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Indemnification Clauses and Defining the Relationship

2.20.2018

We typically think an attorney-client relationship is something that has an unmistakable beginning. One day a client says, “I want you to be my attorney.” To which the attorney replies, “Sure, I will be your attorney.” However, you may be surprised to learn that an attorney client-relationship can arise from something far less definite than an explicit agreement between the attorney and his or her client. As an attorney-client relationship comes with a number of privileges and obligations, understanding when that relationship comes into being is crucial.

In the recently decided Friday Invs., LLC v. Bally Total Fitness of the Mid-Atl., Inc., the North Carolina Supreme Court found the existence of an attorney-client relationship under circumstances where neither party explicitly discussed legal representation. There, the central question was whether an attorney-client relationship exists between a defendant to a lawsuit and a non-party that contractually agreed to indemnify that defendant and, if so, whether correspondence between the two is protected by the attorney-client privilege.

Distilled down to the key points, the relevant facts are fairly straightforward:

  • Defendant operated a health club and leased a large commercial space from Plaintiff.
  • Defendant later sold its health club, also assigning its rights under the lease to Buyer.
  • The agreement, transferring ownership of the health club, also included an indemnification clause, wherein Buyer agreed to "defend, indemnify, and hold [Defendant] . . . harmless of, from and against any Losses incurred . . . on account of or relating to . . . any Assumed Liabilities, including those arising from or under the Real Property Leases after the Closing."
  • Sometime after being assigned the rights under the lease, Buyer failed to pay rent. Plaintiff brought suit against Defendant.
  • Pursuant to the indemnification clause, Buyer promptly agreed to indemnify and defend Defendant.
  • During discovery, counsel for Plaintiff requested copies of "post-suit correspondence and documents exchanged between [Defendant] and [Buyer]." After Defendant refused to comply, citing attorney-client privilege, Plaintiff moved to compel production of the requested documents. The trial court granted Plaintiff's motion to compel.

On appeal, to determine whether the documents were privileged, the Supreme Court first weighed whether an attorney-client relationship existed. While it may seem odd to recognize an attorney-client relationship between a defendant and a non-party, such an arrangement is consistent with existing case law. Our courts routinely recognize a multiparty attorney-client relationship in which an attorney represents two or more clients. The rationale being that individuals with a common interest in the litigation should be able to freely communicate, with the protection of attorney-client privilege, with their attorney, and with each other, to more effectively defend or prosecute their claims.

The Supreme Court extended the logic of the multiparty attorney-client relationship to a relationship formed by an indemnity agreement. Buyer contractually agreed to indemnify and defend Defendant against any losses incurred relating to the real property lease. After the litigation commenced, Buyer engaged counsel to defend the case under the indemnification agreement. Like the common interest found in the insurance context, Buyer's interest in Defendant’s legal well-being creates the common interest in this litigation: the indemnification provision subjects Buyer to any damages that result from an adverse judgment against Defendant. Accordingly, the Supreme Court found a tripartite attorney-client relationship existed between Defendant, Buyer, and defense counsel.

Interestingly, the Supreme Court, though willing to find an attorney-client relationship, was unwilling to extend the attorney-client privilege. For the attorney-client privilege to apply, the communication must satisfy the following five-factor test:

(1) the relation of attorney and client existed at the time the communication was made, (2) the communication was made in confidence, (3) the communication relates to a matter about which the attorney is being professionally consulted, (4) the communication was made in the course of giving or seeking legal advice for a proper purpose although litigation need not be contemplated, and (5) the client has not waived the privilege.

Unfortunately for Defendant, the trial court's discovery ruling was reviewed for abuse of discretion. Showing that a trial court abused its discretion is often a tall order, requiring an appellate court to find that the lower court’s ruling was manifestly unsupported by reason and could not have been the result of a reasoned decision. Here, that high burden proved insurmountable as the trial record was almost entirely bare; as neither party requested it, the underlying trial court order compelling discovery contained neither findings of fact nor conclusions of law. Without such findings and conclusions, the Supreme Court could not find that the trial court abused its discretion.

What does this decision mean for you? As always, read your contracts carefully. Language such as “shall defend,” “shall indemnify,” or “shall hold harmless” should alert you to the possibility that your agreement contains an indemnification clause. While there is nothing inherently wrong with an indemnification agreement, you will want to be certain to identify the extent and scope of such an agreement thus avoiding surprises down the road.

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