Wednesday, June 1, 2011

I Screw-Up, You Pay. Risk Allocation in Contracts.

A customer leaves your flower shop, slips on ice your landlord failed to clear from the parking lot, and sues your landlord for her injuries. Your landlord then sues you under the lease to reimburse him for whatever he has to pay your injured customer. Outrageous? Indemnification injustice? No, it’s risk allocation by contract, and it’s allowed, to an extent, under Colorado law.
Any resemblance between my daughters and any party in this case is purely coincidental. 
Leases, consulting agreements, service contracts, and business purchase agreements are but a few examples of business relationships in which it is common for the legal document to shift liability from the one who screwed-up to the other who did nothing wrong. Before anyone gets too worked up about “fairness”, let me ask if you carry liability insurance. We do the same thing with liability insurance. For a fee, my insurance company agrees to cover the damages caused by my mistakes.

Risk allocation is not limited to insurance policies, as the Colorado Supreme Court recently confirmed in the slip-and-fall case that opens this post. In that case, the lease was “clear and unequivocal”--the tenant agreed to indemnify (reimburse) the landlord against damages suffered the tenant’s customers, even if the damages were caused by the landlord’s own negligence. With that provision in place, a tenant is sort of an insurance company for a landlord, but instead of receiving a premium paid by the landlord, the tenant has the benefit of a lease rate that is arguably less than what would be charged if the landlord alone carried that risk.

Not all risks can be allocated, however. Colorado law is equally clear that agreements to indemnify a person against their own intentional or willful wrong acts are against public policy and not enforceable. Harm caused by the landlord’s gross negligence or intentional torts was an exception to the indemnification required under the lease in this slip-and-fall case. Thus, even if the flower shop owner was shocked by the risk allocation that is permitted by law, clearly the landlord had anticipated and planned for it, which is what you should do.

Before signing any contract, consider how it shifts risks. As long as you don’t cross the line into intentional or willful acts, a clearly written allocation of risk should be enforceable. That could work for you or against you. It’s better to think it out and negotiate it upfront than it is to fight about it later.

I should note, in closing, that under this lease, the tenant’s only right when confronted by the landlord’s failure to clear the ice was to do it herself and deduct the cost from her rent. Query, however, if several complaints to the landlord about the ice might have shifted the question from simple negligence to possible gross negligence, which would have been solely the landlord’s problem.

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