Let us start with a very short primer on contracts.1 Point #1 – A contract tells the story of the relationship of the parties to the contract. Point #2 – A contract allocates numerous rights and responsibilities between those parties. Point #3 – Those allocations involve financial, operational… and risk-related matters. Point #4 – Except for provisions which are legally mandatory or prohibited in a contract,2 all other matters are negotiable.
The parties to a contract, then, can allocate risks associated with the contract by the use of risk shifting covenants (lawyer-speak for promises).3
Three common risk allocation covenants involve:
- Indemnification – As between the two parties to a contract, if one party pays for damages which should be properly paid by the other, then the ‘paying’ party will be reimbursed. For example, when a business is sold, the seller indemnifies the buyer for losses attributed prior to the closing and the buyer indemnifies the seller for losses attributed after the closing.
- Hold harmless – As between the two parties to a contract, if damages are claimed by one party against the other party, it will not make that claim. For example, following upon the business sale model above, if the buyer incurs a loss or damages related to a specific operational element of the purchase attributed back to the seller (for example, within an existing and identified product-line), the buyer will not claim against the seller. (Again, there can be mutual models for hold harmless scenarios when appropriate to the underlying transaction.)
- Defense – As between the two parties to a contract, if one party is sued, the other party will provide the legal defense on behalf of that party. And yet again following upon the business sale model, if the buyer is sued (or another adversarial claim is posed) by a third-party, the seller will pay for the buyer’s attorney’s fees and costs. (Again, mutuality is possible.)
It must be noted that each of those covenants (a) are specific in-nature (meaning they are not open-ended or generic exculpations) and (b) can be mutual between the parties when relevant.
Follow-up notes: (i) Sometimes these have ‘add-on’ specifically functioning features such as protection, saving, and exoneration, which serve to expand the ‘net’ of risk allocation. Those can be laid-out as “indemnify, hold harmless, defend, protect, save, and exonerate…” (ii) The party assuming the relevant risk should consider maintaining insurance in case they have to actually implement that allocation.
It must be noted that contractual allocations beyond the technical ones above ‘live in the real world’. Examples which are routinely addressed involve:
- Insurance requirements: ensures adequate protection for allocated risks
- Maintenance requirements: allocates responsibility for risk-mitigation related to physical plant and assets
- Pre-litigation provisions: permits agreed advance ‘alternative dispute resolution’ (a/k/a ‘ADR’) to be used prior to inception of litigation
- Litigation issues: addresses case forum, venue; attorney’s fees and court costs (typically using the ‘prevailing party rule’)
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If ‘you’ do not think this all happens in routine contracts, look at a standard commercial lease, which – among many other things – customarily allocates whether the tenant or the landlord is responsible for air conditioning system (often called ‘heating, ventilation, and air conditioning’ or ‘HVAC’ as short-hand) maintenance and repairs. (And does so on a specific manner, describing standards and acceptable maintenance contracts and vendors).
The parties to a contract, then, can allocate risks associated with the contract by the use of risk shifting covenants (lawyer-speak for promises).
Among this and the prior two pieces, then, it can be concluded that conscious attention to risk management forms a core function inside business operations and management. Not to be repetitive, but business professionals should always be proactive about their proactive, reactive, and contractual risk management.
1 This short description is derived from the writer’s business and real estate courses at the University of Florida Warrington College of Business (Legal Environment of Business, Law of Real Estate Transactions) and the Levin College of Law (Real Estate Document Drafting).
2 Mandatory and prohibited provisions are typically based on statutes specifically related to the underlying subject matters, such as construction contracts, environmental matters, fair housing, and terrorism financing prevention.
3 This ‘rule’ applies, although in differing ways, to business, consumer, and individual-party contracts.
– For more information, call Philip N. Kabler of the Gainesville, FL office of Bogin, Munns & Munns at 352.332.7688, where he practices in the areas of business, banking, real estate, and equine law. He has taught business and real estate law courses at the University of Florida Levin College of Law and Warrington College of Business Administration. And is now the President-Elect of the Eighth Judicial Circuit Bar Association.
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