Insurance, Indemnification and the Franchise Relationship: How to Make 'Belt and Suspenders' Work for Your Business

Insurance contracts and indemnification agreements both seek to do the same thing: to transfer risk from one party to another. But it is important to understand how the law transfers risk in the absence of any agreement, as those rules define where the parties will find themselves if their agreements are held to be vague, unclear, or otherwise unenforceable. It also is important to be aware of default rules that render certain forms of risk-transfer void under the law.

Contribution is a doctrine that allows for the apportioning of liability between parties even where their liability is joint and several. See, e.g., Cal. Code Civ. Proc. ' 875; N.Y. C.P.L.R. ' 1401; 740 Ill. Comp. Stat. 100/2; Tex. Civ. Prac. & Rem. Code ' 33.015. This doctrine is typically applicable only after a judgment, where a defendant can point to another party as responsible for some portion of the fault. In such a case, the party may be able to bring a contribution action to recover the percentage of the judgment properly attributable to a third party's fault. However, in several states, a settling defendant is immune from a contribution proceeding by a non-settling co-defendant, and may even waive its own potential right to contribution against third parties. See, e.g., N.Y. Gen. Oblig. Law ” 15-108(b), 108(c); Glaser v. M. Fortunoff of Westbury Corp., 524 N.E.2d 413, 415 (N.Y. 1988); Tex. Civ. Prac. & Rem. Code ' 33.015(d); Beech Aircraft Corp. v. Jinkins, 739 S.W.2d 19, 22 (Tex. 1987).

Beyond the partial risk-transfer that is allowed for under the right of contribution, some jurisdictions allow one tortfeasor to completely shift liability to another tortfeasor through common-law indemnification. This common-law indemnification is generally limited to specific factual circumstances, such as in the product-liability context, or other contexts where a party can be liable despite having committed no “wrong,” such as in vicarious liability situations. See, e.g., Am. Nat'l Bank & Trust Co. v. Columbus-Cuneo-Cabrini Med. Ctr., 609 N.E.2d 285, 288 (Ill. 1992); Glaser, supra.

These doctrines can have significant implications for insurance, as highlighted by a case decided last year in the U.S. District Court in Florida. In that case, the court held that an insurance policy issued by an insurer to a franchisee actually covered the franchisor as well, despite the fact that the franchisor was not named as an additional insured. Employers Ins. Co. of Wassau v. National Union Fire Insurance Co., No. 07-1099, 2008 U.S. Dist. LEXIS 32312, at *19-20 (D. Fla. April 18, 2008). This was based on the fact that while the policy excluded “contractual liability,” that exclusion did not apply to damages “[t]hat the insured would have in the absence of the contract or agreement.” Id. at *14. Because Florida's common-law indemnity doctrine would have made the franchisee liable to the innocent franchisor in any event, as the liability was purely vicarious, the court held that the franchisor was entitled to coverage under the franchisee's primary policy.

Contractual Indemnification and Insurance Requirements

Aside from some narrow exceptions, private parties are normally free to contract around the “default” rules and apportion liability amongst themselves however they see fit. In the typical franchisee-franchisor relationship, the franchisor is looking for protection from the franchisee, in the form of contractual indemnification, requirements that franchisees maintain certain amounts of insurance, and requirements that the franchisee name the franchisor as an “additional named insured” under the franchisee's insurance policy. The relationship between the franchisee, franchisor, and their respective insurers typically looks like the visual set forth in the “Insurance and Indemnity in the Franchise Relationship” chart below.

[IMGCAP(1)]

Contractual indemnification, unlike common-law indemnification, allows for a party to indemnify itself even against its own negligence. See, e.g., Trzandel v. E.W. Howell Corp., 446 N.Y.S.2d 861, 866 (Sup. Ct. 1981); Heppler v. J.M. Peters Co., Inc., 87 Cal. Rptr. 2d 497, 508-509 (Ct. App. 1999). It is not uncommon that a franchisor will want enhanced protection against any and all claims stemming out of the franchise relationship. But franchisors should be aware that such agreements are typically construed strictly against the indemnitee, especially in the context where a franchisor issues a uniform indemnity agreement, and no negotiation of the terms occurs. See Goldman v. Ecco-Phoenix Elec. Corp., 396 P.2d 377, 382 (Cal. 1964); Alberto-Culver v. Avon Corp., 812 N.E.2d 369, 377 (Ill. App. Ct. 2004).

Accordingly, a party seeking to be indemnified against its own negligence will need to be very clear in the drafting of the indemnification provisions. See Vinnell Co. v. Pac. Elec. Ry. Co., 340 P.2d 604, 607 (Cal. 1959) (holding that an indemnity provision indicating full indemnification for damages, “howsoever same may be caused” was insufficient in the case of the indemnitee's own negligence).

On the insurance side, franchise agreements will typically require both that: 1) the franchisee have certain minimum limits of insurance coverage; and 2) that the franchisor also be included as an “additional named insured” under that coverage. The addition of the franchisor as an “additional named insured” can be accomplished in an insurance policy through a separate endorsement, or sometimes through definition of “insured” by drafting it to accommodate additional parties. For example, in Wassau, the insurance policy automatically included the franchisor, as it defined “insured” as “any person, organization, trustee or estate to whom you are obligated by a written Insured Contract to provide insurance such as is afforded by this policy.” 2008 U.S. Dist. LEXIS 32312, at *12-13.

However, some insurance policies may only protect an additional insured for claims arising from the wrongful acts of the primary named insured. Accordingly, being added as an additional insured to a franchisee's insurance policy never obviates the franchisor's need for its own insurance.

Insurance Issues That Frequently Arise

'Other Insurance' Clauses

Assuming that the franchisor is covered by both its own policy and as an additional named insured on its franchisee's policy, who pays first in the event of a loss? “Other Insurance” clauses in most Commercial General Liability (“CGL”) policies limit the insurer's obligation to indemnify or defend “if other valid and collectible insurance is available to the insured for a loss we cover under the policy.” Most Other Insurance clauses contain language indicating that the policy is to be treated as “excess” of any other coverage that applies to the loss. However, since virtually all CGL policies say this, and therefore both the franchisor's and franchisee's policies claim to be excess of each other, most courts will resolve the paradox via a pro rata apportionment of cost sharing between the two policies, either based on time of the loss, amount of available limits, or some other apportionment method. See, e.g., Am. Indem. Lloyds v. Travelers Prop. & Cas. Ins. Co., 335 F.3d 429, 435-436 (5th Cir. 2003).

However, the presence of an indemnification agreement can modify the way courts interpret the Other Insurance clause. If one insured is required, by common law or contract, to indemnify or provide primary insurance to the other, then that insured's policy typically will be required to pay first and assume the duty to defend. Id. at 436; Allstate Ins. Co. v. Fowler, 480 So. 2d 1287, 1290 (Fla. 1985). This can result in an umbrella excess policy of the franchisee, if it contains a duty to defend claims, being required to act as primary policy even prior to the first-level coverage of the franchisor.

Subrogation

Under “default” principles in most jurisdictions, an insurance company paying for a defense or indemnity succeeds to any rights its insured may have against third parties for recovery of those expenditures. See North Star Reins. Corp. v. Cont'l Ins. Co., 82 N.Y.2d 281, 294 (1993). Moreover, most insurance policies will contain “subrogation clauses,” which lay out the insurer's subrogation rights and restrict the insured from taking any action to prejudice a claim to which an insurer would be subrogated.

Often, a franchise agreement will require the franchisee to waive any claims it may have against the franchisor in connection with the operation of the business. But if that agreement does not also contain a waiver of subrogation, then the franchisee's insurer could still seek contribution or indemnification from the franchisor for any amounts paid on a loss. A waiver of subrogation is typically enforceable against the insurer, as long as it was agreed to prior to the events giving rise to a loss or claim. If it occurs afterward, the franchisee risks voiding its coverage due to the violation of the subrogation clause of the insurance contract. Since neither the franchisor nor franchisee wants to have an insurer disclaim coverage, parties should check the insurance language carefully or insert language in the waiver of subrogation to indicate that the waiver will be void if it violates the franchisee's insurance contract.

Practical Considerations and Pitfalls

When analyzing the interplay between common-law rules, contractual indemnification, and insurance agreements, there are two common pitfalls that often arise in franchise contexts ' pitfalls that can deprive the parties of protections for which they thought they had negotiated. The two common pitfalls involve a failure: 1) to specify all the required details of the indemnification and insurance provisions in the franchise agreement; or 2) to monitor compliance with the insurance requirements of the franchise agreement.

As noted above, indemnification agreements can protect against even a party's own negligence, but the agreement needs to be specific in doing so. A simple indemnification against “any and all claims” will often not be interpreted as covering a party's own sole negligence. If the parties intend to compensate a prevailing party for attorneys' fees and expenses associated with enforcing the indemnification, they need to say so explicitly. Accordingly, write your indemnification agreements very clearly, laying out precisely how the parties wish to allocate risk.

Similarly, a franchise agreement that requires a franchisee to purchase “insurance coverage” up to a certain amount is generally not sufficient. Specify the types of coverage the franchisee is required to obtain, and the limits, deductibles, and other necessary terms of the coverage. If the franchisee's insurance policy does not cover the types of claims the business is likely to face, such as privacy-related claims, personal or advertising injury, or other types of specialized coverage, then the franchisor's status as an additional insured is not of any value.

Once the terms are agreed to, all franchised businesses need to have some form of a compliance program to monitor that the insurance and other provisions are being complied with. As in Wausau, just because a franchisee is contractually obligated to take certain steps does not mean it has done so. At a minimum, the franchisor should obtain copies of the certificate of insurance. But this may not be enough, as some courts have held that a certificate of insurance showing that the parties intended to add an additional named insured will not suffice as proof where the “additional insured” language does not actually appear in the policy itself. See Tribeca Broadway Assoc., LLC v. Mount Vernon Fire Ins. Co., 774 N.Y.S.2d 11, 13 (Sup. Ct. App. Div. 2004). Accordingly, a franchisor should periodically review its franchisees' actual policies to make sure that the franchisee has secured the coverage required by the franchise agreement.

The key in achieving effective risk-transfer under franchise agreements is to make sure the parties get the results they intended. The only way to accomplish that is to be aware of the governing law and to ensure that ' at the outset ' the parties structure agreements between themselves and their insurers so that they achieve their objectives.

Andrew S. Wein is an attorney in the Washington, DC office of Kelley Drye & Warren LLP, who works in the insurance recovery and litigation practice groups. He can be contacted at [email protected] or 202-342-8887.

Contractual relationships create situations involving the transfer of risk among parties, and franchise relationships are no exception. Typically, the parties to a franchise agreement will rely on two different methods to apportion risk and provide themselves with protection: insurance and indemnification. Often referred to by the metaphor, “belt and suspenders,” the idea is to have two separate avenues of protection, and therefore to be doubly protected in the event of a loss or claim. But unless one is aware of the potential pitfalls, even so-called “iron-clad” indemnification clauses or insurance provisions in a franchise agreement can be all for naught.

This article discusses the interplay between insurance, indemnification, and the default common-law rules, so that franchisors and franchisees can avoid those dangerous pitfalls.

Default Rules on Risk-Transfer

Insurance contracts and indemnification agreements both seek to do the same thing: to transfer risk from one party to another. But it is important to understand how the law transfers risk in the absence of any agreement, as those rules define where the parties will find themselves if their agreements are held to be vague, unclear, or otherwise unenforceable. It also is important to be aware of default rules that render certain forms of risk-transfer void under the law.

Contribution is a doctrine that allows for the apportioning of liability between parties even where their liability is joint and several. See, e.g., Cal. Code Civ. Proc. ' 875; N.Y. C.P.L.R. ' 1401; 740 Ill. Comp. Stat. 100/2; Tex. Civ. Prac. & Rem. Code ' 33.015. This doctrine is typically applicable only after a judgment, where a defendant can point to another party as responsible for some portion of the fault. In such a case, the party may be able to bring a contribution action to recover the percentage of the judgment properly attributable to a third party's fault. However, in several states, a settling defendant is immune from a contribution proceeding by a non-settling co-defendant, and may even waive its own potential right to contribution against third parties. See, e.g., N.Y. Gen. Oblig. Law ” 15-108(b), 108(c); Glaser v. M. Fortunoff of Westbury Corp. , 524 N.E.2d 413, 415 (N.Y. 1988); Tex. Civ. Prac. & Rem. Code ' 33.015(d); Beech Aircraft Corp. v. Jinkins , 739 S.W.2d 19, 22 (Tex. 1987).

Beyond the partial risk-transfer that is allowed for under the right of contribution, some jurisdictions allow one tortfeasor to completely shift liability to another tortfeasor through common-law indemnification. This common-law indemnification is generally limited to specific factual circumstances, such as in the product-liability context, or other contexts where a party can be liable despite having committed no “wrong,” such as in vicarious liability situations. See, e.g., Am. Nat'l Bank & Trust Co. v. Columbus-Cuneo-Cabrini Med. Ctr. , 609 N.E.2d 285, 288 (Ill. 1992); Glaser, supra.

These doctrines can have significant implications for insurance, as highlighted by a case decided last year in the U.S. District Court in Florida. In that case, the court held that an insurance policy issued by an insurer to a franchisee actually covered the franchisor as well, despite the fact that the franchisor was not named as an additional insured. Employers Ins. Co. of Wassau v. National Union Fire Insurance Co., No. 07-1099, 2008 U.S. Dist. LEXIS 32312, at *19-20 (D. Fla. April 18, 2008). This was based on the fact that while the policy excluded “contractual liability,” that exclusion did not apply to damages “[t]hat the insured would have in the absence of the contract or agreement.” Id. at *14. Because Florida's common-law indemnity doctrine would have made the franchisee liable to the innocent franchisor in any event, as the liability was purely vicarious, the court held that the franchisor was entitled to coverage under the franchisee's primary policy.

Contractual Indemnification and Insurance Requirements

Aside from some narrow exceptions, private parties are normally free to contract around the “default” rules and apportion liability amongst themselves however they see fit. In the typical franchisee-franchisor relationship, the franchisor is looking for protection from the franchisee, in the form of contractual indemnification, requirements that franchisees maintain certain amounts of insurance, and requirements that the franchisee name the franchisor as an “additional named insured” under the franchisee's insurance policy. The relationship between the franchisee, franchisor, and their respective insurers typically looks like the visual set forth in the “Insurance and Indemnity in the Franchise Relationship” chart below.

[IMGCAP(1)]

Contractual indemnification, unlike common-law indemnification, allows for a party to indemnify itself even against its own negligence. See, e.g., Trzandel v. E.W. Howell Corp., 446 N.Y.S.2d 861, 866 (Sup. Ct. 1981); Heppler v. J.M. Peters Co., Inc., 87 Cal. Rptr. 2d 497, 508-509 (Ct. App. 1999). It is not uncommon that a franchisor will want enhanced protection against any and all claims stemming out of the franchise relationship. But franchisors should be aware that such agreements are typically construed strictly against the indemnitee, especially in the context where a franchisor issues a uniform indemnity agreement, and no negotiation of the terms occurs. See Goldman v. Ecco-Phoenix Elec. Corp., 396 P.2d 377, 382 (Cal. 1964); Alberto-Culver v. Avon Corp., 812 N.E.2d 369, 377 (Ill. App. Ct. 2004).

Accordingly, a party seeking to be indemnified against its own negligence will need to be very clear in the drafting of the indemnification provisions. See Vinnell Co. v. Pac. Elec. Ry. Co., 340 P.2d 604, 607 (Cal. 1959) (holding that an indemnity provision indicating full indemnification for damages, “howsoever same may be caused” was insufficient in the case of the indemnitee's own negligence).

On the insurance side, franchise agreements will typically require both that: 1) the franchisee have certain minimum limits of insurance coverage; and 2) that the franchisor also be included as an “additional named insured” under that coverage. The addition of the franchisor as an “additional named insured” can be accomplished in an insurance policy through a separate endorsement, or sometimes through definition of “insured” by drafting it to accommodate additional parties. For example, in Wassau, the insurance policy automatically included the franchisor, as it defined “insured” as “any person, organization, trustee or estate to whom you are obligated by a written Insured Contract to provide insurance such as is afforded by this policy.” 2008 U.S. Dist. LEXIS 32312, at *12-13.

However, some insurance policies may only protect an additional insured for claims arising from the wrongful acts of the primary named insured. Accordingly, being added as an additional insured to a franchisee's insurance policy never obviates the franchisor's need for its own insurance.

Insurance Issues That Frequently Arise

'Other Insurance' Clauses

Assuming that the franchisor is covered by both its own policy and as an additional named insured on its franchisee's policy, who pays first in the event of a loss? “Other Insurance” clauses in most Commercial General Liability (“CGL”) policies limit the insurer's obligation to indemnify or defend “if other valid and collectible insurance is available to the insured for a loss we cover under the policy.” Most Other Insurance clauses contain language indicating that the policy is to be treated as “excess” of any other coverage that applies to the loss. However, since virtually all CGL policies say this, and therefore both the franchisor's and franchisee's policies claim to be excess of each other, most courts will resolve the paradox via a pro rata apportionment of cost sharing between the two policies, either based on time of the loss, amount of available limits, or some other apportionment method. See, e.g., Am. Indem. Lloyds v. Travelers Prop. & Cas. Ins. Co. , 335 F.3d 429, 435-436 (5th Cir. 2003).

However, the presence of an indemnification agreement can modify the way courts interpret the Other Insurance clause. If one insured is required, by common law or contract, to indemnify or provide primary insurance to the other, then that insured's policy typically will be required to pay first and assume the duty to defend. Id. at 436; Allstate Ins. Co. v. Fowler, 480 So. 2d 1287, 1290 (Fla. 1985). This can result in an umbrella excess policy of the franchisee, if it contains a duty to defend claims, being required to act as primary policy even prior to the first-level coverage of the franchisor.

Subrogation

Under “default” principles in most jurisdictions, an insurance company paying for a defense or indemnity succeeds to any rights its insured may have against third parties for recovery of those expenditures. See North Star Reins. Corp. v. Cont'l Ins. Co. , 82 N.Y.2d 281, 294 (1993). Moreover, most insurance policies will contain “subrogation clauses,” which lay out the insurer's subrogation rights and restrict the insured from taking any action to prejudice a claim to which an insurer would be subrogated.

Often, a franchise agreement will require the franchisee to waive any claims it may have against the franchisor in connection with the operation of the business. But if that agreement does not also contain a waiver of subrogation, then the franchisee's insurer could still seek contribution or indemnification from the franchisor for any amounts paid on a loss. A waiver of subrogation is typically enforceable against the insurer, as long as it was agreed to prior to the events giving rise to a loss or claim. If it occurs afterward, the franchisee risks voiding its coverage due to the violation of the subrogation clause of the insurance contract. Since neither the franchisor nor franchisee wants to have an insurer disclaim coverage, parties should check the insurance language carefully or insert language in the waiver of subrogation to indicate that the waiver will be void if it violates the franchisee's insurance contract.

Practical Considerations and Pitfalls

When analyzing the interplay between common-law rules, contractual indemnification, and insurance agreements, there are two common pitfalls that often arise in franchise contexts ' pitfalls that can deprive the parties of protections for which they thought they had negotiated. The two common pitfalls involve a failure: 1) to specify all the required details of the indemnification and insurance provisions in the franchise agreement; or 2) to monitor compliance with the insurance requirements of the franchise agreement.

As noted above, indemnification agreements can protect against even a party's own negligence, but the agreement needs to be specific in doing so. A simple indemnification against “any and all claims” will often not be interpreted as covering a party's own sole negligence. If the parties intend to compensate a prevailing party for attorneys' fees and expenses associated with enforcing the indemnification, they need to say so explicitly. Accordingly, write your indemnification agreements very clearly, laying out precisely how the parties wish to allocate risk.

Similarly, a franchise agreement that requires a franchisee to purchase “insurance coverage” up to a certain amount is generally not sufficient. Specify the types of coverage the franchisee is required to obtain, and the limits, deductibles, and other necessary terms of the coverage. If the franchisee's insurance policy does not cover the types of claims the business is likely to face, such as privacy-related claims, personal or advertising injury, or other types of specialized coverage, then the franchisor's status as an additional insured is not of any value.

Once the terms are agreed to, all franchised businesses need to have some form of a compliance program to monitor that the insurance and other provisions are being complied with. As in Wausau, just because a franchisee is contractually obligated to take certain steps does not mean it has done so. At a minimum, the franchisor should obtain copies of the certificate of insurance. But this may not be enough, as some courts have held that a certificate of insurance showing that the parties intended to add an additional named insured will not suffice as proof where the “additional insured” language does not actually appear in the policy itself. See Tribeca Broadway Assoc., LLC v. Mount Vernon Fire Ins. Co. , 774 N.Y.S.2d 11, 13 (Sup. Ct. App. Div. 2004). Accordingly, a franchisor should periodically review its franchisees' actual policies to make sure that the franchisee has secured the coverage required by the franchise agreement.

The key in achieving effective risk-transfer under franchise agreements is to make sure the parties get the results they intended. The only way to accomplish that is to be aware of the governing law and to ensure that ' at the outset ' the parties structure agreements between themselves and their insurers so that they achieve their objectives.

Andrew S. Wein is an attorney in the Washington, DC office of Kelley Drye & Warren LLP, who works in the insurance recovery and litigation practice groups. He can be contacted at [email protected] or 202-342-8887.