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Indemnification Provisions in Personal Injury
Settlement Agreements as Ethics Traps

Nov. 6, 2012, 5:00 AM

Plaintiffs in personal injury litigation typically have financial obligations to hospitals and various other health care providers. The providers, in turn, have claims to repayment of those obligations from any settlement or judgment the plaintiff receives. Medicaid and Medicare may seek reimbursement of payments made for the plaintiff’s care. Workers’ compensation insurers are also in the mix. If, for example, a plaintiff injured at work files a product liability action against the manufacturer of the machine that injured him, a workers’ compensation insurer that paid benefits may assert a subrogation lien on potential settlement proceeds.

A health care provider or workers’ compensation insurer with a lien or subrogation interest frequently perfects its claim by giving required notice to the plaintiff or to her lawyer. Where a lien holder knows the identity of a defendant or its insurer, it may in some cases give notice of the lien to the defendant or its insurer, as well.

In any event, plaintiffs’ lawyers are accustomed to dealing with third-parties’ claims to or liens on settlement or judgment proceeds. Indeed, they often negotiate with lien holders to reduce the amounts sought and thereby maximize the plaintiff’s recovery in a lawsuit. Veteran plaintiffs’ lawyers further recognize that they potentially face personal liability if they release funds to clients in which they know third parties to be legitimately interested.

On the other side of the case, a settling defendant or its liability insurer wants to be certain when it pays a settlement that it achieves finality. A defendant or its liability insurer may worry that if a plaintiff fails to satisfy claims or liens out of settlement proceeds, those claimants or lien holders will sue the defendant or insurer for repayment. See Strunk v. Goldberg, 258 P.3d 334, 338 (Colo. Ct. App. 2011) (noting that hospital lien holders may seek compensation from tortfeasors and their insurers).

Veteran plaintiffs’ lawyers recognize that they potentially face personal liability if they release funds to clients in which they know third parties to be legitimately interested.

The defendant or its insurer does not want to be exposed to lien or subrogation claims made after a settlement is seemingly concluded. If the defendant or insurer is arguably required to satisfy a lien in that instance, it may be difficult to obtain reimbursement from the plaintiff.

To mitigate this risk, defendants and their insurers may attempt to include in settlement agreements indemnification provisions by which the plaintiff’s lawyer promises to hold the defendant or its insurer harmless from any lien claims that might be asserted, and to indemnify them against any claims that the plaintiff should have paid out of the settlement proceeds. Defendants and their insurers recognize that, as a general rule, plaintiffs’ lawyers are a more reliable source of indemnity than are their clients.

Plaintiffs’ lawyers generally resist this practice. They have a good point. It appears that every ethics authority that has considered the issue has concluded that it is unethical for plaintiffs’ lawyers to enter into such agreements.

See Arizona Ethics Op. 2003-05 (2003); Illinois Ethics Op. 06-01 (2006); Indiana Ethics Op. 1 of 2005; Kansas Ethics Op. 11-02 (2011); Missouri Formal Ethics Op. 125 (2008); New York State Ethics Op. 852 (2011); New York City Ethics Op. 2010-3 (2010); North Carolina Ethics Op. 2000-4 (2001); Ohio Supreme Court Ethics Op. 2011-1 (2011); South Carolina Ethics Op. 08-07 (2008); Tennessee Formal Ethics Op. 2010-F-154 (2010); Wisconsin Formal Ethics Op. E-87-11 (1987).

Far more surprisingly, several of these authorities have further opined that it is unethical for defense lawyers to seek indemnification agreements from plaintiffs’ lawyers in connection with settlements. See Kansas Ethics Op. 11-02, at 1-2; Missouri Formal Ethics Op. 125, at *2 (2008); New York City Ethics Op. 2010-3, at 3; Ohio Supreme Court Ethics Op. 2011-1, at *3; Wisconsin Formal Ethics Op. E-87-11, at 1.

In most cases in which indemnification is sought, the plaintiff’s lawyer will refuse and the defendant will retreat, because, when it comes right down to it, the defendant’s desire to consummate the settlement is high and its need for indemnity is low. If the settlement is being funded by a liability insurer, a failure to settle because such a demand was made and refused could potentially expose the insurer to bad faith liability. Unrecognized liens or other unknown third-party claims to settlement proceeds are rare. Long story short, no reasonable defendant or insurer wants to either jeopardize or delay a settlement over a contract term of marginal utility.

Moreover, indemnification terms are rarely bargained for; they typically surface for the first time in the release prepared by defense counsel, or in some other communication after the settlement has been agreed. Because the term was never negotiated, the defendant cannot enforce it by way of a motion. See, e.g., Reppy v. Winters, 351 S.W.3d 717, 721-22 (Mo. Ct. App. 2011). And, if the plaintiff moves to enforce the settlement agreement minus the indemnification provision, the plaintiff will surely win on the same grounds.

This practical resolution will not play out in all cases, however, and it is thus worth exploring the relevant professional responsibility terrain. Moreover, even where this practical resolution is realized, the defense lawyer still faces possible discipline simply for seeking the indemnity agreement.

Ethics Concerns for the Plaintiffs’ Bar

It is possible to boil down the professional responsibility issues for plaintiffs’ counsel without discussing every ethics opinion in this area. Basically, critics of indemnity provisions in settlement agreements assert that a plaintiff’s lawyer who agrees to indemnify a defendant violates one or more of the following Model Rules of Professional Conduct: 1.2(a), 1.7(a)(2), 1.8(e), and 2.1. The reasoning behind these supposed violations is uniformly weak.

Candid Advice.

First, a requirement that a plaintiff’s lawyer indemnify a defendant against claims by third parties to settlement funds supposedly violates Rule 1.2(a), which provides in pertinent part that a lawyer “shall abide by a client’s decision to settle a matter.” Model Rule 1.2(a).

The stated concern with respect to Rule 1.2(a) is that the indemnification demand could cause the lawyer to refuse the settlement offer or to try to dissuade the client from settling in order to protect the lawyer’s own interests. As the South Carolina Bar opinion explains, the lawyer’s “refusal, for ethical reasons, to accede to such a demand as a condition of settlement could prevent the client from effectuating a settlement that the client otherwise desires.” South Carolina Ethics Op. 08-07, at 1. More fully described, the insistence upon a lawyer’s agreement to indemnify as a condition of settlement could “cause the lawyer to recommend that the client reject an offer that would be in the client’s best interest because it would potentially expose the lawyer to the payment of hundreds of thousands of dollars in lien expenses, or litigation over such lien expenses.” Id.

This argument strangely assumes that there are armies of unknown lien claimants lurking in the mist, rather than more logically assuming that the plaintiff’s lawyer has identified all such claimants and is prepared to either pay the amounts due them out of settlement proceeds or negotiate the reduced satisfaction of their claims. In fact, in most cases, the opinion’s fundamental concern does not exist precisely for these reasons. But even if it did, then you also have to conclude that contingent fee agreements are unethical because they might cause plaintiffs’ lawyers to forgo settlements that might reduce the lawyer’s fee from that which would be earned based on a large judgment following trial.

Whether it is unethical for a plaintiff’s lawyer to agree to indemnify defendants against post-settlement claims by lien holders should be a case-specific inquiry.

Certainly, incurring an indemnity obligation may pose a more concrete financial risk to a plaintiff’s lawyer than forgoing what might be a larger contingent fee were the case not to settle. Even so, it is wrong to presume the existence of a Rule 1.2(a) violation. Indeed, there can be no Rule 1.2(a) violation if the lawyer does not let an indemnification demand influence her recommendation to her client, or where the plaintiff’s lawyer accepts an indemnity obligation secure in the knowledge that the obligation will never arise.

A plaintiff’s lawyer who blew up a settlement over a defendant’s insistence on the lawyer’s acceptance of an indemnity obligation might violate Rule 1.2(a) if the plaintiff wanted to settle on the terms offered. And, as we will see in a moment, the lawyer’s conduct would evidence a personal interest conflict under Model Rule 1.7(a)(2). But those problems can be addressed if and when they arise. A broad prophylactic approach is unnecessary in this context.

Personal Interest.

Second, and consistent with the strained reasoning offered to support a Rule 1.2(a) violation, agreements to indemnify defendants are often said to violate Rule 1.7(a)(2), which provides that a concurrent conflict of interest exists if “there is a significant risk that the representation of one or more clients will be materially limited … by a personal interest of the lawyer.”

To be sure, defendants’ insistence on indemnity provisions in settlement agreements may in some cases spawn Rule 1.7(a)(2) conflicts between plaintiffs and their lawyers. But it is just as certain that Model Rule 1.7(a)(2) conflicts can be cured by the client’s informed consent as provided for in Model Rule 1.7(b). So, again, generalized concerns must yield to the facts of particular cases.

Financial Assistance.

Third, critics contend, plaintiffs’ lawyers who agree to indemnify defendants in settlement agreements violate Model Rule 1.8(e), which states that a lawyer “shall not provide financial assistance to a client in connection with pending or contemplated litigation,” subject to two exceptions not relevant here. Indeed, the violation of Rule 1.8(e) is the principal objection voiced by all of the authorities to have considered lawyers’ promises of indemnity in settlement agreements.

Rule 1.8(e) certainly provides the best argument for rejecting the practice, but it is still a tenuous basis for prohibition. Even if an indemnity agreement made in order to settle litigation and which may never be enforced in the future constitutes financial assistance “in connection with pending or contemplated litigation,” which is at least something of a reach, there are other reasons to doubt Rule 1.8(e)'s application—starting with the rule’s essential purpose.

As Comment [10] to Rule 1.8 explains, lawyers may not subsidize lawsuits they bring on behalf of their clients, including making or guaranteeing loans to clients for living expenses, “because to do so would encourage clients to pursue lawsuits that might not otherwise be brought and because such assistance gives lawyers too great a financial stake in the litigation.”

Of course, the concerns that animate the Model Rule 1.8(e) prohibition on financial assistance to clients are not present at the conclusion of a lawsuit as compared to earlier points in the litigation process. There is no chance that a lawyer’s agreement to indemnify a defendant against liens or claims that a plaintiff should satisfy will encourage frivolous litigation, nor will it perpetuate meritless litigation that is already underway. Indeed, such an indemnity agreement actually facilitates the termination of litigation.

Expanding on the comment, it might be argued that a lawyer’s indemnity agreement violates Model Rule 1.8(e) regardless of the odd timing because it gives her “too great a financial stake in the litigation.” This argument is ambitious. A plaintiff’s lawyer can refuse to indemnify a defendant and thereby avoid any related stake in the litigation. If the worry is that the lawyer’s refusal to agree to indemnify the defendant will queer a settlement that the plaintiff wants to accept, that is the same “financial stake” that implicates Model Rules 1.2(a) and 1.7(a)(2). At some point, we risk becoming stuck in an endless loop of speculative professional responsibility harms instead of focusing on the facts of a given case.

Finally on this point, a lawyer is not providing financial assistance to a client if the lawyer indemnifies a defendant but then attempts to recoup that payment from the client. This was not a loan; the lawyer paid the client’s debt and is now seeking repayment. The fact that the plaintiff’s lawyer may have a harder time collecting from the client than the defendant had collecting from the plaintiff does not transform this sequence of events into the provision of financial assistance to the client for Model Rule 1.8(e) purposes.

Impact on Judgment.

Fourth, indemnification provisions in settlement agreements are thought to violate Model Rule 2.1, which provides that in representing a client, “a lawyer shall exercise independent professional judgment and render candid advice.”

Several of the ethics bodies that have considered lawyers’ potential assumption of indemnity obligations in settlement agreements have speculated that “even if the lawyer were ethically permitted to provide such financial assistance [contrary to Rule 1.8(e)], such an agreement might compromise the lawyer’s exercise of independent professional judgment and rendering candid advice in violation of Rule 2.1.” Arizona Ethics Op. 2003-05, at 3; see also Indiana Ethics Op. 1, at 14 (2005) (stating that “[f]orcing the attorney to weigh the settlement’s benefits to the client with his own personal risk places an inappropriate burden on the essential element of independence”); South Carolina Ethics Op. 08-07, at 2 (“[E]ven if a lawyer were permitted and willing to enter into such an agreement to accept such a burden, acceptance of such a duty might compromise the lawyer’s exercise of independent professional judgment in violation of Rule 2.1”).

The comments reinforce the settled principle that in rendering advice lawyers should be candid and straightforward rather than simply telling clients what they want to hear.

Any lawyer who reads the comments to Model Rule 2.1 should quickly agree that the rule was never intended to be applied to these facts. Rather, the comments reinforce the settled principle that in rendering advice lawyers should be candid and straightforward rather than simply telling clients what they want to hear. The comments further support the text of the rule by making clear that in appropriate circumstances lawyers should not limit their advice to legal or procedural aspects of representations.

Certainly, nothing in the text of Model Rule 2.1 or in the comments suggests that the rule embodies any sort of prohibition against personal interest conflicts as the ethics opinions invoking it seemingly assume. But even if a square Rule 2.1 can somehow be crammed into the round hole of indemnity in settlement, its redundant repackaging of the Rule 1.7(a)(2) personal conflict concern outlined earlier adds nothing to the discussion.

Insofar as Medicaid and Medicare repayment claims are concerned, all of the foregoing concerns are mitigated if not eliminated by plaintiffs’ lawyers’ direct repayment obligations.

To explain, when Medicare or Medicaid makes a conditional payment—i.e., a payment made for services rendered on behalf of a beneficiary where another payor may be responsible—the Center for Medicare & Medicaid Services, or CMS, has the right to recover such payments from any person or entity that has received a third-party payment. 42 C.F.R. §411.24(g). This includes the right to recover from a plaintiff’s lawyer directly. Id. (listing attorneys as among those from whom CMS as a right of recovery); see, e.g., United States v. Harris, Civ. No. 5:08CV102, 2009 BL 62667 (N.D. W. Va. Mar. 26, 2009). Thus, a plaintiff’s lawyer who agrees to indemnify a defendant against Medicare or Medicaid reimbursement claims is not assuming a new obligation, nor is the lawyer providing financial assistance to the client.

Case-Specific Approach.

In summary, plaintiffs’ lawyers who contemplate agreeing to indemnify defendants against post-settlement claims by lien holders, subrogated insurers, and the like must satisfy themselves that they can do so without running afoul of several rules of professional conduct. Rules 1.8(e) and 1.7(a)(2) are at the top of the list. If they conclude that accepting an indemnity obligation would violate Rule 1.8(e), they cannot agree to do so. If they conclude that Rule 1.8(e) presents no obstacle, the question then becomes whether they believe that they can seek the client’s consent to the apparent Rule 1.(7)(2) personal interest conflict, and, secondarily, whether they want to do so.

Naturally, this case-specific approach will not work in a jurisdiction that has banned the practice and which treats formal ethics opinions as binding on lawyers admitted there. For that matter, given the weight typically afforded ethics opinions by courts and disciplinary authorities, lawyers may be understandably reluctant to swim against the tide even in states where ethics opinions are only advisory.

There are many reasons to disfavor defendants’ efforts to foist indemnity agreements on plaintiffs’ lawyers during settlement, and for lawyers on both sides of the “v” to eschew such efforts. The practice may seriously impede settlement and generate unnecessary ill will. The benefits to defendants from such indemnity agreements are generally not material. In some cases the practice may drive a wedge between the plaintiff and her lawyer.

For these reasons and perhaps others, ethics committees appear to have reacted viscerally to questions posed about the practice. Their reflexive response has been to ban it outright. It may be helpful to lawyers to flatly prohibit the practice rather than outline the concerns and urge a careful case-by-case analysis, since it provides them with a ready basis for rejecting indemnification requests, but that approach is difficult to reconcile with the case-specific inquiry that characterizes most professional responsibility questions.

The Ethics Trap for Defense Lawyers

Even if you accept the position that defendants’ practice of seeking indemnity from plaintiffs’ lawyers at settlement time is so troublesome from the perspective of plaintiffs’ lawyers that they should be prohibited from making such agreements, you might understandably be surprised by the Kansas, Missouri, New York City, Ohio, and Wisconsin authorities’ further position that it is unethical for defense lawyers to propose or insist upon indemnity provisions. The Kansas, Missouri, New York City, and Ohio opinions conclude that because plaintiffs’ lawyers cannot agree to indemnify a defendant as part of a settlement without violating one or more of the rules of professional conduct discussed above, defense lawyers’ indemnification demands or requests violate Rule 8.4(a). See Kansas Ethics Op. 11-02, at 1-2; Missouri Formal Ethics Op. 125, at *2; New York City Formal Ethics Op. 2010-3, at 3; Ohio Supreme Court Ethics Op. 2011-1, at *3.

Of course, Model Rule 8.4(a) states that it is professional misconduct for a lawyer to “violate or attempt to violate the Rules of Professional Conduct, knowingly assist or induce another to do so, or do so through the acts of another.” Unlike the other opinions, which rely on Rule 8.4(a) to prohibit defense lawyers from carrying out their clients’ wishes, the Wisconsin opinion offers no authority for its head-scratching position that “lawyers may not propose [or] demand … such agreements.” Wisconsin Formal Ethics Op. E-87-11, at 1.

Rule 8.4(a).

Naturally, a defense lawyer cannot violate Rule 8.4(a) in any case in which a plaintiff’s lawyer’s agreement to indemnify the defendant or its insurer is ethically permissible. Beyond that, the Rule 8.4(a) angle merits serious analysis. Rule 8.4(a) has traditionally been understood to prevent lawyers from doing through another that which they cannot ethically do themselves. Thus, lawyers cannot bypass their ethical obligations by having an agent act in their place. See Model Rule 8.4 cmt. [1]. For example, a lawyer who is prohibited from speaking with a represented person under Model Rule 4.2 cannot circumvent the rule by having a legal assistant or nonlawyer investigator communicate with the person. To apply Rule 8.4(a) as urged in the Kansas, Missouri, New York City, and Ohio opinions reflects an idiosyncratic use or understanding of the rule.

Interpreting Rule 8.4(a) to prohibit defense lawyers from seeking an indemnity provision from plaintiffs’ lawyers is unsupportable.

Assume, for example, that Lawyer L represents Plaintiff A in a lawsuit against Defendants B and C. Defendants B and C are jointly represented by Lawyer X. As the suit is originally filed, X can represent both B and C without a conflict of interest. Now, L amends A’s complaint to add new claims that create a conflict for X in X’s joint representation of B and C. Under the Rule 8.4(a) reasoning embraced by the four authorities identified above, Lawyer L has violated Rule 8.4(a) because, in advancing A’s interests, Lawyer L has created a conflict of interest for Lawyer X.

The response from any of the four authorities would likely be that this is a comparison of apples and oranges. In the hypothetical case, A has a cause of action against B and C and therefore has a right to assert the new claims. In that instance L’s duties of competence and diligence require L to pursue those claims even if they create a disqualifying conflict for X. On the other hand, a defendant seeking indemnity from a plaintiff’s lawyer has no right to indemnification; it is simply nice to have should the plaintiff spend all his money on riotous living and there is no other source of recovery.

Strange Reasoning.

That is no answer, however, for at least three reasons. First, client right or not, L is still “assisting” or “inducing” X to violate Rule 1.7 under the expansive reading of the terms “assist” and “induce” employed by the Kansas, Missouri, New York City, and Ohio authorities. Model Rule 8.4(a) has no exception for violations incurred in the vindication of clients’ rights. Nowhere do the Model Rules provide that Rules 1.1 and 1.3 trump Rule 8.4(a).

Second, depending on the case, Lawyer L may not have a duty to amend A’s complaint to add the claims that will operate to disqualify Lawyer X. See Model Rule 1.3 cmt. [1] (“A lawyer is not bound … to press for every advantage that might be realized for a client. … [A] lawyer may have authority to exercise professional discretion in determining the means by which a matter should be pursued.”).

Third, a defendant has a “right” not to be subjected to litigation over a debt owed to a third party by a plaintiff, and it has a further “right” to avoid paying an obligation owed by the plaintiff. The fact that the defendant legitimately seeks to enforce those rights by seeking indemnity from the plaintiff’s lawyer should not subject its lawyer to professional discipline.

Or, consider this scenario. Lawyer L represents Plaintiffs A, B, and C in a case. Now, on behalf of the defendant, Lawyer X makes an aggregate settlement offer of $100,000. This potentially poses a Rule 1.7(a) and Rule 1.8(g) problem for Lawyer L. Has Lawyer X violated Rule 8.4(a) simply by making the aggregate settlement offer? What if Lawyer X made the settlement offer rather than interpleading the funds?

Flawed Result.

In summary, the conclusion that a defense lawyer violates Model Rule 8.4(a) by requesting that a plaintiff’s lawyer enter into an indemnity agreement as part of a settlement is unsupportable. It cannot be that a lawyer violates Rule 8.4(a) merely by making a decision, demand, offer, or request that poses a potential professional responsibility challenge for opposing counsel. That obviously flawed conclusion is, however, the logical extension of the Kansas, Missouri, New York City, and Ohio authorities cited above.

It might be, perhaps, that ethics committees perceive the inclusion of indemnity provisions in settlement agreements to be so disruptive that bilateral prohibition is necessary as a matter of policy; not only must plaintiffs’ lawyers be precluded to making such agreements, but defense lawyers must be prohibited from asking for them. That would certainly be a permissible approach to take. Indeed, that is essentially the Model Rule 5.6 regime, which prohibits the “offering or making” of agreements that restrict lawyers’ right to practice. But were that so, one might have expected the various committees to invoke the Rule 8.4(d) prohibition on conduct prejudicial to the administration of justice as authority for a blanket ban, rather than stretching Rule 8.4(a) far beyond its logical limits. None appear to have done so.

Conclusion

The common practice of defendants or their insurers insisting that plaintiffs’ personal injury lawyers agree to indemnify them against possible claims by lien holders and subrogated insurers for amounts rightly owed by plaintiffs presents a number of professional responsibility challenges for plaintiffs’ lawyers. Whether any of those challenges are realized should pivot on the facts of the particular case.

On the defense side of the ledger, the position taken by several ethics bodies that defense lawyers who initiate or join in the settlement-indemnity dance violate Rule 8.4(a) by doing so is unsupportable. No court should ever adopt that position.