Insurance, Contracts and Interoperability

By: Lee Hoffman CIC, LIC, CPIA
© All Rights Reserved



When insurance is intended to be the primary assurance that indemnification agreements are properly funded, it is critical that contract language is written in such a way that insurance policies are able to respond.    

Crafting insurance and indemnification agreements is an art that involves understanding the nature of risks transferred, the nature of risks assumed and how to best protect a client from the legal and financial implications of those risks. It also requires an understanding of insurance policies and the type of coverage they can or cannot provide.

This article explores the issues and problems related to drafting insurance, indemnification and hold harmless agreements.


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Insurance, Contracts & Interoperability

Lee Hoffman CIC, LIC, CPIA
Lee M. Hoffman & Associates, LLC
Offices in Indiana & Michigan


A good contract is one that provides a clear expression of mutual consent enabling two or more parties to come together for common purpose. A great contract is one that a Supreme Court upholds as providing a clear expression of mutual consent.   

Is there any way to tell if a contract is “great” or not? Unfortunately there are too many jurisdictions and variables for anyone to make that kind of guarantee. However, it does not mean an attorney should simply trust to luck. 

Most attorneys have no problem creating good contracts, particularly when all parties to an agreement sign on the dotted line. But what if a key player to a contract is a disenfranchised third party? A party that has had no part in negotiating the contract terms or conditions, yet in many cases is the glue that holds everything together? A party that could very well provide the backing for many of the obligations found in the contract? 

I am talking about insurance companies. They are usually the disenfranchised third party providing backing by way of insurance and indemnification - the glue. Understanding how to successfully weave this third party into contracts is an area of law in which some attorneys fall flat.

Crafting insurance and indemnification provisions is an art that involves understanding the nature of risks transferred, the nature of risks assumed and how best protect a client from the legal and financial implications of those risks. It also requires an understanding of insurance policies and the type of protection they can or cannot provide.

Without this understanding, attorneys who draft contracts may be creating useless insurance and indemnification provisions, thus making some of the most important provisions in their contracts defective. By defective, I mean that they are unable to effect desired results because of improper terminology and phraseology. Worse yet, the type of insurance required in the agreement may not even apply to the purpose intended. The defects can lead to blocked rights of subrogation, uninsured indemnification agreements and inadequate or improper property and liability insurance.

The problem is wide spread encompassing contracts of every nature including contracts of sale, lease agreements, purchase order agreements, rentals, construction contracts and repair and maintenance agreements. The list is virtually endless.  

It's not that attorneys are insensitive to the needs of their clients, but rather that they lack insurance education. Few law schools offer classes on basic insurance practices and principles even though all states allow attorneys to perform insurance consulting as part of their practice of law while at the same time exempting them from any insurance license or insurance continuing education requirement. This is a formula for disaster.

To compound the problem, there are few CLE seminars on how to draft effective insurance, indemnification and risk transfer agreements. A number of years ago I published an insurance newsletter for attorneys and focused on this area of law. I also developed a continuing legal education seminar to teach attorneys about the changes that have occurred in the insurance industry over the years and how most contracts written by attorneys have not kept up with those changes resulting in defective contracts.

At the beginning of my PowerPoint presentation there are slides that set the tone for everything that follows. The first reads: When it comes to contractual relationships, attorneys are the gatekeepers of their clients' "insured protection”. The next reads: Insured protection is the condition that is created when contractual risk transfers (leases, rental agreements, subcontract agreements, etc.) are drafted in such a way that insurance becomes the primary assurance that conditions at risk are properly funded.

There is a term I use that describes the ideal relationship between insurance policies and contractual agreements. It is called interoperability. Simply defined, interoperability is the ability of one system to work with, use and rely on the parts of another system – like insurance policies and contracts. Insurance policies are promises that under certain conditions are activated. Attorneys, through well crafted agreements, can not only create the requirements for the type of insurance they want for their client, they can also create some of the conditions under which insurance companies will respond. One plays off the other – interoperability.

Attorneys are in an important position but unfortunately, as previously mentioned, many lack the knowledge to skillfully execute such an agreement. They may, instead, choose hit or miss from a library of formerly used or canned contracts.

However, it’s a win-win situation for knowledgeable attorneys. They are the “gatekeepers” and set the rules, assess the consequences and dictate how those consequences are to be funded. For example, in a commercial lease, the provisions stating how property can be used and how it must be maintained, the consequences for failing to properly use and maintain it, and the type of insurance that must be in place to fund the consequences of misuse, all rest with the attorney. 

When conditions at risk are insurable, completion of contractual obligations could almost be guaranteed. Landlords should not have to rely on their own insurance or the personal assets of their tenants to provide protection against loss arising out of their tenants’ exposures or their negligence. The tenants’ insurance should provide the landlord with that protection - and a properly worded contract can guide the entire process.

Assume a client owns a building with a current replacement value of $1,000,000 and he wants to lease it to a tenant for five years with two five-year options. Even if your client has exercised due diligence by checking tenant references, you the attorney still have the responsibility of making sure the asset (building) is transferred in such a way that, should it be damaged or destroyed, all parties are in agreement as to who replaces it and how it is to be insured.

Assume the landlord wants to keep the insurance on the building – a standard lease. This is a common and safe position to take. But how do you draft the lease in such a way that the tenants are required to purchase the correct insurance to cover their obligation to repair or replace the building should they be found negligent for the damage? At this point many attorneys use generic, simplistic insurance language because they feel it is not their job to be specific – that’s the insurance agent’s job. Besides, the landlord’s insurance will repair and replace the building and subrogate against the tenant. What’s the big deal?

The big deal is that the landlord is relying on his attorney to make sure his assets are properly protected from the negligence of the tenant. If the lease is properly drafted the landlord’s insurance should be for the sole benefit of the landlord; the tenant should not also benefit. But that is exactly what will happen when attorneys draft incomplete agreements. Just requiring the tenant to repair or replace all damage caused by his negligence is not good enough.

Another problem is that the attorneys who draft the agreements are seldom the ones who defend them. Trial lawyers know what to look for, but for some reason the message is slow in reaching business and corporate lawyers and as a result they continue to use defective contract language.   

In the case of United Farm Bureau Mutual Insurance Company v. Chadwick Owen, 1996.IN.18 <> the tenant readily admitted that he was negligent and caused the fire that damaged the home they were renting. However, the landlord never recovered a dime from the tenant. The entire case centered on the lease language and not the issue of negligence. The way the lease was written in essence blocked the landlord’s right of subrogation. This is what I refer to as defective contract language.

The case involved a tenant in an apartment building who decided to use their kerosene lantern to heat the living room. A fire severely damaged the building and the tenant readily admitted to his negligence. The landlord’s insurance company repaired the building then subrogated against the tenant. The tenant’s carrier refused to pay based on their belief that their insured was an automatic co-insured under the landlord’s insurance policy.

The trial and appellate courts barely discussed the tenant’s negligence as it was not an issue.  This case was all about subrogation rights and interpretation of the lease language, which the courts say was clear and unambiguous – unfortunately in favor of the tenant.

Here are the “lease clauses” the court deemed most damaging to the landlord’s subrogation case.

1.This indemnification shall not include any matter for which the Landlord is effectively protected by insurance…

2.Landlord and Tenant do each hereby release the other from all liability for any accident damage or injury caused to person or property, provided, this release shall be effective only to the extent that the injured or damaged party is insured against such injury or damage and only if this release shall not adversely affect the right of the injured or damaged party to recover under such insurance policy.

3.Tenant shall surrender to Landlord the Leased Premises broom clean and in the same order and condition in which the Tenant received them, the effects of ordinary wear, acts of God, casualty, insurrection, riot or public disorder excepted.

(Note: Many courts deem fire a casualty no matter how it is caused.)

The lease did contain the following clause but when stacked up against the other clauses the Supreme Court deemed that it carried no weight:

“Tenant shall not be obligated under this provision to repair any injury to the Leased Premises resulting from fire or other casualty. The preceding sentence is not intended to limit, modify, or release Tenant from any liability it may have for damages or destruction”.

This is not an isolated case, as jurisdictions have ruled the same way on similar cases. Some excellent cases that further explore the issue include Alaska Insurance Company v. RCA Alaska, 623P.2d. 1216 (Alaska 1981), 1981.AK.46 <http://www/>, United States Fire & Casualty v. Jerry Bruggeman, 505 N.W.2d 87 (Minn. App. 1993), 1993.MN.854 <>, and Sutton v. Jondahl, 532 P.2d 478, 482 (Okla. Ct. App. 1975).

When subrogation is blocked, so is access to the indemnitor’s insurance.

As previously stated, attorneys are the gatekeepers. With well crafted agreements they can create the requirements for the type of insurance they want for their client and some of the conditions to which insurance companies will respond. One plays off the other – interoperability. Knowing how to create interoperability between contracts and insurance policies is the key. Attorneys who have not attended any insurance classes or have not taken updates on the most current changes and trends within the insurance industry and related case law should seek the assistance of a qualified insurance and risk management consultant.

Lee M. Hoffman CIC LIC CPIA is Managing Member of Lee M. Hoffman & Associates, LLC. He is an insurance and risk management consultant with expertise in aiding attorneys with analysis of their client’s exposure to risk and assisting with the drafting of insurance and indemnification agreements. He is also a testifying and consulting insurance expert. (