Community associations are engaged in multi-faceted and dynamic operations, often handling a wide assortment of items from handling reserve funds to arranging for swimming pool operations. There are also considerable administrative burdens in the operation of a community association such as handling communications with owners, payment of insurance premiums, collection of assessments, and preparing Virginia State Corporation Commission (“SCC”) annual reports. To assist with these administrative items, community associations are often managed by professional community management companies. These management relationships are often memorialized by written management contracts. 

Hopefully, the relationship between the management company and the community association is both productive and pleasant. Unfortunately, community associations may find themselves in disputes with their management company. In some cases, a community association may end up wanting to terminate their management contract and change their management company. Conversely, it is also possible that a management company may no longer wish to manage a particular community association, necessitating the community association to begin the process of finding new management. 

It can be very time-consuming for community associations to interview and select a community management company. Typically, once a new management company is chosen, the community association is presented with a draft management contract from the management company. 

While these draft contracts may look routine and boilerplate, community management contracts are binding legal contracts that have serious implications for the parties, including community associations. Community management contracts may include all sorts of provisions, including provisions setting forth the management fees and other charges, the scope of services the management company will provide, and insurance requirements, to name a few.

It is critical for a community associations to review the draft management contract with their legal counsel before agreeing to the contract. Often, a community association lawyer can review and suggest edits to the draft management contract for the management company’s consideration.

This next series of blog posts will focus on some key provisions of community association management contracts. This first post will be about the concept of indemnification. 

Indemnification: A Basic Explanation

According to the Legal Information Institute, indemnification “means compensating a person for damages or losses they have incurred or will incur related to a specified accident, incident, or event.” Indemnification is a way to address, shift, and allocate legal risk among the parties to a contract.

Often, contracts will contain indemnification provisions that provide that one or more parties to a contract will indemnify (pay certain expenses of) another in certain circumstances. An indemnification provision may also include additional obligations to “defend” (meaning to defend a person in litigation or in response to a legal claim or other action) or “hold harmless.”

For example, a management contract may contain an indemnification provision that provides that a community association will indemnify the community management company for all expenses, costs, etc. in the event that the community management company is sued while carrying out its duties under the management contract.

While a provision such as this may appear relatively boilerplate, it is important to analyze such a provision closely. For example, it is critical to look at who will be indemnifying whom.  Oftentimes, indemnification provisions will include a broad scope of persons to be indemnified, for example, the management company, its agents, owners, members, managers, employees, and representatives. Might this be too broad? Could that possibly cover an unapproved third-party vendor hired by the community management company that the community association did not know of? 

Additionally, it is important to look at which expenses the indemnifying party will indemnify for the indemnitee (the person receiving the benefit of the indemnification obligation). In other words, what expenses and amounts of money are to be paid if the indemnification provision is actuated? For example, in an indemnification provision that provides for the community management company to indemnify the community association under certain circumstances, is the scope of what expenses are to be indemnified broad enough to adequately protect the community association? In this case, does the indemnification provision include attorney’s fees and costs as well as all court judgments and monetary awards? Does it include attorney’s fees and costs incurred pre-litigation? Often there are significant expenses incurred in investigating and defending a claim before a lawsuit is filed.

Another consideration is under what circumstances the indemnification obligation arises.  For example, does the indemnification obligation in favor of the community management company arise in situations in which the community association or its agents are grossly negligent or willfully negligent, or is it far broader to include situations where the community association or its agents are simply negligent (which is typically much easier to prove compared to gross negligence)? Or, is a showing of negligence required, and is the indemnification actuated by acts or omissions of the community association or its agents?

Additionally, it is often prudent to build in some exceptions to an indemnification provision such as when the indemnification obligation will not arise, such as in the cases of the indemnitee’s or its agents’ own negligence, gross negligence, willful misconduct, illegal conduct, or misconduct. As one can see, an indemnification provision can have serious implications for the parties to a contract. Indemnification provisions can result in serious legal risk, liability, and expenses for the parties. Reviewing draft management contracts with legal counsel can help the community association better understand and manage its risk. If you have any questions about indemnification or would like assistance reviewing draft management contracts, please contact an author or a member of Gordon Rees Scully Mansukhani’s Real Estate practice group.