The Pactix Pretty Good Contract Clauses compendium includes a detailed section on "Claim Defense procedures." It addresses the situation where a "Claim-Defender" party is obligated to defend one or more "protected persons" against third-party claims.

Heads-up for protected persons

Protected persons should keep in mind that Claim-Defender will not necessarily be overjoyed to provide a defense, even if the contract clearly requires it to do so. In the real world, Claim-Defender might try to find “wiggle room” to let it avoid the defense obligation. This could cause serious problems for the protected person(s), especially those that cannot afford to pay for their own defenses in the meantime.

Indeed, Claim-Defender may even find itself under pressure from government authorities not to provide a defense. See, for example, the tale of KPMG's refusal to advance legal fees to a number of its former partners in their trial on tax-fraud charges. Judge Lewis Kaplan ruled (PDF) that federal prosecutors had violated the ex-partners' constitutional rights by pressuring the firm not to advance defense costs; he held that "KPMG refused to pay because the government held the proverbial gun to its head." (Id. at 2.)

Obligation: Provide a competent defense

Claim-Defender's basic obligations is to provide a "competent defense" against the third-party claim. That term is intentionally not defined, on the assumption that Claim-Defender will thus be motivated to err on the side of “doing the needful” for the protected party.

Option to defend claim even if not requested

Even if a protected person doesn't request a claim defense, Claim-Defender has the right to provide such a defense in its discretion. That's because a situation might arise where a protected person doesn’t really care about the third-party claim (perhaps because it doesn’t think it has any “skin in the game”) and doesn’t intend to mount a defense. In that case, Claim-Defender should have the option to step in and provide a defense anyway (because it might well have a lot of its own skin in the game).

Reasonable cooperation in the defense

Chances are that the protected person will need to provide Claim-Defender’s counsel with information and documents to aid in the defense. The protected person may also need to testify in deposition and perhaps at trial. The Pactix clause requires Claim-Defender to reimburse the protected person for its reasonable out-of-pocket expenses in this regard.

Reimbursement of reasonable out-of-pocket expenses

A protected person's might include fees of separate counsel for the protected party, to the extent that the separate counsel didn’t duplicate the effort of Claim-Defender’s counsel. Another clause in this section allows the parties to specify clearly whether such fees are or are not reimbursable.

Control of defense

As is typical of such clauses, the Pactix Claim Defense procedures section gives Claim-Defender the right to control the defense, with certain limitations.

(To similar effect is UCC § 2-607(5)(B), which addresses only third-party infringement claims.)

Prompt request for defense

Under the Pactix provisions, if a protected person delays requesting a defense, Claim-Defender is not excused from its defense obligation, but is merely absolved from responsibility for any damages the protected party suffers as a result of the delay. So, for example, if the protected party allowed the claim to proceed to judgment without requesting a claim defense, Claim-Defender would be responsible only for providing a competent appeal (assuming one were possible).

Contrast this approach with UCC § 2-607(3)(B), which (in the context of third-party infringement claims) in essence lets Claim-Defender off the hook completely if the protected person does not give Claim-Defender notice of litigation within a reasonable time after itself receiving notice of the litigation.

Separate counsel for protected person

One clause in the Pactix provision allows a protected person to engage separate counsel to monitor the defense, but only on its own dime. But what if Claim-Defender’s interests are so divergent from those of the protected person counsel that Claim-Defender's counsel has a conflict of interest? In that case, it’s reasonable for Claim-Defender to cover the cost of separate counsel as well as that of its own counsel.

Heads-up: Subrogation as requirement for claim defense

A few contracts here and there require the protected person to agree that Claim-Defender will be subrogated to the protected person's rights in respect of the relevant claims and defenses. This could mean that, if the protected person is found liable for the third-party claim, Claim-Defender would be able to turn around and sue the protected person to recover the defense costs. That might be directly contrary to what the protected person thought it was bargaining for.