The Basics of Contractual Risk Transfer

In an age of outsourcing, before a finished medical device or pharmaceutical product reaches its end user, it will be "touched," literally and figuratively, by multiple vendors, such as raw material suppliers, contract manufacturers, and distributors. Too often manufacturers fail to include provisions in their contracts that can shift risk to, or deflect risk from, vendors and are exposed to liability that originates with vendors. Manufacturers also sometimes sign contracts without understanding the potential consequences of certain provisions.

This article summarizes some of the risk transfer provisions available to manufacturers who are entering into contracts with vendors. Manufacturers need to understand these provisions in order to effectively manage the risks associated with their vendor transactions.

Indemnity Provisions

Indemnity provisions, often referred to as hold harmless agreements, are one of the primary vehicles by which manufacturers can shift or apportion risk in a contract. Indemnity provisions may include any, or all, of three obligations to (1) indemnify, (2) defend and (3) hold harmless the other party. "Indemnify" means to reimburse the other party following a loss. "Defend" means to pay the other party's legal expenses as it defends itself against a third party claim. "Hold harmless" may have different meanings, but most generally it is understood to be an agreement to absolve another party from any responsibility for damage or other liability arising from a transaction.

A simplified indemnity provision in a contract may look something like the following:

Vendor agrees to indemnify, defend and hold harmless Manufacturer from and against any and all actions and expenses incurred or asserted by any third party arising out of this transaction.

Indemnity provisions can be extremely effective risk transfer tools for manufacturers. Vendors who contractually agree to indemnify manufacturers are then liable for any damages that occur as a result of the transaction. In other words, any risk incurred as a result of the transaction lies with the vendor. Manufacturers who fail to include indemnifying provisions in their vendor contracts are exposed to liability for an injury that occurs due to the action, or inaction, of a vendor Many indemnity provisions are mutual, granting both the vendor and the manufacturer a right of indemnity if held liable for the acts or omissions of the other. In other words, each party respectively carries the potential liability associated with their own products. A simplified mutual indemnity provision may look something like the following:

Each party agrees to indemnify, defend, and hold harmless the other party from and against any and all actions and expenses incurred or asserted by any third party arising out of this transaction.

Indemnity provisions do not have to provide for absolute and unlimited indemnity, but can be specifically tailored to fit the needs of the contracting parties. For example, indemnification provisions can include restrictions such as:

• Monetary limits on the amount of indemnity to be paid;
• Time restrictions on the duration of the indemnity obligations; or
• Categories of claims to which the indemnity obligation does or does not apply.

It is important to note that the laws governing indemnity provisions vary from state to state. Provisions that may be upheld in one jurisdiction may not be upheld in another. Therefore, companies should review state laws regarding indemnification provisions prior to entering into any sort of indemnification provision. Otherwise, a court may invalidate the indemnity provision-or in extreme cases the entire agreement-and a company could find itself financially responsible for a liability it believed had been successfully transferred.

Additional Insured Provisions

Additional insured provisions can also be useful tools for manufacturers in shifting or apportioning risk. These provisions require one party to list the other party as an "additional insured" on its insurance policy.

A simplified additional insured requirement provision may look like the following:

Vendor shall maintain products liability insurance under which Manufacturer is named as an additional insured, with limits of liability of $X. 

The insurer is obligated to indemnify and defend the additional insured in accordance with the policy terms and conditions. The fact that the additional insured pays no premium does not diminish the insurer's obligation to the additional insured. Thus, manufacturers who are listed as additional insureds on their vendors' insurance policies may receive additional insurance coverage in the event of a lawsuit.

As with indemnity provisions, additional insured provisions may be customized according to the specific needs of the contracting parties. The provision may require that the insurance meet certain needs with respect to:

• Duration of coverage;
• Policy limits;
• Policy form ("claims made" vs. "occurrence"); or 
• Hazards to be covered.

A manufacturer who adds an additional insured provision to a vendor contract should require the vendor to provide proof of compliance. In other words, manufacturers should contractually require vendors to provide evidence that they are in fact listed as additional insureds on vendors' insurance policies. This evidence may generally be supplied in the form of a Certificate of Insurance or an Additional Insured Endorsement.

Note that a Certificate of Insurance is not itself a valid endorsement to a policy and usually does not provide the specifics of what is covered. As insurance companies sometimes revise their Additional Insured Endorsements to limit their coverage obligations, manufacturers who are listed as additional insureds on vendors' policies should request copies of the actual endorsements in order to understand the extent of coverage.

Exculpatory Provisions 

An exculpatory provision is one that relieves a party from liability resulting from its own wrongful acts. In other words, it is a party's attempt to escape tort liability for claims resulting from its own negligence.

A simplified exculpatory provision may look something like the following disclaimer:

Vendor expressly waives any claim for any loss, damage, or injury that may occur as a result of this transaction. 

Exculpatory provisions may initially seem like an effective risk transfer tool; however, manufacturers should be wary of including-and extremely wary of accepting-such provisions in contracts with their vendors. While exculpatory clauses can be convenient tools to shift risk and avoid litigation, they garner mixed reviews from the courts. As a general rule, courts will not enforce an exculpatory clause against an act that was caused by willful neglect or gross negligence, and some states bar these provisions as against public policy.

Narrowly tailored exculpatory provisions may be used to shift risk in limited circumstances; however, manufacturers who use or accept such provisions in contracts with their vendors should do so with caution and should consider consulting with a local attorney prior to entering into the contract.

When exculpatory provisions are appropriate, they need not limit all liability. For example, some of the limitations of liability may include:

• Monetary limits on the amount of liability to be paid;
• Restrictions on the duration of the exculpatory provision;
• Specific remedies (e.g., lost or destroyed equipment must be reimbursed according to its replacement, rather than its intrinsic value); or
• The types of claims to which the exculpatory provision applies (e.g., remedies are limited to those arising from express warranty claims).

Waiver of Subrogation Provisions

A vendor's insurer has the right to seek reimbursement from a manufacturer-generally through the manufacturer's insurer-for the costs of a claim if the manufacturer was at fault or gave rise to the claim. This right to reimbursement is called subrogation.

The pursuit of subrogation can result in significant legal actions and blaming between parties. In order to avoid such actions and to protect business relationships, a manufacturer may request that the vendor and the vendor's insurer agree prior to any loss to waive their rights to subrogation.

A simplified waiver of subrogation provision may look something like the following:

Vendor waives its rights of recovery against Manufacturer for loss or damage arising out of or incident to this transaction, whether due to negligence of Vendor or Manufacturer or their agents, employees, contractors, and/or invitees. 

Manufacturers will also need to obtain a waiver of subrogation from the vendor's insurer. Waivers of subrogation from insurers are typically in the form of an endorsement to the insurance policy issued to the vendor. Note that not all insurance carriers are willing to grant waivers of subrogation, and obtaining such a waiver on a policy frequently comes at a cost.

As with the previously discussed provisions, waivers of subrogation can be tailored according to the specific needs of the parties involved. For example, waivers of subrogation may:

• Be general or specific, encompassing all hazards or pertaining to only a particular danger;
• Contain limitations as to the specific entities, locations or work; or
• Contain clauses requiring the consent of the named insured.

It should be noted that, as with exculpatory provisions, these waivers may be invalidated if against public policy-more specifically where claims involve gross negligence or willful or wanton conduct.

Conclusion

The use of these risk transfer provisions does not guarantee that a manufacturer will be protected from all liability for the acts or omissions of its vendors. However, these provisions can-when used appropriately-be effective risk management tools and help manufacturers to avoid unnecessary liability.