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The Morton Memo - October 2012
This newsletter concerns traps for the unwary. The first article discusses an obscure but sometimes critical legal term - the indemnification clause. This clause can drop on a business owner like a bomb if it every comes into play. The second article continues with our focus on estate planning. Some people try to get around the need for a good estate plan and create more problems than they solve.
Since we are in the last quarter of the year, it's a good time to consider end of the year planning. We published an article on that last Fall and we recommend a review of There Is No Time Like The Present
for end of the year planning.
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A contract bomb: the indemnification clause
By Eric Morton
Some years ago, I published a newsletter article entitled “Hidden Consequences of Legal Boilerplate, What you don’t know (or pay attention to) can hurt you…” The article concerned the potential consequences of standard legal provisions, such as Entire Agreement, Governing Law, Time is of the Essence, and so forth. Business owners often enter into contracts without considering the import of these boilerplate provisions. Sometimes such a term can have an impact like a bomb out of the sky in the event a lawsuit.
Recently, I saw the effects of such boilerplate regarding another common term – the indemnification clause – that requires one party to provide a defense for the other party.
In a litigation matter I concluded a few months ago, my client had to provide a defense for another party—the property owner of a large construction project—when a third-party subcontractor sued the property owner. Under the contract, my client had assumed a duty to provide a complete defense and indemnify. Needless to say, this was very expensive and time-consuming for my client. Furthermore, my client wasn't aware that this indemnification clause was in the contract until receiving a demand for defense from the owner. In this case, we were ultimately able to obtain a judgment in the client’s favor, and an award of attorney’s fees. But that is certainly not the case in every lawsuit, as the facts and the strengths of a client’s position always vary.
We have seen indemnification clauses that require one party to a contract to indemnify the party who drafted the contract for any legal action related to the transaction. This means that if anyone sues the party that drafted the contract, the other party would be obligated to hire attorneys to defend the drafting party and pay any court costs and judgments, even if the indemnifying party had nothing to do with the legal action.
We always change those clauses to read that our clients only have a duty to indemnify if the legal action is something they caused. Furthermore, we always change the terms so that the duty to indemnify is mutual.
While indemnification clauses are common in construction contracts, they are also found in many other types of agreements. Indemnification clauses are often found in intellectual property agreements such as license agreements. These clauses can be a serious trap. Often companies will slip indemnification clauses into contracts they draft. The terms can be egregiously one-sided.
If you are signing contracts that have extensive legal terms, there is a good chance that one of those terms is an indemnification clause. Have an attorney review those contracts before you sign.
If you would like amore information about contract terms, please contact us at at firstname.lastname@example.org or (760) 722-6582.
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why you really need a trust
We have long urged our clients to have a living trust for their estates. Having a trust can prevent the need for probate and simplify the administration of your estate.
Clients sometimes attempt to hold property in other ways that they hope will avoid probate. However, doing so can have unexpected consequences and we therefore emphasize that caution should be used before taking steps such as holding property in joint tenancy. For example, many married couples hold real property as joint tenants. However, a joint tenancy can be inflexible because, after a joint tenancy is established, the property cannot be sold or transferred without the consent of both parties. Furthermore, the property becomes subject to the debts of both parties.
Our experience is that holding property as joint tenants with a child can also cause misunderstandings among siblings. We have seen children in court litigating the intentions of a parent because the parent left substantial property to one child in joint tenancy.
Furthermore, property should definitely not be held in joint tenancy if the surviving joint tenant is expected to make distributions of that property to other persons. For instance, a parent might add a child to a bank account as a joint owner, so the child can help pay the parent’s bills. The parent and child understand that, on the death of the parent, the child will distribute the remainder of the money to the other children. Parents may also do this with retirement accounts.
However, these types of joint tenancy arrangements may have unintended tax consequences for the surviving child who is expected to make distributions upon the death of the parent. For example, if the parent and child were joint tenants on an account worth more than $100,000—and the intention was to split the funds in equal parts among 3 children (thus avoiding probate or the need for a trust)—the child named as joint tenant legally owns all money in the account upon the death of the parent. Therefore, if the child distributes money to the other children in an amount greater than $13,000.00 each (the maximum for 2012), the child making the distribution will owe a substantial gift tax on all amounts distributed that exceed that amount. This can be a serious problem.
The solution is to create a trust, put all property in the trust, and maintain it there. With a properly drafted trust, property in the trust can be administered by a successor trustee on the death of person creating the trust (called a trustor). A trusted relative is often named as a successor trustee who can administer the trust for the beneficiaries, sometimes an adult, who can distribute property to the other children or beneficiaries without misunderstanding. The trustee can provide accountings of the trust, so there is no question that the trust purpose is being carried out.
For these reasons, we urge everyone who owns any real estate, but also any substantial property, to create a trust.
If you would like amore information about estate planning, please contact us at at email@example.com or (760) 722-6582.
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