New Contracts in Kansas Can No Longer Contain Commonly Used Liability Indemnity Provisions

The 2008 Kansas Legislature passed a statute that declares void as against Kansas public policy long-standing contract risk-allocation provisions in many commercial contracts ' including franchise and dealership contracts. The story begins in 2004, when the legislature enacted a prohibition against liability indemnity provisions in construction contracts. After several years of discussions, lawmakers passed a new statute, which amends K.S.A. '16-121, to prohibit indemnity, additional-insured, choice-of-law and forum-selection provisions in a broad array of Kansas construction, manufacturing, transportation, dealership, and franchise contracts (collectively defined by the statute as “Contracts”) entered into after Jan. 1, 2009. As described below, certain aspects of the statute may also apply to contracts entered into before that date.

Common Provisions

Indemnity and insurance provisions are common and accepted terms in many commercial contracts. Indemnification agreements transfer risk and assign future liability arising from the contract performance. They remove doubt about future legal liability and avoid application of the comparative fault rule to marginally involved defendants. The Kansas courts have historically enforced these risk-allocation provisions.

As an alternative or in addition to indemnity, contracting parties can agree to allocate risk among their respective insurance carriers. In response to an identified need in the marketplace, the insurance market developed “additional insured” coverage, under which liability coverage is extended to someone other than the policyholder. For example, a franchisee may for a price name a franchisor as an additional-insured on the franchisee's commercial general liability policy. But no more in Kansas.

Prohibited Contract Terms

The 2008 statute severely hamstrings the ability of private parties to contract around the Kansas comparative-fault rule, under which parties generally bear
responsibility for accidents in proportion to their fault for that accident. The new statute generally renders void and unenforceable:

Contract terms that require indemnification for negligence or intentional acts or omissions of the indemnified party. The definition of “indemnification provision” includes a promise, agreement, clause, or understanding “in connection with, contained in, or collateral to a [C]ontract”;

Contract terms that require the extension of liability coverage to another party by naming them as an additional-insured for liability arising from their own actions; and

Choice-of-law and forum-selection clauses in covered Contracts. Kansas law will apply to and govern every Contract that is performed in Kansas, and all disputes will be resolved in a Kansas arbitration or court forum.

Contracts Subject to

Regulation

The 2004 statute covered only agreements for the design, construction, alteration, renovation, repair, or maintenance of a structure, road (except oil-field road), bridge, waste, sewer, or oil or gas line. The 2008 statute exponentially expands its breadth to include:

dealership agreements between an equipment manufacturer or service provider and an equipment or service dealer, which provide for the purchase or sale of equipment or services;

motor carrier transportation contracts covering the storage and transportation of property by a motor carrier and the entrance onto property by the motor carrier for the purpose of loading, unloading, or transporting property. A motor carrier transportation contract does not include a uniform intermodal interchange and facilities access agreement; and

franchise agreements, which are defined in the 2008 statute as follows:

“Franchise agreement” means any contract or franchise or any other terminology used to describe the contractual relationship between manufacturers, distributors and dealers, by which:

“(A) A right is granted one party to engage in the business of offering, selling or otherwise distributing goods or services under a marketing plan or system prescribed in substantial part by the other party, and in which there is a community of interest in the marketing of goods or services at wholesale or retail, by lease, agreement or otherwise; and

“(B) the operation of the grantee's business pursuant to such agreement is substantially associated with the grantor's trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the grantor or an affiliate of the grantor.”

The 2008 statute does not define the terms “manufacturers,” “distributors,” or “dealers.” The remainder of the definition of a “franchise agreement” is quite broad, and because the point of virtually every franchise arrangement from the perspective of the franchisee is to offer, sell, or otherwise distribute goods or services, the 2008 statute arguably covers virtually all franchise arrangements.

The franchise agreements of many franchise systems have historically allocated all risks for any loss or damage relating to the operation of the franchised unit to the franchisee, and required the franchisee to list the franchisor as an additional-insured on the franchisee's liability policies. The justification for these provisions from the franchisor's perspective was that the franchisee should bear all costs relating to the operation of the franchised unit, including costs relating to claims from customers who are allegedly injured on the franchised premises. Because the franchisee agreed to indemnify the franchisor from these claims and to list the franchisor as an additional insured, the franchisee and its insurance company, and not the franchisor or its insurance company, are obligated to bear the cost of defending and paying such claims. Except for the limited safe harbors described in this article, the 2008 statute substantially limits these common allocation-of-risk provisions.

Choice of Law and Venue

As noted, the 2008 Kansas Legislature determined that Kansas law will govern all Contracts to be performed in Kansas, and that disputes will be resolved in a Kansas arbitration or court forum. The 2008 statute's choice-of-law and venue requirements are not limited to contractual provisions and disputes relating to indemnification or insurance, but instead appear to cover the entire franchise agreement or other Contract and any dispute arising from the franchise agreement or other Contract. While the 2008 statute's mandates relating to indemnification and additional-insured provisions clearly only apply to provisions entered into after Jan. 1, 2009, the statute's Kansas venue and choice-of-law requirements, as drafted, apply to all Contracts. To the extent a court or arbitration panel is asked to apply the provisions of the statute to existing Contracts, it may also get the opportunity to address related potential constitutional issues.

Limited Safe Harbors

The 2008 statute specifically preserves the most-obvious form of indemnity obligation ' the validity of an insurance contract or construction bond issued by an insurer or bonding company. It also preserves the vitality of contract provisions: 1) obligating a contractor or owner to provide general liability insurance or railroad protective insurance; 2) obligating an owner to indemnify a contractor for strict liability under environmental laws; and 3) incorporating an indemnity obligation integral to settlement of a construction contract dispute.

The legislature, in a nod to the freedom of contract, did create two safe harbors for use by sophisticated contracting parties and their counsel in allocating liability risk in their transactions. First, the statute preserves the enforceability of a separately negotiated provision in which the parties agree to a “reasonable allocation of risk,” if it is based on industry loss experience and supported by adequate consideration. The legislature did not attempt to define the bounds of reasonableness or specify the criteria for a provision to be “separately negotiated,” leaving abundant opportunity for legal challenges to the enforceability of the provision that ' by definition ' will arise only after the risk has manifested itself. From a practical perspective, in the franchise context, the requirement that the provision be separately negotiated will, at a minimum, encumber the historic franchise sales process with an additional agreement and enhanced disclosures.

Second, the statute enables parties to allocate risk through indemnity underwritten by liability insurance. The indemnity obligation must be limited to the extent of coverage and dollar limits of the insurance. In the case of a unilateral indemnity obligation (under which only one party agrees to indemnify the other without a reciprocal obligation), the coverage must be obtained through a separate liability insurance policy procured at the indemnified party's expense. This final alternative will undoubtedly increase the cost of the transaction, but it will provide the most secure allocation of risk for all but the most catastrophic of accidents. Franchisors will want to review their own insurance coverage and determine whether it is cost-effective to acquire the additional liability coverage allowed by the 2008 statute (at the franchisor's expense) to take advantage of this safe harbor.

William R. Wood II is a partner at Foulston Siefkin LLP in Wichita, KS. He can be contacted by phone at 316-291-9772, or by e-mail at [email protected].

The 2008 Kansas Legislature passed a statute that declares void as against Kansas public policy long-standing contract risk-allocation provisions in many commercial contracts ' including franchise and dealership contracts. The story begins in 2004, when the legislature enacted a prohibition against liability indemnity provisions in construction contracts. After several years of discussions, lawmakers passed a new statute, which amends K.S.A. '16-121, to prohibit indemnity, additional-insured, choice-of-law and forum-selection provisions in a broad array of Kansas construction, manufacturing, transportation, dealership, and franchise contracts (collectively defined by the statute as “Contracts”) entered into after Jan. 1, 2009. As described below, certain aspects of the statute may also apply to contracts entered into before that date.

Common Provisions

Indemnity and insurance provisions are common and accepted terms in many commercial contracts. Indemnification agreements transfer risk and assign future liability arising from the contract performance. They remove doubt about future legal liability and avoid application of the comparative fault rule to marginally involved defendants. The Kansas courts have historically enforced these risk-allocation provisions.

As an alternative or in addition to indemnity, contracting parties can agree to allocate risk among their respective insurance carriers. In response to an identified need in the marketplace, the insurance market developed “additional insured” coverage, under which liability coverage is extended to someone other than the policyholder. For example, a franchisee may for a price name a franchisor as an additional-insured on the franchisee's commercial general liability policy. But no more in Kansas.

Prohibited Contract Terms

The 2008 statute severely hamstrings the ability of private parties to contract around the Kansas comparative-fault rule, under which parties generally bear
responsibility for accidents in proportion to their fault for that accident. The new statute generally renders void and unenforceable:

Contract terms that require indemnification for negligence or intentional acts or omissions of the indemnified party. The definition of “indemnification provision” includes a promise, agreement, clause, or understanding “in connection with, contained in, or collateral to a [C]ontract”;

Contract terms that require the extension of liability coverage to another party by naming them as an additional-insured for liability arising from their own actions; and

Choice-of-law and forum-selection clauses in covered Contracts. Kansas law will apply to and govern every Contract that is performed in Kansas, and all disputes will be resolved in a Kansas arbitration or court forum.

Contracts Subject to

Regulation

The 2004 statute covered only agreements for the design, construction, alteration, renovation, repair, or maintenance of a structure, road (except oil-field road), bridge, waste, sewer, or oil or gas line. The 2008 statute exponentially expands its breadth to include:

dealership agreements between an equipment manufacturer or service provider and an equipment or service dealer, which provide for the purchase or sale of equipment or services;

motor carrier transportation contracts covering the storage and transportation of property by a motor carrier and the entrance onto property by the motor carrier for the purpose of loading, unloading, or transporting property. A motor carrier transportation contract does not include a uniform intermodal interchange and facilities access agreement; and

franchise agreements, which are defined in the 2008 statute as follows:

“Franchise agreement” means any contract or franchise or any other terminology used to describe the contractual relationship between manufacturers, distributors and dealers, by which:

“(A) A right is granted one party to engage in the business of offering, selling or otherwise distributing goods or services under a marketing plan or system prescribed in substantial part by the other party, and in which there is a community of interest in the marketing of goods or services at wholesale or retail, by lease, agreement or otherwise; and

“(B) the operation of the grantee's business pursuant to such agreement is substantially associated with the grantor's trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the grantor or an affiliate of the grantor.”

The 2008 statute does not define the terms “manufacturers,” “distributors,” or “dealers.” The remainder of the definition of a “franchise agreement” is quite broad, and because the point of virtually every franchise arrangement from the perspective of the franchisee is to offer, sell, or otherwise distribute goods or services, the 2008 statute arguably covers virtually all franchise arrangements.

The franchise agreements of many franchise systems have historically allocated all risks for any loss or damage relating to the operation of the franchised unit to the franchisee, and required the franchisee to list the franchisor as an additional-insured on the franchisee's liability policies. The justification for these provisions from the franchisor's perspective was that the franchisee should bear all costs relating to the operation of the franchised unit, including costs relating to claims from customers who are allegedly injured on the franchised premises. Because the franchisee agreed to indemnify the franchisor from these claims and to list the franchisor as an additional insured, the franchisee and its insurance company, and not the franchisor or its insurance company, are obligated to bear the cost of defending and paying such claims. Except for the limited safe harbors described in this article, the 2008 statute substantially limits these common allocation-of-risk provisions.

Choice of Law and Venue

As noted, the 2008 Kansas Legislature determined that Kansas law will govern all Contracts to be performed in Kansas, and that disputes will be resolved in a Kansas arbitration or court forum. The 2008 statute's choice-of-law and venue requirements are not limited to contractual provisions and disputes relating to indemnification or insurance, but instead appear to cover the entire franchise agreement or other Contract and any dispute arising from the franchise agreement or other Contract. While the 2008 statute's mandates relating to indemnification and additional-insured provisions clearly only apply to provisions entered into after Jan. 1, 2009, the statute's Kansas venue and choice-of-law requirements, as drafted, apply to all Contracts. To the extent a court or arbitration panel is asked to apply the provisions of the statute to existing Contracts, it may also get the opportunity to address related potential constitutional issues.

Limited Safe Harbors

The 2008 statute specifically preserves the most-obvious form of indemnity obligation ' the validity of an insurance contract or construction bond issued by an insurer or bonding company. It also preserves the vitality of contract provisions: 1) obligating a contractor or owner to provide general liability insurance or railroad protective insurance; 2) obligating an owner to indemnify a contractor for strict liability under environmental laws; and 3) incorporating an indemnity obligation integral to settlement of a construction contract dispute.

The legislature, in a nod to the freedom of contract, did create two safe harbors for use by sophisticated contracting parties and their counsel in allocating liability risk in their transactions. First, the statute preserves the enforceability of a separately negotiated provision in which the parties agree to a “reasonable allocation of risk,” if it is based on industry loss experience and supported by adequate consideration. The legislature did not attempt to define the bounds of reasonableness or specify the criteria for a provision to be “separately negotiated,” leaving abundant opportunity for legal challenges to the enforceability of the provision that ' by definition ' will arise only after the risk has manifested itself. From a practical perspective, in the franchise context, the requirement that the provision be separately negotiated will, at a minimum, encumber the historic franchise sales process with an additional agreement and enhanced disclosures.

Second, the statute enables parties to allocate risk through indemnity underwritten by liability insurance. The indemnity obligation must be limited to the extent of coverage and dollar limits of the insurance. In the case of a unilateral indemnity obligation (under which only one party agrees to indemnify the other without a reciprocal obligation), the coverage must be obtained through a separate liability insurance policy procured at the indemnified party's expense. This final alternative will undoubtedly increase the cost of the transaction, but it will provide the most secure allocation of risk for all but the most catastrophic of accidents. Franchisors will want to review their own insurance coverage and determine whether it is cost-effective to acquire the additional liability coverage allowed by the 2008 statute (at the franchisor's expense) to take advantage of this safe harbor.

William R. Wood II is a partner at Foulston Siefkin LLP in Wichita, KS. He can be contacted by phone at 316-291-9772, or by e-mail at [email protected].