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Associations and Management Companies Must Balance Competing Interests and Indemnification Clauses
The owner of a mid-rise suburban condominium had been complaining to the manager for months about water leaks in her unit, to no avail. Predictably, the water damage created mold, the mold made the owner sick, and she sued the association for damages. The association then sued the association’s management company and the management company counter-sued, each claiming that the other was the negligent party. The result: a complicated and costly — not to mention counterproductive — legal mess that a properly worded indemnification clause in the management contract could have avoided.
Given the continual increase of litigation in associations, the insistence of community association managers and management companies on including indemnification clauses in their contracts is not surprising. Very few contracts now do not contain indemnification clauses and “hold harmless” language, which reflects a manager’s understandable desire to limit litigation risks. Managers worry about damages resulting from errors they might make (or be accused of making) in the course of doing their job and about being named in law suits filed against the association, despite having no direct or indirect involvement in the subject of the complaint. Since indemnification or “hold harmless” language can have sweeping ramifications for both parties, its inclusion needs thoughtful consideration and a thorough review by legal counsel.
Competing Interests
Of course, management companies prefer complete indemnification while community associations prefer to offer no indemnification. Although negotiations can achieve an acceptable middle ground for both parties, how these parties balance their competing interests varies, depending on the parties’ needs and the relative strength of their negotiating positions. No two negotiations are exactly alike, so no “standard” wording for hold harmless clauses exists. However, the following example illustrates features common to many of them:
The association 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.
The purpose of this language is to define when the association has the duty to indemnify its manager and when the manager incurs the liability arising from his or her actions on the job. Specifically,
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The management company is liable only for damages resulting from gross negligence or criminal behavior. This standard sets a high legal bar, making managers liable for blatant dereliction of their duties, but not for ordinary mistakes made in the course of the job. For example, in a “slip and fall” suit filed against the association and its manager, the manager’s delay in ordering snow removal and sanding after a snow storm would likely be deemed simple negligence, triggering the association’s duty to indemnify the manager. If the manager, however, completely failed to request snow removal service, such failure would likely qualify as gross negligence, making the manager responsible for any resulting damages. Therefore, when gross negligence or criminal acts are not involved, the association covers the cost of defending suits arising from the management company’s contractual relationship with the association.
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In addition, the indemnification clause clarifies that, even when a manager is accused of gross negligence or criminal wrongdoing, the association has the duty to pay the manager’s defense costs until a court, following all appeals, finds the management company guilty of such behavior. In this manner, a manager accused of gross negligence or criminal wrongdoing is protected from paying defense costs until the allegations are proven.
Insurance Overlay
Financial concerns underlie both a management company’s insistence on indemnification and an association’s questions about how much indemnification is necessary or appropriate. Both parties worry about the cost of fighting law suits as well as the prospect of paying a large damage claim. If an association has appropriate insurance coverage, the majority of these concerns can be alleviated. An association’s commercial general liability (“CGL”) policy should include its manager as a named insured. This inclusion provides the manager with automatic coverage for negligent acts resulting in personal injury or property damage. To clarify this point, language should be added to the indemnification clause stating that indemnification applies to any situation covered by insurance. Since the association pays the insurance premium anyway, including the manager in the coverage does not increase costs to the association.
An association should also name its manager in its Directors and Officers (“D&O”) liability policy, which typically covers areas, usually excluded by an association’s general liability policy, such as discrimination claims or allegations that the manager acted improperly. The D&O policy creates the equivalent of errors and omissions coverage for the manager, which many management companies do not carry as they find the cost of D&O coverage prohibitive.
Despite having the appropriate insurance coverage, associations sometimes still name their manager as an added defendant in lawsuits filed against the association. This situation usually results from unclear indemnification language and an association’s failure to read its insurance policy carefully enough to realize that it also covers the manager. Unfortunately for the association, once the association names its manager in the suit, as a covered party under the policy, the manager is entitled to a separate defense. Now the association and its manager are fighting each other and the person bringing the suit, instead of joining together to defend against the claim. At minimum, this situation wastes valuable resources; at worst, it may also seriously weaken their defense.
For these reasons, associations must ensure that the indemnification language accepted mirrors the type and amount of their insurance coverage. Therefore, many associations may want to review their coverage limits as the standard one million per claim cap will likely prove less than adequate when considering the prevalence of multi-million dollar awards.
Closing the Gaps
Although adequate insurance coverage addresses most indemnification concerns, it does not cover all of them. For example, insurance policies vary as some cover defense costs but exclude payment of a judgment, or vice versa. In addition, insurance companies will not even cover some areas, such as mold and terrorism-related damages currently and prominently among them.
Management companies, which want no part of potential mold liability, argue that mold problems sometimes begin inside owners’ units, for which management has no responsibility or control. Associations, which are equally nervous about mold claims, often contend that the management company should be completely accountable for the quality of its maintenance service. This difference of opinions illustrates another issue that the parties must resolve to succeed in negotiating an acceptable indemnification clause.
One possible solution is to allocate who is responsible for what. The management company might say, “We should be defended in any situation in which we followed the association’s directions.” For example, if the association orders its manager to wrongfully terminate an employee, it seems fair for the association to shoulder the liability for any resulting damages. The association, in turn, might say that manager indemnification doesn’t apply when the board, relying on its manager’s expertise, follows its advice. Choosing adequate insurance coverage provides an example. Boards often rely on the manager to place and maintain adequate insurance coverage and if the manager fails to do this, then the manager, arguably, should have some liability for the losses. The indemnification language can be structured to distinguish between situations in which one party or the other is giving instructions or following orders; providing expert advice or relying on it.
What’s Good for the Goose
Some associations take the position that if they offer indemnification to their management company, the management company should offer indemnification in return. Like management companies, these associations argue that they should not have to assume the defense costs in suits in which the association is named simply because of its contract with the management company. For example, an association should not have to pay the defense costs in a suit filed by an employee of their management company for wrongful termination in which the fired employee includes the association as a potential “deep pocket.”
Management companies, however, usually resist offering any kind of indemnification. 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. Fortunately, compromises almost always seem to be reached. We have never seen or heard of a situation in which a contract negotiation has broken down because the association and the management company failed to agree on indemnification language. Even well-written indemnification clauses cannot prevent all disputes, but thoughtfully structured indemnification language can reduce the potential for serious ones.
Management companies and associations both have legitimate indemnification concerns and equally valid needs to protect their interests. Unfortunately, in the honeymoon period that follows the decision to sign a contract, both sides, focused on beginning the relationship, do not pay the necessary attention to the indemnification wording.
If all goes well, as it often does, the contract, once drafted, is stuffed in a drawer and forgotten. But like marriages, management company-association relationships are not always smooth, and indemnification details can have a dramatic effect on the resolution of potentially difficult and expensive problems. Although indemnification clauses are not triggered often, when they are, neither associations nor managers want to discover that they have waived a protection better insisted on or accepted a provision better rejected.
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