Sponsors Should Ask for Indemnification in Provider Contracts

Indemnification clauses cover costs when being sued—but don’t eliminate fiduciary responsibilities.

Retirement plan sponsors should ask for indemnification clauses when they enter into contracts with service providers and retirement plan advisers, experts say.

Indemnification clauses are promises by the service providers that if they do something wrong that causes harm to the plan sponsor or causes a third party to sue the sponsor, the service provider will cover their legal costs, explains Fred Reish, chair of the Financial Services ERISA practice at Drinker, Biddle & Reath in San Francisco.

However, while it is important for plan sponsors to realize that indemnification clauses are helpful protections, they are not “exculpatory provisions” that eliminate sponsors’ fiduciary liabilities, Reish says. Sponsors still need to take steps to meet their fiduciary responsibilities when entering into a contract with a service provider. “You don’t offload your fiduciary responsibilities with an indemnification clause,” he says.

Sponsors should also be aware that when asking a service provider for an indemnification clause, the provider might say that as a general policy, it doesn’t offer such clauses—or it might ask the plan sponsor to reciprocate and indemnify the provider in return, Reish says. Sponsors will then need to determine if they are comfortable indemnifying their providers or working with a provider that doesn’t offer indemnification, he notes.

NEXT: Negotiating indemnification clauses

Retirement plan sponsors inevitably will need an Employee Retirement Income Security Act (ERISA) attorney’s help in negotiating indemnification clauses because their terms can vary widely, according to Reish. “Does it just cover the settlement amount of a lawsuit or attorney fees and the cost of hiring experts, or are the terms broader whereby the indemnification agreement covers any reasonable amount that needs to be paid in relation to a lawsuit?” Reish notes. “Does the indemnification clause cover any kind of mistake that is made, or is it limited to certain kinds of mistakes?”

It is vital for a plan sponsor to ensure the indemnification clause covers not just the plan sponsor, but also related persons, says Kishka McClain, a partner with Venable LLP in Washington. “That includes the company, its officers, directors, employees, agents, stockholders and affiliates,” McClain says.

It is also essential for sponsors to seek out indemnification clauses for actions where the service provider or a third-party subcontractor has discretionary authority and the sponsor is not in control, adds Jason Roberts, a partner with Retirement Law Group in Los Angeles. “An example would be where the service provider subcontracts service to a custodian or a trust company,” Roberts says. “Because the plan sponsor isn’t conducting due diligence on those third parties, they might want to seek indemnification for any misconduct by those third parties. Another very common issue is data throughputs. After the recordkeeper receives data from payroll, the sponsor no longer has control over the information and they should expect to be indemnified for the recordkeeper’s handling of this information.”

Privacy is another common issue that comes up in indemnification clauses for retirement plans, Roberts says. “Recordkeepers handle a lot of sensitive and personal information on participants. Plan sponsors should be indemnified against a breach or intentional dissemination of that information,” he says.

The scope of the indemnification is also important. When David Kaleda, a principal in the fiduciary responsibility practice group at Groom Law Group in Washington, D.C., goes over indemnification clauses in service provider contracts for his plan sponsor clients, he makes sure the terms are broad enough to provide ample coverage. For example, Kaleda doesn’t want the clause to apply to “gross negligence but to regular negligence, and not just to willful misconduct but to a material breach of the service agreement or applicable loss.”

Next: True fiduciary protection

Aside from seeking out indemnification clauses, plan sponsors have a fiduciary responsibility to thoroughly vet service providers before entering into a contract with them, says Babu Sivadasan, group president of Envestnet | Retirement Solutions in San Francisco. “Ask questions about their experience and their prudent fiduciary process,” Sivadasan says. “Ask about the underlying technology supporting the fiduciary processes. Make sure they are sound. If it’s a retirement plan adviser offering 3(38) or 3(21) fiduciary services, find out if they are offering those services on their own or if they are relying on a third-party administrator. Look at the skillset of all of the players.”                  

Kaleda agrees that thoroughly vetting service providers is key. “Sponsors need to have done thorough due diligence in selecting the service provider to ensure that they are competent and, importantly, their fees are reasonable,” he says. Sponsors also have a fiduciary responsibility to monitor their service providers to ensure they are delivering on the services delineated in their contracts.

Both Reish and Sivadasan also believe it is a smart move for plan sponsors to completely offload the investment selection and monitoring process by hiring a 3(38) fiduciary as opposed to a 3(21) fiduciary who will make suggestions but leave the decision up to the sponsor. “Plan sponsors seeking fiduciary protection should consider turning to a retirement plan adviser who can serve as a 3(38) fiduciary whereby they pick their investments and prudently monitor them,” Reish says. “That is the highest degree of protection you can get.”

In addition, “having fiduciary breach insurance is a great backstop because even if you are wrongfully sued, it can cost you hundreds of thousands of dollars to get out of a case,” he adds. In line with this, it is also smart for plan sponsors to make sure their recordkeeper and third-party administrator either also carry fiduciary breach insurance or are large enough to pay a legal expense, Reish says.

Finally, sponsors might consider asking an ERISA attorney to review their service provider contracts to ensure the terms are favorable for them and that they are indemnified wherever possible. By reviewing the entire service provider contract along with the indemnification clauses, an attorney can detect “whether the provider has added language to the contract that would shift risk,” McClain says. “For example, if the service provider has included a standard of care by which it will render its obligations, and they tie the indemnification clause to the standard of care, that can dilute your indemnification protection.”

Reish adds: “I am constantly amazed that sponsors will sign 20- to 30-page, complicated contract without reading them or having their attorneys read review them.”  Plan sponsors can really benefit from an ERISA attorney’s help in negotiating and reviewing service provider contracts—particularly with indemnification clauses because few plan sponsors are aware such clauses exist, Reish says. “This is not on their radar.”