential Risks Involved
One aspect to consider is the financial exposure for both the indemnitor and the indemnitee. There are several privacy laws and breaches for which the liability can be absorbed by a deductible indemnity agreement. For example, FCRA has an aggregate limit per year, so if there are 1000 claims for $500 each, the indemnitor may be liable for $200,000. Course of conduct could add up quickly as well. Similarly, a Personal Injury Protection ("PIP") claim under a particular state no fault law could lead to the indemnitee being responsible for all PIP damages due to the annual limit.
Disagreements between liability, albeit on the first party level or the third party level, over the deductible amount are common. It is important that the parties have a clear understanding on how to arbitrate the amount of damages owed in the event of a disagreement. Keeping in mind that the parties can define a facilitator and outline how that facilitator interacts to resolve disputes, it is an important aspect to have in place from the beginning. A third party claims adjuster is also an option.
Things to consider for the policyholder are:
• Negotiating the amount of the deductible – There is often a negotiation here between the risk management of the insured and the insurer.
• Retain the A team – Having qualified legal and loss prevention councils are imperative for this unique type of coverage
• Risk assessment – Having adequate stop gaps to remediate against breaches outlined in the policy so as to avoid liability in the first place will limit exposure.
• Seeking counsel – No matter what route a policyholder chooses, they would be wise to seek counsel experienced with these types of agreements.
Legal and Regulatory Considerations
Section 111 of the Medicare, Medicaid, and SCHIP Extension Act of 2007 (MMSEA) requires that an applicable plans that provide, or indirectly cover, the medical expenses of any kind be identified and reported in all insurance policies, self-insurance arrangements, and no-fault insurance as set forth in the MMSEA. This reporting is required for any applicable plans that have a deductible component, including indemnity plans . The Medicare Secondary Payer Mandatory Reporting (MSP) provisions contained in the MMSEA require insurers, employers, workers compensation intermediaries, and others, identified as Responsible Reporting Entities (RRE), that provide or are peripherally involved in the process of providing medical services and supplies in various manners, to report settlements, coverage, or similar payments to the Medicare Coordination Center if such settlements, coverage, or payment includes a Medicare beneficiary and a deductible. The Centers for Medicare & Medicaid Services (CMS) is responsible for overseeing the reporting requirements. Failure to comply with reporting requirements carries with it serious legal consequences. If you believe your organization has in any way violated the reporting requirements, it is imperative that you take immediate action to address any discrepancies.
Negotiating a Deductible Indemnity Agreement
Negotiating an agreement which provides for indemnity or other protection where parties have agreed to be responsible for some or all losses under an insurance policy can be done in various ways. A basic consideration is whose loss is subject to the deductible. Where a party will not be filing a claim under the insurance policy, a deductible clause should provide that the deductible will be for the account of the party with a loss. Where a deductible is payable, it should not be recoverable from a party which incurred the loss.
A deductible which is applicable as between parties where only one of them is a two-way street should operate in like fashion between parties who are subject to a deductible. Thus, if the deductible is 100 primary, 50 excess, where the deductible is applicable only to the primary layer, the deductible should be held to 100 as between those parties.
Where the indemnity is in respect of a contractual loss, consideration should be given as to whether the deductible will no longer apply where the insured is only liable to indemnify losses in respect of a cap or deductible under the contract. Normally, the indemnitor would be liable for the deductible.
Indemnity against liability coverage may be precluded where the policy contains a deductible which is entirely in excess of the ordinary course business conduct type of deductible. In that circumstance, the court will look at the conduct of the insured in the type of activity at issue. If the action was in the course of business, the deductible will apply. If outside, it will not. But in any event, an indemnity clause should be negotiated which protects against the imposition of a deductible which monetary amount is unrelated to the policy’s deductibles for losses arising out of the regular course of business.
Where a deductible exists in respect of property cover, if the contractual loss involves a loss in respect of accumulated insurance proceeds, they will be lost to the extent of the deductible applicable to the contractual loss. To address this possibility, a deductible should be incurred in terms of any arrangement with respect to insurance proceeds, not with respect to "the Insuring Agreements". Other language is often used as well, such as deductibles "with respect to" any indemnity or insurance arrangements or for "each loss insured under" any insurance. Use of the word indemnity here may be problematic and subject to evidence of the intended meaning. Such wording could relate to indemnity outside of insurance or under an insurance policy.
Real-World Examples and Applications
Deductible indemnity agreements are commonly used when employers need to shift liability for payment of attorneys’ fees to their employees. The contractual promise to reimburse a client for attorneys’ fees has long been held to be sufficient to establish an exception to the attorney/client fee-shifting rule. As a result, many law firms have entered into deductible indemnity agreements with their clients in which the law firm agrees to pay their own attorneys’ fees up to a certain amount and which contain a carve-out from the typical fee-shifting rule for employees who sue the firm or the firm’s partners. Of course, the extent to which a law firm can enforce such an indemnity agreement against its client will depend on the applicable law and the particular circumstances of the case.
For example, in McKenna Long & Aldridge LLP v. Infusion Dev., Inc., 2014 WL 4630316 (Del. Super. Ct. Sept. 8, 2014), McKenna entered into an engagement agreement with a start-up company to provide legal services on an open-account basis. The engagement agreement contained an indemnification provision that stated: "If a party seeks indemnification hereunder, the other party shall be responsible for payment of the first $500.00 in fees and expenses incurred by the indemnified party in regard to such claim, demand, action or cause of action." The majority of McKenna’s fees were paid each month under the engagement agreement. However, after McKenna withdrew from representing the startup, it informed the company that it would no longer waive the requirement that the startup pay its attorneys’ fees as incurred. When the startup filed a counterclaim against McKenna for breach of fiduciary duty and legal malpractice in connection with the engagement, McKenna incurred additional attorneys’ fees. However, McKenna did not meet and confer with the client before it incurred the additional fees, including the $500 cap in the indemnity provision. In response to McKenna’s motion for summary judgment on its claim for attorneys’ fees, the Delaware Superior Court found that by not refuting the existence of the contract or challenging the enforceability of the provision at the time McKenna incurred its post-withdrawal fees, the client had waived its objections. Nonetheless, the Superior Court denied McKenna’s motion for summary judgment for the full amount of its fees because there were factual disputes in need of resolution as to the reasonableness of some of McKenna’s hours. Nevertheless, the court limited McKenna’s damages, for purposes of the contract claim, to the $500 deductible limit in the indemnity provision.
In a subsequent decision, the court entered judgment against the client for $499 and denied one of McKenna’s motions for sanctions against the client for litigation conduct. The court found that the client had behaved unreasonably by making meritless arguments for denying liability. However, the court denied sanctions because McKenna had not submitted evidence of its fees incurred in making the claim for sanctions.
Another state court decision involving an indemnity provision, Hayward v. Kelsey, involved the indemnity provision in a merger agreement. 1 F.Supp.3d 1390 (N.D. Ga. 2014). In this case, the plaintiff agreed to be employed by the defendant company as president and CEO for at least five years. The deal was documented in a merger agreement that contained an indemnity provision. The plaintiff, a longtime friend and colleague of the defendant, was also funding the purchase of the company through his separate company by loaning millions of dollars to the defendant. The agreement was negotiated by their respective lawyers over a period of four months. In 2011, the defendant violated a credit agreement with the loan company and the loan defaulted. The loan company moved to enforce the indemnity provision which required the defendant to indemnify the plaintiff for all losses, expenses, costs and fees related to the loan default. The defendant argued in response that the indemnity provision was unenforceable for public policy reasons, citing in support that there was no limit on the amount of indemnity pledged, the indemnity provision did not allow for any reduction in the event of any contribution by the plaintiff, and the defendant was permitted to indemnify itself without a finding of wrongdoing or negligence. The indemnity provision, argued the defendant, would allow a jury to decide a verdict far beyond the five year employment term, essentially giving a perpetual indemnity to the plaintiff. The court, however, disagreed and found that the indemnity provision was consistent with a modern trend to make corporate officers and directors more accountable for their actions, and it imposed no greater risk on the defendant than it would have otherwise.
What these two cases show is that they both involve claims for indemnity relating to attorneys’ fees incurred by the prevailing party — a fee-shifting mechanism not required by law. The result of the contract claims for reimbursement of fees incurred by the prevailing party on the third-party claims therefore seem appropriate since the parties expressly bargained for the indemnity provision.
The Future of Deductible Indemnity Agreements
In recent years, deductible indemnity agreements in the self-insurance field have grown increasingly prominent due to a variety of factors. Two of the more significant triggers for this trend are the reluctance of insurers to extend coverage to past contract terms and rising premiums. Simply put, individuals wish to broaden their scope of coverage and their ability to afford this coverage may lead them to vote in favor of increased deductibles. As the market has cooled, the contracting parties have also tended to have longer lead times to negotiate new deals . In negotiations, the parties are careful to protect themselves from adverse outcomes, by adding in a deductible provision that may be subject to even further negotiation depending on the jurisdiction. It is important to understand that the commercial practices concerning these agreements may develop alongside the law. While currently, the development of case law in this area has been rather limited, parties should be aware of the potential future influence of newer regulations, since we may see the first far-reaching cases in the near future. For example, the consideration of the creation of insurance company arbitrators and the establishment of an arbitration board could both have an impact on the future of deductible indemnity agreements.