I.

In today’s litigious society, it is not uncommon for individuals, businesses and entities to attempt to protect themselves through the use of indemnity agreements. While indemnity agreements may be effective tools for shifting risks, there are many nuances with which practitioners should be familiar with before drafting such agreements. This paper summarizes recent developments and trends as they relate to indemnity agreements in general. This paper also focuses on the limitations of indemnity agreements as they relate to school districts.

II.

An indemnity agreement is legally defined as a collateral contract or assurance, by which one person engages to secure another against an anticipated loss or to prevent him from being damnified by the legal consequences of an act or forbearance on the part of one of the parties or of some third person. Dresser Industries, Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508 (Tex. 1993). In more simple terms, an indemnity agreement is a promise to safeguard or hold the indemnitee harmless against either existing and/or future loss, damage or injury liability. Id.; citing to Russell v. Lemons, 205 S.W.2d 629, 631 (Tex. Civ. App. – Amarillo 1947, writ ref’d n.r.e.).

III.

In Texas, a contractual indemnity agreement is read as any other contract. Safeco Insurance Company of America v. Gaubert, 829 S.W.2d 274, 281 (Tex. App. – Dallas 1992, writ denied). Under defined principles of contract law, courts must ascertain and give effect to the intentions of the parties as expressed in the instrument. Id. Courts will only look within the four (4) corners of the contract to interpret or construe an indemnity clause. In determining the parties’ intentions in an indemnity agreement, words and phrases are given their ordinary, popular and commonly accepted meaning. Id.; see also Keystone Equity Management v. Thoen, 730 S.W.2d 339, 340 (Tex. App. – Dallas 1987, no writ). Unless the contract is ambiguous, a court must discern intention of the parties from only the contract itself. Ideal Lease Service, Inc. v. Amoco Production Company, Inc., 662 S.W.2d 951, 953 (Tex. 1983). Courts are not allowed to expand the parties’ rights or responsibilities beyond the limits agreed upon by them in the contract.

The Texas Supreme Court itself has recognized that there is a trend towards stricter construction of indemnity contracts. Ethyl Corp. v. Daniel Construction Company, 725 S.W.2d 705, 707 (Tex. 1987). In an indemnity agreement, a party may agree to indemnify or hold harmless another party, even though the damage may result from the negligence of a party to be indemnified. Ohio Oil Company v. Smith, 365 S.W.2d 621, 626 (Tex. 1963). In order to shift this potential liability, early decisions required that indemnity agreements meet a "clear and unequivocal test" before they would be found to be valid. Sira & Payne, Inc. v. Wallace & Riddle, 484 S.W.2d 559, 560-61 (Tex. 1972). To be enforceable the contract must express in clear and unequivocal language the intent of the indemnitor to indemnify the indemnitee against the consequences of the indemnitee’s own negligence, whether such negligence was the sole proximate cause of the injury or a proximate cause jointly and concurrently with the indemnitor’s negligence. Id. at 561.

Through the years that the "clear and unequivocal test" was in effect, courts found that scriveners of indemnity agreements devised novel methods of drafting provisions which failed to expressly state the true intent of the these provisions. Ethyl Corp., 725 S.W.2d at 707-08. Courts found that the intent of the scriveners was to indemnify the indemnitee for its negligence, yet be just ambiguous enough to conceal that intent from the indemnitor. Id. The result of this creative drafting was a plethora of lawsuits to construe these ambiguous contracts. Id.

In light of the numerous lawsuits involving the construction of indemnity agreements, the courts disposed of the "clear and unequivocal test" and adopted in its place the "express negligence doctrine." Ethyl Corp., 725 S.W.2d at 708.

IV.

Under the express negligence doctrine, parties seeking to indemnify the indemnitee from the consequences of its own negligence must express that intent in clear and specific terms. Ethyl Corp., 725 S.W.2d at 709. Under this test, the intent of the parties must be specifically stated within the four (4) corners of the contract itself. Id. Because indemnification of a party for its own negligence is an extraordinary shifting of risk, courts have developed "fair notice" requirements in these types of agreements. In order to provide fair notice, not only must intentions be clearly expressed, the indemnification language must be "conspicuous." Enserch Corp. v. Parker, 794 S.W.2d 2, 8 (Tex. 1990). The conspicuousness requirement mandates that something must appear on the face of the contract to attract the attention of a reasonable person when he looks at it. Dresser Industries, Inc., S.W.2d at 508; citing to Ling & Company v. Trinity Savings & Loan Ass’n., 482 S.W.2d 841, 843 (Tex. 1972). The rationale for fair notice in indemnity agreements is to prevent injustice. Spence & Howe Construction Company v. Gulf Oil Corp., 365 S.W.2d 631, 634 (Tex. 1963). A contracting party should be given fair notice that under the agreement and, through no fault of his own, an award of damages may be assessed against him. Id.

V.

There are very few exceptions to the fair notice requirements. However, in Dresser Industries, Inc., the Texas Supreme Court held that the fair notice requirements are not applicable when the indemnitee establishes that the indemnitor had actual notice or knowledge of the indemnity agreement. Dresser Industries, Inc., 853 S.W.2d at 508 n.2. Actual notice or knowledge is in the nature of an affirmative defense to a claim of lack of fair notice. U.S. Rentals, Inc. v. Mundy Service Corp., 901 S.W.2d 789, 793 (Tex. App. – Houston [14^th Dist.] 1995, writ denied). It is the indemnitee’s burden to prove, not the indemnitor’s burden to disprove, actual notice or knowledge. Id.

VI.

Great care should be taken by attorneys who find themselves drafting indemnity agreements. In order to be enforceable, attorneys must follow the express negligence doctrine and also the conspicuous requirements to ensure that provisions will be enforced if litigated. Compliance with both of the fair notice requirements is a question of law that a court will decide if litigation ensues. Dresser Industries, Inc., 853 S.W.2d at 509.

Practitioners should be mindful that the express negligence requirement is simply a rule of contract interpretation. Fisk Electric Company v. Constructors & Associates, Inc., 888 S.W.2d 813, 814 (Tex. 1994). In order to satisfy this prong of fair notice, attorneys should strive to draft agreements which clearly provide for indemnification for the indemnitees own negligence. If the indemnity provision fails to establish this prong within the four (4) corners of the contract, indemnification will be denied.

In 1993, the Texas Supreme Court adopted the standard for conspicuousness contained in Section 1.201 of the Texas Uniform Commercial Code. Dresser Industries, Inc., 853 S.W.2d at 511. Under this standard, a term or clause is held to be conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it. Tex. Bus. & Com. Code Ann. §1.201(10) (Vernon 1994). By way of example, the drafters of the U.C.C. stated that a printed heading in capitals is conspicuous. Id. Language in the body of a form is conspicuous if it is in larger or other contracting type or color. Id. An excellent discussion of drafting indemnity provisions that comply with the conspicuousness requirements can be found in Greer, The Conspicuousness Requirement: Litigating and Drafting Contractual Indemnity Provisions in Texas After Dresser Industries, Inc. v. Page Petroleum Inc., 35 S. Tex. L. Rev. 243, 265-268 (1994).

Suggestions that drafters of such agreements should keep in mind include the following:

1. Make the indemnity provision look noticeable;
2. Avoid making the indemnity provision look different by merely using italics, lighter-colored type, same-typed print or smaller print;
3. Emphasize the entire indemnity provision, not just portions of it;
4. Do not over-use conspicuousness techniques in other contractual provisions;
5. Avoid putting indemnity provisions on the backs of contracts;
6. Make indemnity provisions more conspicuous by placement at the beginning or end of the contract;
7. Avoid using misleading headings;
8. Do not surround indemnity provisions with unrelated terms; and
9. Require parties to initial indemnity paragraphs.

Id.

VII.

When considering contracts under which the school district or other governmental entity is sought to be charged with the duty to indemnify the other party, it must be remembered that school districts and other governmental entities are unlike private individuals and entities. The very nature of school districts and the restrictions on the power of both administration and boards of trustees may and, often do, render such paragraphs void and unenforceable.

Governmental entities, including school districts, are limited by constitutional mandate from entering into certain contracts. These limitations are placed on governmental entities through constitutional restrictions on the use of public funds and public credit. The expenditure of public funds and credit can occur in a variety of situations. The Texas Constitution contains several restrictions which are directed to prevent the type of ventures which would amount to improper expenditure of funds. Relevant provisions include the following:

1. Tex. Const. art. III, §50:

The Legislature shall have no power to give or to lend, or to authorize the giving or lending, of the credit of the state in aid of, or to any person, association or corporation, whether municipal or other, or to pledge the credit of the state in any manner whatsoever, for the payment of the liabilities, present or prospective, of any individual, association of individuals, municipal or other corporations whatsoever.

2. Tex. Const. art. III, §51:

The Legislature shall have no power to make any grant or authorize the making of any grant of any public monies to any individual, association of individuals, municipal or other corporations whatsoever; provided, however, the Legislature may grant aid to indigent and disabled Confederate soldiers and sailors under such regulations and limitations as may be deemed by the Legislature as expedient, and to their widows of an indigent circumstances under such regulations and limitations as may be deemed by the Legislature as expedient; provided that the provisions of this section shall not be construed so as to prevent the grant of aid in cases of public calamity.

3. Tex. Const. art. III, §52:

Except as otherwise provided by this section, the Legislature shall have no power to authorize any county, city, town or other political corporation or subdivision of the state to lend its credit or to grant public money or thing of value in aid of, or to any individual, association or corporation whatsoever, or to become a stockholder in such corporation, association or company.

4. Tex. Const. art. XI, §3:

The purpose of the above constitutional provisions was to prevent the gratuitous application of public funds. Byrd v. City of Dallas, 118 Tex. 28, 6 S.W.2d 738 (Tex. Comm’n. App. 1928, opinion adopted); see also, State v. City of Austin, 160 Tex. 348, 331 S.W.2d 737, 732 (1960). This purpose rang true when these provisions were first drafted and still holds true in our modern society. Graves v. Morales, 923 S.W.2d 754, 757 (Tex. App. – Austin 1996, writ denied).

When a governmental entity attempts to spend government funds, it must make sure that those funds are spent on items which constitute a "public purpose." The public purpose doctrine was first enunciated in Sharpless v. Mayor of Philadelphia, 21 Pa. 147 (1853); see also, Willatt, Constitutional Restrictions on Use of Public Money and Public Credit, 38 Tex. B.J. 413, 414 (1975). In Sharpless, the court held that it was implicit in the Pennsylvania State Constitution that taxes could be levied only for a public purpose. Id. The court also held that any statute assessing taxes for private purposes would violate the state’s due process clause as a taking of property for private use. Id. The public purpose doctrine has now been universally accepted either by constitutional provisions or by judicial decision. See Taylor, A Proposal to Prohibit Industrial Relocation Subsidies, 72 Tex. L. Rev. 669, 673 (1994).

VIII.

The constitutional restrictions regarding expenditure of governmental funds restricts the "Legislature", "Counties", "Cities", "Towns", "Political Corporations" and "Political Subdivisions" from certain actions. See Tex. Const. art. III §§50, 51, 52 and 55. In 1931, the Texas Supreme Court analogized school districts to cities, towns and municipal corporations. Love v. City of Dallas, 120 Tex. 351, 40 S.W.2d 20, 25-27 (1931). The Love court stated that school districts are local public corporations of the same general character as municipal corporations. Id. Today, Texas courts define school districts as "quasi-municipalities." San Antonio ISD v. McKinney, 936 S.W.2d 279, 283 (Tex. 1996). Accordingly, school districts are subject to the constitutional restrictions regarding pubic money and public credit. This view has also been followed by the Texas Attorney General’s Office which has held that independent school districts are subject to constitutional restrictions regarding public funds. Op. Tex. Att’y Gen. No. MW-89 (1979).

IX.

Governmental bodies and school districts enter into innumerable contracts with private entities. The authority to enter into contracts is limited to the power that is either expressly or by reasonable implication conferred on the governmental body by the constitution or by statute. Op. Tex. Att’y Gen. JM-157 (1984). Any act undertaken by a governmental body without authority is "ultra vires", i.e., beyond the power of the governmental body to perform under any circumstances and for any purpose. Whitmier v. Kriegel, 678 S.W.2d 567, 569 (Tex. App.-Houston [14^th Dist.] 1984, write ref’d. n.r.e.).

A governmental body may contract only in the manner and for the purposes provided by the Constitution or by statute and is not bound by a contract beyond the scope of its powers or foreign to its purpose, or which is outside the authority of the public officers making it. Galveston, H. Hyberstan S.A. Ry. Co. v. Uvalde County, 167 S.W.2d 305, 307 (Tex. Civ. App.-San Antonio 1942, write ref’d. n.r.e.).

When a governmental body commits an "ultra vires" act, the private entity that is the other party to the contract must bear the loss. This is because a person contracting with public officers must take notice of the public officer’s powers. Uvalde County, 167 S.W.2d at 306-07. The private party to the contract is charged with knowledge of the law and is held to make a contract in violation of the law at its own risk. Id.

X.

Although some agencies have attempted to circumvent them, there is no way to circumvent the constitutional limitations regarding public funds. See Tex. Att’y Gen. LO-90-99 (1990). In LO-90-99, San Saba County sought to guarantee a bank loan to a private entity. The opinion stated that such a contract would clearly violate Article III, §52 of the Texas Constitution and was therefor void and unenforceable. Id. As part of the contract, San Saba County added language waiving its defenses to enforcement of its guaranty. Id. The opinion held that the county could not avoid constitutional limitations regarding public money or credit by stating that it would not raise them in its own defense. Id. Counties, the opinion stated, do not have the option of waiving these mandatory constitution restrictions. Id.

XI.

In light of the constitutional restrictions on public funds, can a school district enter into a contract to indemnify another party? As might be expected, the giving of indemnity by a school district may amount to making a gift of public funds or lending of public credit for private purposes contra to the restrictions found in the Texas Constitution. See Op. Tex. Att’y Gen. No. DM-467 (1998); See also Tex. Att’y Gen. LO-90-107 (1993).

In Texas Attorney General Opinion MW-475 (1982), the attorney general considered the authority of a state university to enter into an indemnity contract. The indemnity provision at issue in MW-475 stated as follows:

University shall indemnify and hold harmless contractor from and against any and all claims, actions, or damages including attorney’s fees caused by or arising out of the performance, failure to perform or breach of any of the university’s obligations under this lease.

The opinion concluded that because of constitutional restrictions on the creation of debt by the state, a state agency would ordinarily be unable to execute an enforceable indemnity agreement in favor of another party. Id. The attorney general’s opinion invalidated the indemnity provision by holding as follows:

To the extent that such a clause merely reinforces obligations the university has legally undertaken elsewhere, and does not expand or increase the school’s liability or the scope of its liability, it is harmless surplusage. But to the extent that it purports to create liability or potential liability on the part of the university beyond its statutory or constitutional powers to incur liability, it is invalid.

The reasoning set forth in Op. Tex. Att’y Gen. No. MW-475 has long been the established law in Texas. See Texas & N.O.R. Co. v. Galveston County, 161 S.W.2d 530 (Tex. Civ. App.-Galveston 1942), affirmed, 141 Tex. 34, 169 S.W.2d 713 (1943). In Galveston County, the county and several railroads entered into a contract for the construction and operation of a drawbridge. Id. In the contract, Galveston County agreed to indemnify the railroads from liability for any injury to persons or property that might occur in the bridge’s operation. Id. After three persons were injured on the bridge, one of the railroads sued the county to recover defense costs and settlement amounts paid to the three (3) injured persons. Id. The court denied the railroad relief holding that the indemnity agreement between it and the county was void as violative of the constitutional restrictions on public money and credit. Id.

Without question, school districts and other governmental entities may not create liability or potential liability through indemnity provisions beyond their statutory or constitutional powers to incur. However, does such a clause in a contract void the entire agreement? The answer to this question is no. Op. Tex. Att’y Gen. No. MW-475 held that an indemnity agreement negotiated by a state entity in violation of law is unenforceable and void, but did not invalidate the entire contract. Id. This reasoning follows the rule that where consideration for the contract is valid, an agreement containing more than one promise is not necessarily rendered invalid by the illegality of one of the promises. Williams v. Williams, 569 S.W.2d 867, 871 (Tex. 1978). In such a case, the invalid provisions may be severed and the valid portions of the contract upheld provided the invalid provision does not constitute the main purpose of the contract. Id.

XII.

If a school district is to be indemnified, attorneys should make sure that agreements are properly drafted to ensure that they are valid. Because courts recognize that indemnification is an extraordinary shifting of risk and closely construe such provisions, attorneys should take extra caution in drafting indemnity provisions. Care should be taken to see that the contract complies with the fair notice requirements mandated by the Supreme Court. This includes both the express negligence doctrine and the conspicuousness requirement. Through proper drafting, the school attorney can provide his or her school district client optimum protection from potential liability or loss.

Conversely, when counsel for a school district is presented with a contract purporting to require the district to indemnify the other party, several defenses may be available. Any indemnity provision will likely be in violation of the constitutional restrictions against the giving away of public funds. If the putative indemnity agreement seeks to impose liability on the district or damages for which the district would otherwise be immune under the doctrine of governmental immunity, the provision will likely be held void and unenforceable by the courts. Additionally, the district may have the defense that either the indemnity provisions did not clearly express the fact that the district would become liable to the other party or that provisions were not conspicuously shown in the agreement.

In representing school districts in the negotiation of contracts, the authors have found that most parties will agree to remove the any indemnity provisions under which the school district might be required to indemnify the other party. After all, if the liability sought to be imposed would exist absent the indemnity provision, the indemnity provision is mere surplusage. On the other hand, if the liability does not exist absent the indemnity provision, the indemnity provision would gratuitously bestow public funds on the other party and the provision will likely be held to be void.