Breakout Session: Shoreline Eric Howell Senior Corporate Counsel, Contracts & Major Programs

1. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

2. 3rd Party Liability Post 9-11: Indemnification and The Safety Act Breakout Session: Shoreline Eric Howell Senior Corporate Counsel, Contracts & Major Programs Northrop Grumman Corporation Eric.howell@ngc.com Ballroom, 1st Floor Kevin P. Kalinich, J.D. Co-National Managing Director Aon FSG, Technology and Professional Risks Kevin_Kalinich@ars.aon.com July 15, 2004 11:00 a.m. – 12:00 p.m. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

3. Presentation Outline • 3rd Party Liability Post 9-11, Indemnification and Mitigation • Background • Potential Risk Mitigation • SAFETY Act • Pre-Safety Act • Implementation of Safety Act • Safety Act Benefits • Safety Act Caveats • Insurance Issues • Questions and Answers NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

4. 3rd Party Liability Post 9-11, Indemnification And The Safety Act BACKGROUND • 9/11 and other less catastrophic events have completely altered the third party liability landscape for defense contractors • Pre-9/11: Contractors’ primary business was producing military products for the war fighter to use in military operations • Contractor received significant liability protection from Government Contractor (Boyle) Defense for these mil-spec products NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

5. 3rd Party Liability Post 9-11, Indemnification And The Safety Act BACKGROUND (CONT.) • Post-9/11: Contractors are producing hybrid/commercial products for prevention/detection/mitigation of terrorist threats • Products deployed in highly populated civilian environments not under military control • Application of Government Contractor Defense is problematic because many of these products adapt commercial products not manufactured to mil spec requirements • Potential for Contractor to be held liable for catastrophic damages to persons and property has increased exponentially NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

6. 3rd Party Liability Post 9-11, Indemnification And The Safety Act BACKGROUND (CONT.) • The US litigation environment exposes contractors to catastrophic liability • Courts have not dismissed 9/11 suits against airlines, airports, security providers in spite of terrorists’ criminal acts being the “cause” of the losses • Aviation defendants charged with negligently failing to fulfill duty to secure aircraft against potential terrorists • Congress has, in limited instances passed legislation to limit liability • 9/11 Victims Defense Fund bars suits by victims who elect to recover under the Fund; recovery by plaintiffs who “opt out” and sue limited to insurance coverage • Liability of manufactures of anthrax and smallpox vaccines limited by Executive Order NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

7. 3rd Party Liability Post 9-11, Indemnification And The Safety Act BACKGROUND (CONT.) • Future legislation/Executive Orders are unlikely to be enacted, particularly in light of passage of the SAFETY Act • SAFETY Act, signed into law in 2002, was designed to limit liability of sellers of qualified anti-terrorism technology (QATT) • Kevin will cover the SAFETY Act and Insurance considerations in his presentation NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

8. 3rd Party Liability Post 9-11, Indemnification And The Safety Act • THE PROBLEM – The acquisition system, designed prior to 9-11, provides insufficient protections against catastrophic liability of contractors, post 9-11. • THE SOLUTION – Both Government and Industry need to be creative, flexible and innovative in order to mitigate third party liability risks and ensure adequate competition for anti-terrorism products and services. • The following charts offer some potential ideas for mitigating third party liability post 9-11. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

9. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION • Provide for protection against third party liability under all types of contracts, similar to that found in FAR 52.228-7 “Insurance-Liability to Third Persons”for cost reimbursement contracts • Could be done through Special Provision (“H Clause”) or ultimately through a FAR change (future “I Clause”) • New FAR clause could be limited to acquisition of QATT products and services • Contractor would be compensated for certain third party liability losses that exceed insurance coverage • Compensation limited to appropriated funds NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

10. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • Urge DHS to make changes to the rules implementing the SAFETY Act • DHS should streamline application and approval process • For those technologies that have already been deployed prior to designation that are the same or substantially similar to the technology that was reviewed and approved by DHS, SAFTY Act protections should attach to all deployments of the technology NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

11. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • Modify the provisions regarding changes to products so that designation and certification do not automatically terminate when a “substantial” modification to the product is made • Clarify insurance requirements – contractor is only required to use best efforts to obtain required insurance coverage, especially coverage for others in the supply chain, which is problematic; Automatic drop-down provision if insurance is cancelled NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

12. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • Draft contracts for anti-terrorism products/services to maximize protection under the Government Contractor Defense • All contracts should require formal Government/Contractor reviews (PDR/CDR/etc) • Establish CDRL requirement for Contractor submittal of product/services specifications for Government approval; Government approval required before delivery NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

13. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • Contractual obligation by Contractors to warn 1) of known dangers in implementation of systems and use of equipment; and 2) make full disclosure of known risks associated with product performance • Include language in contracts that these products/services are not fail-safe NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

14. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • When COTS is used in performance, include Government direction to use such COTS • In appropriate circumstances include a special CLIN which allows the Contractor to charge the Government for special insurance coverage over and above its corporate general liability insurance NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

15. 3rd Party Liability Post 9-11, Indemnification And The Safety Act POTENTIAL RISK MITIGATION (CONT.) • Government PEOs/Contracting Officers take a proactive approach as advocates/sponsors for Safety Act designation/certification of technologies they are procuring • Facilitate expeditious review and approval • Advocacy will enhance likelihood of approval • Recognition that Government will still provide 85-804 coverage for those contracts which present such a high level of potential third party liability that other defenses are inadequate NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

16. Indemnification Post 9-11, Third Party Liability And The Safety Act The goal is to deliver the world’s best anti-terrorism defense capabilities through an acquisition environment that fosters efficiency, flexibility, creativity and innovation and ensures adequate competition NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

17. SAFETY ACT OUTLINE(Support Anti-Terrorism by Fostering Effective Technologies Act of 2002) • Pre-Safety Act • Implementation of Safety Act • Safety Act Benefit Highlights • Safety Act Caveats • Insurance Issues • Questions and Answers NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

18. Post 9/11 – Pre- Safety Act • Estimated $40.2 billion in losses from 9/11 • 5,493 business interruption claims (approximately $12 billion) • Insurance issues • Limited capacity/availability • Expensive pricing (100%+ additional premiums for TRIA) • Insufficient limits • Inadequate coverage provisions/many exclusions • Reinsurance practically disappeared (TRIA expires 12/31/05 – market has not developed as hoped) • Litigation against aerospace and defense contractors not dismissed by courts (aviation defendants negligently failed to fulfill duty “to secure passenger aircraft against potential terrorists.” • Threat of catastrophic litigation stifles innovation NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

19. Implementation of SAFETY Act • The SAFETY Act is comprised of Sections 861 to 865 of the Homeland Security Act of 2002 (Public Law 107-296), which created the Department of Homeland Security (“DHS”). The Act and the implementing interim final regulations, issued on October 11, 2003, provide broad liability protections for qualified anti-terrorism products and services. • June 18, 2004 • 91 Pre-Applications • 19 Full Applications • 4 Entities Granted Certification and Designation Status • Teledyne Technologies • Michael Stapleton Associates, Inc. • Lockheed Martin Corp. • Northrop Grumman Corp. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

20. Safety Act Benefits • Limited liability of “Seller” to extent of insurance purchased (“Designation”) • Rebuttable presumption of governmental contractor immunity defense (“Certification”) (Extends common law immunity of Boyle decision beyond federal government) • Only “Sellers” may be held liable, not any subcontractors, distributors, purchasers or others in technology chain • Applies regardless of whether for public or private use • Protections apply in perpetuity • No joint and several liability • Transferable to licensees of technology • Punitive damages and prejudgment interest barred • Exclusive jurisdiction in federal courts NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

21. Safety Act Benefits – (continued) • Reduction of plaintiff’s recovery to extent of collateral sources • Broad application • [A]ny product, equipment, service (including support services), device, or technology (including information technology) designed, developed, modified, or procured for the specific purpose of preventing, detecting, identifying, or deterring acts of terrorism or limiting the harm such acts might otherwise cause, that is designated as such by the Secretary • Mobile Fluid Jet System (“Water Sabre”) for bomb squads to remotely cut into suspicious containers • SmartTech PC-based systeme that can be linked to any x-ray machine screening packages for explosive devices • Computer System that analyzes information from a number of sources and compiles it into “near real-time” threat analysis • Biohazard Detection System capable of “sniffing” mail for trace amounts of biological agents such as anthrax as it runs through high-speed sorting machines at post offices • Marketing tool for entities of “Qualified Anti-Terrorism Technology” products and services • Include applicability in contracts NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

22. Safety Act Caveats • Does not cover entities for losses caused by anti-terrorist products and services when no terrorist act occurred (i.e technology causes environmental pollution) • Only entities related to products and services approved by DHS as “Qualified Anti-terrorism Technologies” enjoy statutory protections • Primarily limited to new technologies (with some exceptions for new uses of existing technologies) • Governmental contractor immunity defense is not absolute (but still enjoy limited liability to extent of insurance) • “Sellers” must use good faith efforts to enter into reciprocal waivers with others in the supply, distribution and use chain NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

23. Safety Act Caveats • “Sellers” must name others in the supply, distribution and use chain in their insurance policy • Safety Act protection does not cover non-QATT aspects of the technology • Although the Safety Act protects foreign technology providers that qualify, there are jurisdictional, conflict of laws and international treaty limitations that restrict the protections to cases involving the jurisdiction of U.S. courts that apply U.S. law • Only applies if harm is to “a person, property, or entity in the United States,” with exceptions for U.S. domestic aircraft and U.S.-flag vessels based principally in the U.S. , in or outside the United States NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

24. Safety Act Insurance Provisions • “Sellers” must purchase liability insurance to satisfy compensable claims • Insurance not required beyond the point at which the cost of coverage would unreasonably distort the price of the technology • Insurance must extend to third parties associated with the manufacture, sale, use or operation of the product or service • Must submit annual (at a minimum) certificate of insurance • The Under Secretary for Science and Technology will determine the amounts and types of liability insurance required for each technology, and the Under Secretary will certify the amounts and types of insurance required • Self-insurance is contemplated under certain circumstances NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

25. Safety Act Insurance Issues • Uncertainty regarding appropriate limits of insurance • Uncertainty regarding what constitutes “unreasonable distortion” of price of technology product or service • Insurance carriers largely unfamiliar with Safety Act • Insurance carriers often take 6 – 12 months to issue new policies or endorsements • Dynamic nature of technology products and services requires continuous updates to DHS application • Total insurance limits may be eroded disproportionately compared to revenue generated • Until precedent case law is established, entities and insurers should be leery of creative plaintiff litigation NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

26. Safety Act Insurance Questions and Answers What if there is a constellation of entities that contribute to the Anti-terrorism Technology? Q: What is the definition of “Seller?” A: DHS has revised the definition of Seller in in Section 25.9 of the interim rule in order to clarify that the “Seller” is the actual recipient of the Designation for a QATT. Q: Who determines which entity is the “Seller?” A: Although the DHS has the authority to grant “Designation” and “Certification” status, the courts will ultimately decide the effects of “Seller” status. Q: Can more than one party to a transaction obtain “Seller” status? A: Yes. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

27. Q: Since a plaintiff’s attorney could claim that a designer, manufacturer, installer, distributor, integrator, xSP, etc. is a “Seller”, could/should multiple parties apply for Safety Act protection? A: Any ATT Seller is eligible to apply for Safety Act protections. The DHS has stated that they leave it to the Sellers themselves to decide who is the most efficient party for application. Q: Why is the decision as to who is the “Seller” important? A: According to the Act, the Seller is the only proper defendant. According to DHS, this means that NO ONE else can be sued. Q: Is everyone in the chain of commerce protected, such as providers of components and peripheral parts of a system? A: Yes, theoretically. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

28. Q: What if an entity other than the Seller makes changes to ATT (i.e. owner of ATT after sale?). A: Designation can be revoked if significant modifications are made to the ATT. The courts will decide whether the changes were material enough to negate Safety Act coverage. A plaintiff’s attorney might argue that the Safety Act protections do not apply to the revised product. A Seller might argue that: “It’s not really my technology anymore, so I shouldn’t be liable.” Our advice is that if an entity is using ATT or is depending upon Safety Act protection as a participant in the chain of ATT that has received QATT designation, then such entity has the incentive to ensure that the QATT protection is maintained. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

29. Q: Does the threat of a terrorist act qualify as an “act of terrorism”? Who decides? A: The courts will apply the definition and make the determination. We need a body of law to build up that definition. The DHS will not make that decision. Q: Does the Safety Act apply to ongoing maintenance of ATT? A: Yes, so long as significant changes are not made. Q: Does the Safety Act apply if there is no maintenance of the ATT? A: The protection applies in perpetuity for QATT sold and deployed. Designation is valid for sales and deployments for five to eight years and may be transferred if the QATT is sold. However, many insurance policies exclude coverage for technology that is not maintained -- such exclusions/cancellations must be reported to DHS. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

30. Q: How long does the Designation/Certification process take? A: 6 months, but the DHS is attempting to streamline the process Q: How much time will it take to prepare the application? A: 1,000 hours (Harris Miller, president of the Information Technology Association of America) 108 hours (DHS), but the DHS is revising the application to reduce the time (See www.safetyact.gov for Application Kit, FAQ’s and other helpful material) Q: If a QATT is sold, deployed and there’s a terrorist event which incurs liability, is the Seller protected? A: If you deploy an ATT that failed because of a defect or negligence, the Seller and customer are supposed to be protected under the Act. If an entity is a customer, but doesn’t apply the ATT, then such customer opens itself up to potential liability outside of the Safety Act. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

31. Q: What are the obligations of a Seller once it has been QATT designated or certified? A: It must obtain/maintain liability insurance as proscribed by DHS, enter reciprocal waivers of claims with specified parties, provide annual certification of insurance coverage to DHS, and notify DHS of any change in insurance coverage or technology. Q: Does the existence of the Safety Act change the insurance and/or indemnity requirements the purchaser/user of ATT should include in a bid/proposal/contract requirements? A: It makes sense for the contract requirements to include a provision for Safety Act designation or certification and include the purchaser/user as an “also insured” and specifically named in the reciprocal waiver. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment

32. Q: What is the relationship of the Safety Act to indemnification under Public Law 85 – 804? A: DHS recognizes that Congress intended that the Safety Act’s liability protections would substantially reduce the need for the United States to provide indemnification under Public Law 85 – 804 to Sellers of anti-terrorism technologies. DHS recognizes, however, that there may be, in some limited circumstances, technologies or services with respect to which both Safety Act coverage and indemnification might be warranted. Q: If protection is issued to multiple Sellers (e.g. a situation in which the owner of a technology and one or more of its licensees are to be covered by a single designation), what are the insurance requirements? A: The parties’ respective obligations to obtain insurance will be specified in the Designation. NCMA Aerospace & Defense Contracting Conference Understanding and Preparing for a Changing Business Environment