Kevin M. Quinley11.09.12
Skydivers leave little to chance. Their lives depend on their equipment—parachutes, lines and harnesses. Free-falling toward treetops at 70 miles an hour lends a whole new perspective to the phrase “risk management.”
Medical device manufacturers engage in the risk management equivalent of freefalling. Dealers and distributors face product liability exposures from goods manufactured by other companies. A recognized risk management technique for this situation is non-insurance contractual transfer. Most of us are familiar with insurance as a contractual transfer. With insurance, a medical device manufacturer transfers the financial consequences of loss to a professional risk-bearer, i.e., an insurance company.
With a non-insurance transfer—as the name implies—a company transfers financial consequences to a non-professional risk-bearer. Companies usually do this by contract. The non-professional (read, non-insurance) risk-bearer typically is another business.
Chief among non-insurance contractual transfers are indemnification agreements. In these, another party agrees to defend and/or reimburse expenses incurred in defending you from a product liability claim. Companies can use non-insurance contractual transfers in product liability.
Consider the following situations:
As a result, it can be risky to rely solely on “indemnity clauses” to transfer product liability risks. However, there still may be merit in including such contract wording. If nothing else, it lets the device company tell insurance underwriters that the device firm is transferring the risk. It may not garner any actual premium credit, but it may make the device firm appear to be a more attractive product liability risk. In short, favorable indemnity agreements may have more value from an account-marketing perspective than from successfully insulating oneself from risk through a contractual risk transfer.
Non-insurance contractual transfers often are attractive to risk managers, whose watchwords often are, “Get as many exculpatory agreements as you can, but don’t give any.”
As a way to hermetically seal off your product liability exposure, however, such transfers often can be porous and fraught with pitfalls.
The latter are:
Indemnification vs. Insurance
According to David Shuey, executive vice president of Life Sciences for Willis, a global insurance broker, a common misconception is that insurance and indemnity address identical issues. They don’t, he maintains.
“Insurance is simply a financial backstop for some of the indemnitor’s obligations in a contract,” Shuey says.
For example, indemnity agreements often cover intellectual property, willful misconduct, protocol deviations and other obligations where insurance is unavailable or impractical. He often sees contract language, he notes, requiring indemnitors to “purchase insurance with broad form contractual liability that covers the indemnity obligations of this contract.” Shuey maintains that it is not possible to buy an insurance policy covering all contractual obligations, so nobody can comply with such contract language.
Shuey also observes that disputes can arise regarding the timing of the indemnitor’s obligation to defend and/or pay defense costs. The reason is that contractual indemnification provisions often do not impose upon the indemnitor (at least not clearly and effectively) the obligation to immediately defend or fund an indemnitee’s defense when allegations trigger an indemnitor’s obligations.
Linda Schultz, medtech product manager at OneBeacon Insurance notes, “The effectiveness or advisability of non-insurance contractual transfers in a product liability risk management program depends on where in the chain of commerce the medical device company is located.”
For example, she thinks a contract manufacturer’s need and/or ability to negotiate these contractual terms differs from an OEM, a licensor or a distributor. The purpose of the contract or agreement also determines whether indemnification and hold/harmless is advisable and possible, she says. The key to effective analysis lies in involving experienced contract reviewers and drafters, partnering with counsel and knowledgeable insurance partners.
Other issues to consider when pondering non-insurance contractual transfers:
Who controls claim defense? The standard answer is: “We do!” In other words, you may get another firm to defend you in a liability claim. With that, though, comes the right for them—not you or your insurer—to control the claim defense. This includes everything from selection of counsel to making sensitive defend-or-settle decisions.
You, however, may not want to relinquish the right to choose your own attorney. Or, maybe you want to fight a dubious claim, but the indemnitor’s carrier wants to settle. Perhaps there are clashing interests between the indemnitor and the indemnitee. Whose interests will the indemnitor’s defense attorney put first?
If these questions make you squirm, they should. What you get in contractual protection you may relinquish in claims control. It’s a “package deal” when riding the coattails of another company. This is not to say that you should decline or forgo such promises. It does suggest, however, that the bitter mixes with the sweet. Beware of these negatives. Enter into the situation with open eyes. In some cases, the protection gained may outweigh concerns about relinquishing claim control. In other circumstances, your discomfort with relinquishing control may exceed the benefits of riding an indemnitor’s coattails.
How solvent is the indemnitor? If the indemnitor goes belly up, will there be sufficient assets to pay claims? If the manufacturer self-insures but skirts insolvency, having an airtight “hold harmless” in an indemnitee’s favor means little. Suggestion: Research the financial condition of the indemnitor. Do audited financial statements show financial health? What does Dun & Bradstreet say about its solvency?
What companies has the indemnitor favored? If an indemnitor has a wide market, and commonly indemnifies other firms, other “wannabe” beneficiaries may seek protection under the indemnitor’s liability policy. This may dilute or reduce the available coverage for the indemnitee’s enterprise. An indemnitee may have planned on an intimate dinner for two, only to learn that the host has invited a horde. In this case, the hors d’oeuvres are quickly depleted. Suggestion: Ask the indemnitor for a list of other companies it has agreed to hold harmless.
Maintain your own liability insurance coverage. Look to the indemnitor, but don’t put all your risk management eggs in one basket. You still may need to insure for claims and lawsuits. Having insurance plus indemnification agreements is the risk management equivalent of wearing both a belt and suspenders.
Attorney Jeff Kiburtz of Shapiro, Rodarte & Forman of Santa Monica, Calif., thinks that non-insurance contractual risk transfer is (and should be) a key part of risk management programs. In addition to the broader scope of risks for which non-insurance indemnity is available, many large companies self-insure significant portions, if not all, of their product risk. This drives interest in contractual indemnification provisions to transfer product risk to contracting partners and—if insured—their insurers.
Kiburtz concedes, though, that the lack of broader interest, may be that—as one California Court of Appeal put it—non-insurance indemnity “is a topic so deadly dull that it makes insurance look interesting.”1 Medical device firms in today’s times are like skydivers, in a sense. With attention to these tips, though, they can be confident of safe landings when it comes to risk managing liability exposures. Wrapped up in a pack, it’s hard to tell whether your lifelines are in working order. Analyze closely any documents offered by indemnitors; avoid the cursory review that may characterize such transactions. When you rely solely on an indemnitor, you are jumping out of the plane.
Time to check your product liability ripcord and jump. Does your liability protection “pack” contain a parachute, or a kite? Is it for function or for show? This article can help you find out, before it’s too late.
Happy landings!
Reference:
Kevin Quinley, CPCU is Principal of Quinley Risk Associates, a risk management consulting firm in the Richmond, Va., area. He has more than 25 years of risk management experience with medical device companies. You can reach him at www.kevinquinley.com or at kevin@kevinquinley.com.
Medical device manufacturers engage in the risk management equivalent of freefalling. Dealers and distributors face product liability exposures from goods manufactured by other companies. A recognized risk management technique for this situation is non-insurance contractual transfer. Most of us are familiar with insurance as a contractual transfer. With insurance, a medical device manufacturer transfers the financial consequences of loss to a professional risk-bearer, i.e., an insurance company.
With a non-insurance transfer—as the name implies—a company transfers financial consequences to a non-professional risk-bearer. Companies usually do this by contract. The non-professional (read, non-insurance) risk-bearer typically is another business.
Chief among non-insurance contractual transfers are indemnification agreements. In these, another party agrees to defend and/or reimburse expenses incurred in defending you from a product liability claim. Companies can use non-insurance contractual transfers in product liability.
Consider the following situations:
- A component supplier agrees to reimburse you if its device component malfunctions, ensnaring you in a product liability claim;
- A manufacturer agrees to indemnify a component supplier if the latter is dragged into litigation just because it provided a component part;
- A raw material supplier demands indemnification from manufacturers in exchange for providing the materials needed to make a product; or
- A dealer, distributor or retailer requires indemnification in exchange for selling, advertising or promoting a manufacturer’s products.
As a result, it can be risky to rely solely on “indemnity clauses” to transfer product liability risks. However, there still may be merit in including such contract wording. If nothing else, it lets the device company tell insurance underwriters that the device firm is transferring the risk. It may not garner any actual premium credit, but it may make the device firm appear to be a more attractive product liability risk. In short, favorable indemnity agreements may have more value from an account-marketing perspective than from successfully insulating oneself from risk through a contractual risk transfer.
Non-insurance contractual transfers often are attractive to risk managers, whose watchwords often are, “Get as many exculpatory agreements as you can, but don’t give any.”
As a way to hermetically seal off your product liability exposure, however, such transfers often can be porous and fraught with pitfalls.
The latter are:
- Courts can “gut” contractual transfers for three reasons: First, on public policy grounds, thinking that companies should not be able to contract away their duty to exercise care and make defect-free products and components; second, there is unconscionable disparity of bargaining power and leverage between the parties; or third, there are ambiguities in the transfer agreement, with courts interpreting ambiguity against the party that drafted the contractual transfer;
- Disputes in contract interpretation can delay settlements, case resolution and generate significant legal expense. In addition, they can poison business relationships; and
- The indemnitor may be bankrupt, insolvent or financially strapped, unable to shoulder the financial burden agreed to in a contract. A non-insurance contractual transfer is not worth the paper on which it is written if the indemnitor lacks financial resources. When insurers become insolvent, policyholders may get relief from state guaranty funds. No such funds exist, though, to rescue indemnitees who are left holding the bag because the contract transfer lacked strong financial guarantees.
Indemnification vs. Insurance
According to David Shuey, executive vice president of Life Sciences for Willis, a global insurance broker, a common misconception is that insurance and indemnity address identical issues. They don’t, he maintains.
“Insurance is simply a financial backstop for some of the indemnitor’s obligations in a contract,” Shuey says.
For example, indemnity agreements often cover intellectual property, willful misconduct, protocol deviations and other obligations where insurance is unavailable or impractical. He often sees contract language, he notes, requiring indemnitors to “purchase insurance with broad form contractual liability that covers the indemnity obligations of this contract.” Shuey maintains that it is not possible to buy an insurance policy covering all contractual obligations, so nobody can comply with such contract language.
Shuey also observes that disputes can arise regarding the timing of the indemnitor’s obligation to defend and/or pay defense costs. The reason is that contractual indemnification provisions often do not impose upon the indemnitor (at least not clearly and effectively) the obligation to immediately defend or fund an indemnitee’s defense when allegations trigger an indemnitor’s obligations.
Linda Schultz, medtech product manager at OneBeacon Insurance notes, “The effectiveness or advisability of non-insurance contractual transfers in a product liability risk management program depends on where in the chain of commerce the medical device company is located.”
For example, she thinks a contract manufacturer’s need and/or ability to negotiate these contractual terms differs from an OEM, a licensor or a distributor. The purpose of the contract or agreement also determines whether indemnification and hold/harmless is advisable and possible, she says. The key to effective analysis lies in involving experienced contract reviewers and drafters, partnering with counsel and knowledgeable insurance partners.
Other issues to consider when pondering non-insurance contractual transfers:
Who controls claim defense? The standard answer is: “We do!” In other words, you may get another firm to defend you in a liability claim. With that, though, comes the right for them—not you or your insurer—to control the claim defense. This includes everything from selection of counsel to making sensitive defend-or-settle decisions.
You, however, may not want to relinquish the right to choose your own attorney. Or, maybe you want to fight a dubious claim, but the indemnitor’s carrier wants to settle. Perhaps there are clashing interests between the indemnitor and the indemnitee. Whose interests will the indemnitor’s defense attorney put first?
If these questions make you squirm, they should. What you get in contractual protection you may relinquish in claims control. It’s a “package deal” when riding the coattails of another company. This is not to say that you should decline or forgo such promises. It does suggest, however, that the bitter mixes with the sweet. Beware of these negatives. Enter into the situation with open eyes. In some cases, the protection gained may outweigh concerns about relinquishing claim control. In other circumstances, your discomfort with relinquishing control may exceed the benefits of riding an indemnitor’s coattails.
How solvent is the indemnitor? If the indemnitor goes belly up, will there be sufficient assets to pay claims? If the manufacturer self-insures but skirts insolvency, having an airtight “hold harmless” in an indemnitee’s favor means little. Suggestion: Research the financial condition of the indemnitor. Do audited financial statements show financial health? What does Dun & Bradstreet say about its solvency?
What companies has the indemnitor favored? If an indemnitor has a wide market, and commonly indemnifies other firms, other “wannabe” beneficiaries may seek protection under the indemnitor’s liability policy. This may dilute or reduce the available coverage for the indemnitee’s enterprise. An indemnitee may have planned on an intimate dinner for two, only to learn that the host has invited a horde. In this case, the hors d’oeuvres are quickly depleted. Suggestion: Ask the indemnitor for a list of other companies it has agreed to hold harmless.
Maintain your own liability insurance coverage. Look to the indemnitor, but don’t put all your risk management eggs in one basket. You still may need to insure for claims and lawsuits. Having insurance plus indemnification agreements is the risk management equivalent of wearing both a belt and suspenders.
Attorney Jeff Kiburtz of Shapiro, Rodarte & Forman of Santa Monica, Calif., thinks that non-insurance contractual risk transfer is (and should be) a key part of risk management programs. In addition to the broader scope of risks for which non-insurance indemnity is available, many large companies self-insure significant portions, if not all, of their product risk. This drives interest in contractual indemnification provisions to transfer product risk to contracting partners and—if insured—their insurers.
Kiburtz concedes, though, that the lack of broader interest, may be that—as one California Court of Appeal put it—non-insurance indemnity “is a topic so deadly dull that it makes insurance look interesting.”1 Medical device firms in today’s times are like skydivers, in a sense. With attention to these tips, though, they can be confident of safe landings when it comes to risk managing liability exposures. Wrapped up in a pack, it’s hard to tell whether your lifelines are in working order. Analyze closely any documents offered by indemnitors; avoid the cursory review that may characterize such transactions. When you rely solely on an indemnitor, you are jumping out of the plane.
Time to check your product liability ripcord and jump. Does your liability protection “pack” contain a parachute, or a kite? Is it for function or for show? This article can help you find out, before it’s too late.
Happy landings!
Reference:
- Crawford v. Weather Shield Mfg., Inc. (2006) 38 Cal.Rptr.3d 787
Kevin Quinley, CPCU is Principal of Quinley Risk Associates, a risk management consulting firm in the Richmond, Va., area. He has more than 25 years of risk management experience with medical device companies. You can reach him at www.kevinquinley.com or at kevin@kevinquinley.com.