This week, we will be covering how indemnification clauses can impact liability in manufacturing agreements. It is important to recognize at the outset that many supply chains today are extensive and many products are assembled with components from various manufacturers. As such, the component manufacturer, and the manufacturer who “manufactures” the end product must all take proper steps to protect themselves from liability if the product causes harm or there are material delays in production.
How should a founder think of indemnification with respect to a manufacturing agreement?
As mentioned in previous posts, it is helpful to start by considering market standard indemnification obligations for the specific type of agreement and the particular vertical of the company. In a typical manufacturing agreement, the manufacturer might indemnify, defend and hold harmless the company against liabilities and claims for:
personal injury arising from the manufacturer’s breach of contract;
IP infringement related to the overall manufacturing process;
injury arising from a component that was made to the contract specifications.
In contrast, the company engaging the manufacturer might indemnify, defend and hold harmless the manufacturer against liabilities and claims for:
injury arising from a defective component;
IP infringement related to the specific component;
material breach by the company of any warranty or representation.
While these might be market norms, market norms do vary, usually based on the level of complexity of the relationship (i.e. how many components/players are involved).
For example, if a car causes harm, there are thousands of components that are likely manufactured by dozens of component suppliers all over the world. Let’s assume that an electrical widget malfunctioned and caused a problem in a Ford automobile. Who should be liable? Should it be Ford or should it be the company that made/supplied the electronic widget to Ford? Let’s take a look at the issue from both sides.
Before determining how to approach indemnification in this context, both a manufacturer and supplier should consider the following:
Is the other party financially stable?
Is the other party properly insured?
Has the other party been sued in the past? If so, how many times (risk assessment on how likely it could happen this time)?
With this basic framework in mind, let’s explore how each of the main players should approach indemnification in manufacturing agreements.
Manufacturers
Many would argue that the manufacturer has the most to lose in these types of agreements. Under general product liability principles, the manufacturer would be liable for selling a defective end-product (the assembled automobile). Based on the above assessment, the manufacturer should consider the following as it pertains to the indemnification provision of the agreement:
Does the indemnification survive the termination of the agreement?
Does indemnification apply in all other countries?
Does the indemnification include the cost of defending the claim?
Who is responsible for assuming the burden of defending the claim if the claim involves only a component of the supplier? Multiple suppliers?
Is it required that a final judgment be reached for indemnification obligations to kick or do those obligations arise upon a claim being made?
Other things that a manufacturer should keep in mind:
Consider requesting to be an “additional insured” which would result in the component supplier’s insurance company indemnifying the manufacturer.
May want to ensure that a merchantability warranty is included in the agreement.
Depending on the complexity of the agreement, consider avoiding limitations of liability for both time and amount of damages.
Component Suppliers
The number one thing that component suppliers should focus on is providing detailed and accurate information to the manufacturer related to proper use and potential risks with the component (think about all of the fine print on any medication). A supplier would be wise to document all information provided to the manufacturer because an improperly used component will almost always clear the supplier of liability.
For this reason, a component supplier should request that a manufacturer defend, indemnify, and hold harmless a supplier for claims arising out of the conduct of the manufacturer.
Other things that a component supplier may consider with regard to indemnification:
Does the indemnification include the cost of defending the claim?
Who is responsible for assuming the burden of defending the claim if the claim involves multiple components and multiple component suppliers?
Is it required that a final judgment be reached for indemnification obligations to kick or do those obligations arise upon a claim being made?
Be sure to check back next week when we will explore indemnification in M&A agreements.
*This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.*