Infotech and the Law | Lack of indemnification guidance makes a clear danger

Eliza Nagle

It's déjà vu all over again for companies that regularly do business with state and local governments: Will the state agency negotiate mutually agreeable indemnification and limitation of liability provisions?

The question is significant; indemnification and limitation of liability clauses allocate important material risks between the parties. In the commercial context, it is not unusual for the parties to agree to mutual indemnification and limitation of liability provisions.

By contrast, companies that contract with states face one-sided, often mandatory indemnification and limitation of liability clauses.

Any attempts to negotiate such clauses have met with uneven success, hobbled by the lack of clarity as to whether or not the state is legally permitted to indemnify or limit the liability of its contractors.

Oklahoma and Iowa recently issued guidance on this. Oklahoma determined that its constitution prohibited limitation of liability clauses in state contracts unless, when it entered the contract, it specifically appropriated funds to pay for any liability that may arise. An unfunded limitation of liability clause was found to be void against public policy.

Iowa's assistant attorney general, by contrast, issued an informal advice memorandum recommending against the use of limitation of liability clauses, opining that, in certain contexts, such a clause may violate the state constitution.

These two examples highlight the disparate environments that companies must navigate when contracting with states. More significantly, they illustrate the underlying problem: the issue of whether a state may legally indemnify or limit the liability of a contractor has not been fully resolved.

Consequently, companies and agencies that negotiate modifications to indemnification and limitation of liability provisions may find themselves in the same legal predicament as American Management Systems Inc. of Fairfax, Va., now CGI-AMS.

Recall that AMS and Mississippi entered into a contract that contained a limitation of liability clause capping the contractor's liability at the contract price, about $12 million. Unfortunately, the clause included language that stated it was enforceable "as allowed by Mississippi law, if at all."

A contract dispute ensued between the parties, and AMS sought to limit its liability under the clause. Mississippi argued that the clause was unenforceable under state law, and the parties ultimately settled the case for about $185 million.

This case illuminated the need for states to issue clear and legally binding rules on the proper formation of indemnification and limitation of liability clauses. For states to issue informal advice ? or no advice at all ? on these critical clauses is to do a great disservice to their agencies and contractors.

These are not trivial clauses, and it is highly inequitable to determine they are unenforceable after parties have entered into arms-length negotiations.

And it may backfire. At least one attorney general opinion has suggested that an agency that enters into an illegal indemnification agreement with a contractor may morally obligate the legislature to pay for the financial obligation.

In any case, this surmising does not provide much solace or legal protection to either party.

The recent examples of guidance from Iowa and Oklahoma re-emphasize the importance of issuing clear and binding direction on the proper formation of indemnification and limitation of liability clauses.

Contractors would like to see states develop clauses that are legally enforceable as well as less one-sided and more consistent with those common in the commercial marketplace. At a minimum, states need to provide more transparency into their analysis of this issue so that each party may fully assess the risks involved.

Eliza Nagle is an associate in the Government Contracts practice of DLA Piper Rudnick Gray Cary US LLP in Washington, D.C. Her e-mail address is eliza.nagle@dlapiper.com.

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