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Indemnification Clauses: What Appraisers Should Know

by Isaac Peck, Senior Broker at OREP.org

Editor’s Note: The first edition of this article appeared in Working RE’s Fall 2022 issue (Vol. 60). New details and examples have been added to this latest version.

It’s a tale as old as time. When adding an appraiser to their appraisal panel, a lender or appraisal management company (AMC) will present to the new appraiser a 5-15 page-long “Appraisal Services Agreement” or “Appraiser Engagement Agreement” for signature. Inside these service agreements is an often-discussed and disputed clause: the indemnification clause.

Indemnification clauses were popularized in the years following the 2007/2008 real estate crash, as AMCs took over market share after the passage of HVCC and the Dodd-Frank Act. Today, the vast majority of lenders and AMCs ask appraisers to sign an agreement that contains an indemnification clause. I just reviewed a service agreement from Wells Fargo where the indemnification provisions spanned nearly a full page!

OREP helps over 10,000 appraisers with their E&O insurance every year—and a question that many appraisers routinely ask is: “Do I need to be worried about this indemnification clause?”

What Appraisers Should Know
Here is a sample indemnification clause:
Appraiser shall indemnify, defend and hold harmless AMC from and against and against any and all claims or legal actions which arise out of or relate to the following: (a) any negligent act or omission or willful misconduct by Appraiser; or (b) any breach in a representation, covenant or obligation of appraiser contained in this Agreement.

To unpack this, let’s start with what it means to “indemnify” someone. The Merriam-Webster Dictionary defines “indemnify” as:

• To secure against hurt, loss, or damage;
• To make compensation for incurred hurt, loss, or damage.

In other words, the contracted or subcontracted appraiser is agreeing to defend the AMC (or lender) and make them “whole” in the event the AMC is sued or held liable for mistakes that the appraiser makes.

The good news for appraisers is that most of these clauses are simply restatements of common law indemnification principles, i.e. that when one party (in this case the AMC) is harmed by the actions of another (the appraiser), there is an implied obligation on the part of the wrongdoer to reimburse the harmed party.

These types of clauses are now incredibly common amongst the construction trades, real estate professionals, wedding services, financial services, and more. For example, if you are a general contractor hired by a wealthy patron to build a house, you will probably hire a framing company to frame the house, an electrical company to run the electrical, and so on. In each case, the smart risk management practice is to have these subcontractors agree to indemnification clauses where they agree to take responsibility for any property damage, mistakes, or errors that they make. After all, even though you are the general contractor, if your subcontractors make mistakes, you want them to take responsibility and pay for it, not you.

My advice to any appraiser who hires a subcontractor in the course of their business operation would be to use an indemnification agreement themselves with their own subcontractor. For example, if you hire another appraiser to help you complete an appraisal, or measure a home, or to provide any services in the scope of your operations, you should have a signed agreement with that appraiser where they agree to indemnify you for mistakes, errors, or omissions on their part. It’s just good risk management.

Practical Example: Home Inspector
Here’s a story from an adjacent profession that highlights why using an indemnification clause is a good risk management practice for any professional that is hiring a subcontractor. OREP also serves home inspectors with liability insurance and recently had the privilege of defending a home inspector on a claim in the Midwest. This particular home inspector was offering his clients pest inspection services alongside his regular home inspections. For the pest inspection services, he would charge $80 for the pest inspection and then hire a pest professional to do the inspection for $50, pocketing a cool (extra) $30 on every transaction! Sounds like a good deal! In this case, the OREP home inspector told us that the pest professional was his “buddy,” and that while he had seen a copy of the guy’s liability insurance, he didn’t have a copy on file and he didn’t have a written agreement between himself and the pest professional (his subcontractor). I’ll bet you can start to see where this story goes.

After a year or two of this, one of the new homeowners that hired the OREP home inspector moved into their new house and did a “gut-to-the-studs” remodel, pulling out all the drywall with plans to completely update the home. Can you guess what they discovered? Termite damage. Lots of it. It had been concealed by the drywall and was not visible to the home inspector or to the pest inspector.

This is exactly the type of claim that would traditionally be made directly to a pest professional. But in this case, because the home inspector is the one who was hired to perform the pest inspection, he’s the one who collected the money and entered into an agreement with the homebuyer client, he’s the one with the liability.

But what about his “buddy?” He’s the one who actually did the inspection for termites. Do you think that he, his company, let alone his insurance carrier, will voluntarily step up and take responsibility for this claim? Doubtful to say the least. The pest professional and his insurance carrier are breathing a sigh of relief that they were not named in the lawsuit and that they are, so far, completely unencumbered by the entire ordeal. Whew!

Obviously, the home inspector was left to defend this claim all by himself. The only recourse a company has against a subcontractor like this would be to file a claim against the subcontractor and potentially sue them. In other words, the home inspector would need to sue the pest professional himself, while defending a lawsuit against the homeowner. Many insurance companies and professionals are very uncomfortable with this approach (unless the dollar amounts are very high), and in many cases, the subcontractor will get off scot-free if there is no written agreement between the two parties outlining responsibilities and liabilities.

If the home inspector had (1) a copy of the pest professional’s insurance, and (2) a written agreement with an indemnification clause, it would have been much easier for the home inspector to tender the claim to the pest professional’s insurance carrier and seek retribution and defense in the lawsuit.

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Practical Example: Mortgage Field
Here’s another example. OREP also serves mortgage field professionals with insurance and risk management. These professionals help banks and other large property managers manage their inventory of bank-owned properties (REOs) and their services include boarding up windows, mowing lawns, property maintenance and even property clean-outs—where a firm will go into a home and empty it of all furniture, belongings, and trash.

The relationship between these professionals is structured in a similar way to the appraisal industry: typically, there are larger vendors that service big contracts with a lender. They then sub out the jobs to smaller firms across the country. Just like with appraisals, lenders try to avoid administering their own panel of thousands of vendors across the country.

In one claim OREP has seen, a local mortgage field firm was hired by a larger vendor to perform a “clean out” on a particular property that had been foreclosed on. However, the smaller firm pulled up to the incorrect property address, kicked in the front door, and cleaned out the wrong house—putting all of the current homeowner’s current belongings out on the front lawn! As you can imagine, this resulted in an extremely large claim. But you guessed it: the larger vendor didn’t have an indemnification clause in their service agreement and had difficulty forcing the liability onto the smaller subcontractor who had made the mistake. As a result, the larger vendor ended up defending and settling a serious claim.

The problem here, for the larger company, is that their insurance covers them for claims that they face but doesn’t pay for any recovery efforts that they might want to engage in to sue the smaller subcontractor for their own damages (this is standard). Moreover, even if the smaller subcontractor was carrying their own insurance, without a clear indemnification clause in the agreement signed between the parties, the result is that the larger vendor and the smaller subcontractor’s insurance companies end up arguing about who is responsible for the claim! After taking on several claims because of the volume of their business and their faulty contracts, the larger vendor ended up in a precarious position, facing mid-six-figure insurance premiums and having very few carriers willing to even quote their business. In fact, the only insurance carrier that was willing to quote their business demanded as a condition of coverage that the company begin including indemnification clauses in all their service agreements.

If You Hire a Subcontractor
I tell this story to appraisers and AMCs alike when they ask me about indemnification clauses. Common law indemnification theory dictates that the party responsible for the mistake should pay for it. From a practical standpoint (especially when it comes to insurance), indemnification clauses make all the difference.

In other words, from a risk management perspective, any business that is working with subcontractors, or even businesses that allow subcontractors on their properties (like builders or wedding venues, for example), should be asking those subcontractors to sign an agreement with an indemnification clause. This is true for AMCs and appraisers as well. It is common sense and it is now a widely adopted practice across many industries.

This means that if you as an appraiser hire a subcontractor in your business and you want them (and their insurance) to be responsible for their own mistakes, having a written agreement with them that includes a clause where they agree to indemnify you for their own mistakes is a smart, prudent thing to do.

When You are the Subcontractor
Here’s what to look for when you are the subcontractor—like in cases where you’re working with an AMC or lender.

While indemnification clauses that have the appraiser take responsibility for errors that the appraiser commits are common, there are still things for appraisers to look out for when evaluating an engagement letter or services agreement.

Specifically, you never want to sign any agreement where you agree to indemnify any third-party for their mistakes or errors.

After HVCC and the Dodd-Frank Act were passed in 2010 and 2011, AMCs had disproportionate bargaining power and often tried to force appraisers into signing one-sided indemnification agreements where the appraiser actually agrees to indemnify the AMC for the AMCs own errors and mistakes!

The popularity of such one-sided indemnification clauses has since waned, as several states have passed AMC laws and regulations that specifically prohibit this practice. Here is an excerpt of the AMC regulation passed in Massachusetts listing AMCs’ “prohibited activities”:
Require an appraiser to sign an indemnification agreement that would require the appraiser to defend and hold harmless the appraisal management company or any of its agents, employees or independent contractors for any liability, damages, losses or claims arising out of the services performed by the appraisal management company or its agents, employees or independent contractors and not the services performed by the appraiser…

Thankfully, many other states have adopted similar language, and this issue is much less of a concern today. However, it is still something that appraisers should be on the lookout for when evaluating a new service agreement. From an insurance standpoint, if you agree to indemnify a third-party for their own mistakes and errors, that is not something your insurance will cover. So watch out for that!

How Can I Help?
If you ever have any questions about liability or risk management in your appraisal business, please reach out to me directly at isaac@orep.org or give OREP’s office a call: (888) 347-5273. We are now open 12 hours a day to better serve appraisers across the country! (8 a.m. ET – 8 p.m. ET)

Stay safe out there!

About the Author
Isaac Peck is the Editor of Working RE magazine and the President of OREP Insurance, a leading provider of E&O insurance for real estate professionals. OREP serves over 10,000 appraisers with comprehensive E&O coverage, competitive rates, and 14 hours of CE at no charge for OREP Members (CE not approved in IL, MN, GA). Visit OREP.org to learn more. Reach Isaac at isaac@orep.org or (888) 347-5273. Calif Lic. #4116465.

OREP Insurance Services, LLC. Calif. License #0K99465