Indemnification Clauses in Retainer Agreements and Guidelines: Why Firms Should Say “No”

Charles Davant IV

A GROWING NUMBER of corporate and governmen- tal clients are asking their law firms to agree to indem- nification or “hold harmless” clauses in outside counsel guidelines, retainer agreements, or requests for proposals. Clients are asking to be indemnified against various risks, Charles Davant IV costs, and losses that might arise in connection with their is a partner at Williams & Connolly LLP in Washing- legal matters. E‑discovery vendors, litigation consulting ton, D.C. He represents law firms in legal malprac- tice and professional responsibility matters around firms, and even expert witnesses also are asking law firms the country, and is a member of his firm’s Ethics to indemnify them against future losses. Committee. He also serves on the District of Colum- Law firms agree to such clauses at their peril. Although bia Court of Appeals Committee on Unauthorized Practice of Law and on a District of Columbia Board indemnification clauses can be a sensible tool for allocat- of Professional Responsibility hearing committee. ing risks in some commercial contexts, they are ill-suited to the attorney-client context. They are unnecessary given the many legal and ethical protections that already exist for clients and third parties. Further, such clauses impose catastrophic risks on law firms and their clients, most nota- bly the risk of jeopardizing the law firm’s malpractice or other insurance coverage. This article discusses the rea- sons law firms should say “no” when a client or vendor tries to bind the firm to indemnification language. It also suggests steps law firms should take to lessen their risk in the rare situation where the law firm decides to run the risk of agreeing to some form of indemnification.

THE INDEMNIFICATION FAD • Twenty years ago, it would have been rare for a client, vendor, or expert to request indemnification language. Within the last decade,

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however, a small but growing number have begun be simply a matter of copying the clauses it uses including such language in their (often voluminous) in its commercial vendor relationships.”) (http:// outside counsel guidelines, form retainer agree- www.americanbar.org/content/dam/aba/events/ ments, or requests for proposal. See Gilda T. Rus- professional_responsibility/2014/05/40th-aba-na- sell, Dealing with Client Outside Counsel Guidelines and tional-conference-on-professional-responsibility/ Other Non-Standard Client Engagement Terms (Paragon session13_final_article_re_contracting_ethics.au- Brokers, 2016) (http://www.paragonbrokers.com/ thcheckdam.pdf). Indemnification clauses often are wp-content/uploads/2016/01/Outside_Counsel_ buried in lengthy guidelines that are not provided Guidelines_Article_PDF.pdf). This trend is partly a to law firm personnel until after an attorney-client by-product of larger trends: the expanded use of relationship or engagement has begun. Helen W. outside counsel guidelines; the growing prevalence Gunnarsson, Some Corporate Clients Are Going Too of written retainer agreements (now required by Far With ‘Guidelines’ for Counsel, Speaker Says (Mar. 6, many states’ ethics rules); the perception of a “buy- 2015) (ABA BNA ’ Manual on Professional er’s market” for legal services; increased switching Conduct Mar. 12, 2015) (http://www.bna.com/ of law firms by clients; a shift towards viewing law- corporate-clients-going-n17179923966/). Clients yers as mere vendors rather than advisors; the use may take the position (or the guidelines may state) of “procurement” personnel to hire outside coun- that continued work after receipt of the guidelines sel; client personnel who sometimes do not appreci- constitutes an acceptance of their terms. ate U.S. lawyers’ professional obligations of loyalty, At the broadest extreme, clients ask law firms to diligence, and competence; the growing size of in- indemnify, defend, and hold harmless the client and house counsel’s offices, litigation consulting firms, its personnel from and against any and all costs and and e‑discovery vendors; and the ready availability, losses relating to the law firm’s (or its subcontrac- through publications and internet sources, of boil- tors’) performance of an engagement. One gov- erplate language and guidelines. See Rob ernmental client sought (and obtained) its outside Thomas & Bernadette Bulacan, Outside Counsel Re- counsel’s agreement to the following provision in a tention Agreements (Association of Corporate Counsel retainer agreement: Sept. 16, 2011) (calling on “corporate legal depart- ments to re-tool their relationships to ensure that [Law Firm] agrees to indemnify, hold harm- they receive more value from their outside coun- less, release and defend (even if the allega- sel”) (http://www.acc.com/legalresources/quick- tions are false, fraudulent or groundless), counsel/ocra.cfm?makepdf=1). to the maximum extent permitted by law, In-house counsel who utilize indemnification and covenants not to sue, the City, its City to allocate risk in corporate or commercial con- Council and each member thereof, and its texts have sought to transplant indemnification officers, employees, commission members language and concepts into their employers’ out- and representatives, from any and all liabil- side counsel guidelines, retainer agreements, or ity, loss, suits, claims, damages, costs, judg- requests for proposals, regardless of its suitability ments and expenses (including attorney’s in the attorney-client context. Merri A. Baldwin fees and costs of litigation) which in whole & John Steele, Contracting Ethics? Legal Representation or in part result from, or arise out of, or are between Large Corporate Clients and Law Firms claimed to result from or to arise out of any 4 (ABA Prof ’l Resp. Conf. May 2014) (“Often, performance under this Agreement, or any the client’s use of an indemnity clause appears to acts, errors or omissions (including, with- Indemnification Clauses in Retainer Agreements | 41

out limitation, professional negligence) of computer security. See LogikCull, eDiscovery is the next [Law Firm], its employees, representatives, frontier for hackers, as major law firms now know (Mar. 30, subcontractors, or agents in connection 2016) (http://logikcull.com/blog/ediscovery-next- with the performance of this Agreement. frontier-hackers-major-law-firms-now-know/). This Agreement to indemnify, hold harm- As a final example, imagine a law firm does first- less, release and defend includes, but is not rate legal work drafting a commercial contract for limited to, personal injury (including death its client to use with a potential customer. The law at any time) and property or other damage firm warns the client that the potential customer is (including, but without limitation, contract notorious for filing frivolous lawsuits against its sup- or or patent, copyright, trade secret or pliers and others. The client decides to run the risk trademark infringement) sustained by any of doing business with the litigious customer, which person or persons (including, but not limited later sues the client alleging breach of the contract. to, companies, or corporations, [Law Firm] Even if the client ultimately prevails over its sup- and its employees or agents, and members plier, or pays only a nuisance settlement, the client of the general public). plausibly could contend that the law firm is respon- sible to pay all of the client’s legal fees and the set- Legal Services Agreement Between the City of tlement amount. After all, the law firm agreed to Richmond & Bickmore Risk Services ¶ 17 (Mar. 1, indemnify and “hold harmless” the client from and 2013) (http://www.ci.richmond.ca.us/Document- against any and all costs arising out of or relating to Center/View/26913). its engagement. Such broad indemnification language could For their part, vendors, litigation consulting subject the law firm to strict liability for any number firms, and even individual expert witnesses have of circumstances that develop during an engage- sought similarly broad indemnification language in ment through no fault of counsel or its vendors. their retainer agreements, or have sought language For example, if a law firm that had agreed to the to limit prospectively their liability to the amount foregoing indemnification language filed a lawsuit of fees paid—with the law firm effectively bearing on behalf of its client, and the client’s opponent re- the risk of any additional losses resulting from the sponded by filing counterclaims against the client, vendor’s actions. See Julia Brickell, Mark Cowing the client could argue that the law firm is required et al., Contracting with the E‑Discovery Vendor (http:// to defend the client (at the law firm’s cost) and pay www.shb.com/~/media/files/professionals/cow- any settlement or judgment connected with the ingmark/contractingwiththeediscoveryvendor. counterclaims. As another example, if a law firm pdf ?la=en). made a reasonable judgment on a tactical matter (i.e., whether to call a particular witness at trial), the A SOLUTION IN SEARCH OF A PROBLEM client could argue that the law firm is financially • Historically, an indemnifying party agreed (in ex- responsible, under the indemnification clause, for change for compensation) to be financially respon- negative consequences that allegedly flowed from sible for possible future losses—losses for which it that judgment. If a law firm’s electronic document- would not otherwise be liable. See Eugene L. Grant, hosting vendor were “hacked” and a client’s due Avoiding the Risks: Subrogation, Indemnification, and Ex- diligence files or other data compromised, the law culpation in the Context of Commercial Leases, 21 Real firm arguably could be liable even though it had Est. L.J. 255, 257 (1993). The classic example of selected a reputable vendor with state-of-the-art an indemnifying party is an insurer, which agrees 42 | The Practical Lawyer June 2016

(in exchange for premium payments) to pay the Clients already are amply protected without in- insured for losses caused by third parties or acts demnification clauses, and law firms already have of God. An indemnifying party typically receives powerful incentives to protect their clients’ inter- significant compensation for assuming the risk of ests. Lawyers and law firms are legally and ethically events beyond its control. bound to comply with a complex legal and regula- In most contexts, a party’s agreement to indem- tory framework that has evolved primarily for the nify against its own breaches of legal or contractual protection and benefit of clients: duties would be largely superfluous, because the party already would be liable for its own acts or The attorney’s obligations . . . transcend omissions under tort or theo- those prevailing in the commercial market ries. Parties already have incentives, regardless of place. The duty to deal fairly, honestly and indemnification, to use reasonable care to prevent with undivided loyalty superimposes onto losses for which they would be liable. Moreover, the attorney-client relationship a set of an indemnification clause generally will not ensure special and unique duties, including main- much additional financial protection for a party taining confidentiality, avoiding conflicts of that already has a right of recovery through tort or interest, operating competently, safeguard- contract claims. ing client property and honoring the clients’ The lawyer-client relationship does not fit the interests over the lawyer’s. traditional indemnitor-indemnitee model. For one thing, law firms are not compensated like insurers. Johnson v. Proskauer Rose LLP, 9 N.Y.S.3d 201, 211 Law firms are paid fees, usually on an hourly basis, (N.Y. App. Div. 2015) (citations, emphasis, and quo- to provide legal services. They are not compensated tation marks omitted). Law firms face potential mal- to assume risks of events beyond their control and, practice liability if they breach their fiduciary du- for this reason, they do not maintain the financial ties or if their work falls below a national standard reserves necessary to such risks. Indeed, they of care. Lawyers also face discipline and possible are not compensated to assume any risks beyond malpractice liability if they run afoul of the Rules the risks they assume in the ordinary course of rep- of Professional Conduct. Those Rules, in particu- resenting a client.1 We are aware of no instance in lar, constitute a detailed regulatory regime for the which a law firm and client have negotiated the protection of clients, imposing multitudinous ob- “price” of a law firm’s indemnification obligation. ligations concerning lawyers’ diligence, candor to Indeed, indemnification language is sometimes in- clients, avoidance of conflicts of interest, and pro- cluded in client guidelines that are not sent to the tection of clients’ confidences, among others. See, law firm until after an engagement is already un- e.g., Model Rules of Prof ’l Conduct R. 1.1 (Com- derway. petence); id. at 1.3 (Diligence); id. at R. 1.4 (Com- munications); id. at R. 1.6 (Confidentiality of Infor- 1The Rules of Professional Conduct provide a non- mation); id. at R. 1.7 (Conflict of Interest: Current exclusive list of “factors to be considered in determining the Clients); id. at R. 1.15 (Safekeeping Property); id. at reasonableness of a fee . . . .” Model Rules of Prof ’l Conduct R. 1.5(a) (Am. Bar Ass’n 2016). Although the Rules likely R. 1.16 (Declining or Terminating Representation). would not be interpreted to forbid in rate- In addition, clients are protected by client-friendly setting of risks the client is asking the law firm to assume, legal doctrines, such as the “continuous representa- they do not expressly contemplate that lawyers will base their fee on insuring outcomes or events (except to the extent they tion doctrine,” which can extend statutes of limita- contemplate traditional contingency fee arrangements). tions for the benefit of a law firm’s client. See, e.g., Indemnification Clauses in Retainer Agreements | 43

Shumsky v. Eisenstein, 726 N.Y.S.2d 365, 368 (N.Y. PROBLEMS POSED BY INDEMNIFICA- 2001). TION CLAUSES • One obvious problem with To graft onto this comprehensive legal and reg- indemnification clauses in this context is that they ulatory regime the additional legal obligations of impose potentially catastrophic risks on the law an indemnification clause adds little value and has firm for events beyond the law firm’s reasonable huge downsides for both the law firm and its client, control or traditional duties—for no compensation. as discussed below. Consider a hypothetical scenario where Russian Similarly, it almost never makes sense for a law gangsters “hack” a law firm’s chosen e‑discovery firm to indemnify an e‑discovery vendor, litigation vendor’s computer system and obtain the client’s consulting firm, or expert witness. Vendors and confidential data. The client could face sizable consulting firms can purchase insurance to cov- losses if its trade secrets or business plans are made er the very risks they are asking law firms to bear public, if individual consumers’ credit card or so- through indemnification.E.g. , Insureon Home Page cial security numbers are obtained, or if govern- (https://consultants.insureon.com/small-business- ment authorities commence investigations. A law insurance/cyber-liability/120) (marketing “Cyber firm that has indemnified the client against such an Liability/Data Breach Insurance for Consultants” occurrence could face massive liability despite hav- who are “privy to a wealth of client information”). ing complied with all of its professional obligations, Insurance companies are paid handsomely to bear and despite having used care in selecting a well-re- risks that vendors and consulting firms effectively spected e‑discovery vendor with top-notch security. are asking law firms to insure for free. In addition, A law firm could face losses exceeding its ability to these third parties, by definition, face liability only pay. Although indemnification could devastate the where they have violated their legal obligations—an law firm, it may be of little actual value to the cli- occurrence they are better-positioned to avoid than ent, which likely will have purchased commercial the law firms that hire them. The risk of loss should insurance to cover this very risk. remain with the actor better-positioned to avoid the A less obvious (but extremely serious) problem loss. Further, in a situation where someone seeks to with indemnification clauses is that they can under- blame an e‑discovery vendor, litigation consulting mine the law firm’s malpractice insurance. See Rus- firm, or expert witness for an error or omission that sell, supra, at 1. Many malpractice insurance policies is the fault of the law firm, legal doctrines such as cover the law firm only against malpractice claims. comparative fault and contribution exist to protect Many such policies exclude breach of contract the wrongly accused and to shift liability where it claims from coverage. Indemnification is a creature belongs. Here, too, indemnification from the law of contract. If the law firm has agreed to be con- firm adds little real value to the party seeking an tractually liable to the client for certain events, the indemnification clause. malpractice insurer could deny coverage because It is true that an indemnification clause could the claim is a contract claim rather than a tort (mal- give an indemnified party the right to payment of practice) claim, and the law firm has contractually attorneys’ fees (ordinarily not recoverable under agreed to be strictly liable. Some malpractice poli- the American Rule) and to bring a stronger, sim- cies cover only “wrongful acts” by the law firm, and pler claim than might be available at . indemnification can create liability even in the ab- These advantages to the indemnified party are sence of a wrongful act as defined in a policy. In relatively small, however, and the disadvantages far addition, insurers may take the position that their outweigh them. policies do not apply when the law firm has agreed 44 | The Practical Lawyer June 2016

to expand its own common law tort liability or to Professional Liability Insurance in Virginia (August 2008) undermine defenses that would have been available available at https://www.vsb.org/site/members/ absent the indemnification clause. For example, a Clients that insist on indemnification clauses contractual indemnification claim could have a lon- from their law firms typically have not carefully an- ger statute of limitations than a common law mal- alyzed these issues. Indeed, some client guidelines, practice claim. An insurer could deny coverage for retainer agreements, and requests for proposals claims that would have been untimely but for the require law firms to maintain certain malpractice indemnification clause. Further, many other poten- insurance coverage amounts for the clients’ protec- tial defenses to a malpractice claim—in pari delicto, tion, but then, elsewhere in the same document, im- lack of proximate causation, comparative fault, as- pose indemnification obligations that could invali- sumption of risk—could be unavailable if the law date that very insurance coverage! E.g., Legal Ser- firm has indemnified the client. In addition, mal- vices Agreement Between the City of Richmond & practice insurance policies can require the law firm Bickmore Risk Services, supra, at ¶ 17. A client is not to interfere with the insurer’s subrogation rights, generally better served by having access to a law which an indemnification clause arguably could do. firm’s insurance money than by having an unin- sured law firm that is organized as a limited liability A law firm that agrees to an indemnification clause partnership as an indemnitor. thus risks catastrophic, uninsured liability. It will al- In addition, indemnification clauses could dis- most never make sense to “bet the firm” for the sake tort law firms’ incentives in a manner that may not of representing a particular client or undertaking a serve clients’ interests. To continue the hacking ex- particular engagement. ample, a law firm could have incentives to resist tak- If a client succeeds at forcing a law firm to ac- ing possession of client data if it has agreed, in ef- cept a broad indemnification clause, the client could fect, to be strictly liable for the security of that data. find, when some error or omission by the law firm The law firm could have incentives to insist that or its agents harms the client months or years later, client personnel host the data on the client’s own that the indemnification clause renders unavailable servers, regardless of the inefficiencies and other the insurance money that otherwise could have problems that could present in litigating the case for made it whole. This is bad news for both the law which the client retained the law firm. Law firms firm and its client. Malpractice insurance benefits would have incentives to insist that their clients di- clients as well as lawyers, as reflected by the require- rectly hire vendors, litigation consulting firms, or ment in several states that lawyers disclose their in- expert witnesses—entities the law firm might other- surance coverage (or lack thereof) to clients. See State wise have retained itself—rather than risk becom- by State, Mandatory Malpractice Disclosure Gathers Steam, ing strictly liable for the conduct of “subcontrac- 28 Bar Leader No. 4 (Am. Bar Ass’n March-April tors.” Law firms subject to indemnification clauses 2004) (http://www.americanbar.org/publications/ also could have incentives to give their clients differ- bar_leader/2003_04/2804/malpractice.html). ent (and inappropriate) advice if the law firms are Oregon even requires lawyers to purchase mal- insuring outcomes; they could have incentives to practice insurance for the protection of their clients. steer clients away from even modest risks, regardless Id. “Malpractice insurance is essential to . . . protect of the potential rewards to the client. Indemnifica- the client’s interests in the face of a credible claim.” tion clauses also could affect clients’ incentives in a Virginia State Bar Special Committee on Lawyer manner harmful to the attorney-client relationship Malpractice Insurance, A Guide to Purchasing Lawyer’s or the client itself. Indemnification Clauses in Retainer Agreements | 45

Indemnification clauses in vendors’ and experts’ • To limit the indemnification obligation to cir- retainer agreements pose these same problems: cumstances where the law firm already would they unfairly impose risks for which the law firm is be liable at common law (e.g., for the law firm’s not compensated, they risk the law firm’s insurance negligent acts); coverage, and they distort incentives. In addition, in • To exclude any liability for errors or omissions the case of expert witnesses, indemnification claus- by subcontractors or other third parties; es in retainer agreements could create a fruitful • To exclude liability for events the law firm could new ground for opposing counsel to cross-examine not reasonably have prevented; the witness (e.g., “You insisted on an indemnifica- • To eliminate any obligation to “defend” or tion clause in your engagement agreement because “hold harmless” the client, or to pay its legal you lack confidence that your opinions are correct, fees or costs; right?”), thereby harming the credibility of the wit- • To limit the indemnification obligation to par- ness, counsel, and client. ticular enumerated circumstances; or • To provide that the indemnification obligation WHAT SHOULD LAW FIRMS DO? • A law does not apply to the extent its enforcement firm’s best move when asked to agree to indemni- would limit the availability of the law firm’s fication language is to say “no.” Most sophisticated insurance coverage. Also, the law firm might clients ultimately will agree that such language is attempt to work with its malpractice insurer to unnecessary, unfair, and contrary to the client’s best tailor indemnification language in a manner interest—especially when they learn they may lose that is less likely to jeopardize the insurer’s will- the protection of the law firm’s malpractice insur- ingness to cover a claim. ance. A law firm asked to agree to indemnification language also might seek assistance from its mal- Finally, law firms should implement a central- practice insurer in negotiating with the client. Some ized process for reviewing retainer agreements malpractice insurers are willing to speak directly to and client “guidelines,” and for objecting to inap- clients about the significance the insurer will give propriate terms. One law firm’s general counsel the indemnification clause if a claim is made. If a has reported that he searched his firm’s document client still insists on indemnification (they almost management system for outside counsel guidelines never do), the law firm should decline the engage- and found “hundreds of them.” Gunnarsson, su- ment. pra. Firm management “had no idea” that individ- Vendors, litigation consulting firms, and expert ual lawyers had exposed the law firm to so many witnesses also generally agree to remove indemnifi- “bombs waiting in our files.” Id. Individual lawyers cation language from their retainer agreements if should not be permitted to bind the law firm to in- asked. If one of these entities insists on indemnifi- demnification clauses or other problematic contract cation, it is usually easy to find an equally qualified terms, or to assent (through inaction or otherwise) replacement that will not insist on it. to onerous provisions in client-provided guidelines. In the unusual case where a client insists on Given the risks to the law firm, and the incentives of indemnification, and a law firm nonetheless de- individual lawyers to maintain client relationships, termines it is willing to risk proceeding with an en- a decision to indemnify a client or vendor should be gagement, the law firm might attempt to negotiate a law firm decision, not an individual lawyer’s deci- any or all of the following: sion. Prudent law firms will institute a policy requir- • To limit the law firm’s indemnification obliga- ing all firm lawyers to forward client guidelines (e.g., tion to a monetary amount lower than the de- to the firm’s general counsel or new business com- ductible on the law firm’s insurance policies; mittee) for centralized review and decision-making.