Indemnification Clauses: What Are They and Why Do They Matter?
Indemnification clause are a standard feature of innumerable commercial contracts. Indemnification clauses are designed to shift risk and protect one or both parties in a contract, potentially protecting one side from the risks and costs associated with something going wrong.
How does an indemnification clause work?
An indemnification clause sets out an obligation that one side of a contract will protect the other side from some or all (depending on the exact wording) of the other side’s risks, damages, and losses arising from one or more causes. For example, if your company makes and sells widgets, and you get a certain component for that widget from another company, you could require that other company to be on the hook in case your company ever gets sued by a consumer and the reason you got sued was that specific component didn’t work properly.
Indemnification clauses can protect you from a lot of potential harm to your company, and they usually are worded to cover all the damages you might face as a result of a lawsuit and all your legal costs. On the other hand, depending on how the contract is written, it could be your company that’s on the hook for the potential losses, damages and legal costs the other side faces.
Why you should care about the indemnification clause in your contract
While the indemnification clause in your next contract may be perfectly fair and reflective of the actual responsibilities of your and the other party to the contract, there is no guarantee that is the case. Frequently indemnification clauses are drafted so that businesses are contractually responsible for the kinds of risks and damages that, as per the commercial realities of the situation, the other party of the contract should have to deal with. And these are the sorts of risks and damages that could easily damage a small business operating on lean margins or a short cash supply!
The other common problem businesses face is that there may be no indemnification clause in the contract even when one should definitely be there to properly protect you. In these cases, think about the risks – especially risks that your business could get sued over – that the other side should be responsible for. Those are the risks that should get covered in the contract’s indemnification clause if that isn’t the case already.
What to look for in indemnification clauses?
As you can imagine, this is one section of your contract with the specific details can make a huge impact on the risks you will take on or be protected from. Here are some of the most important things for you to look for in an indemnification clause.
Who gets protected? This can be specific or very broad. It could include both sides of the deal or just one side. It could cover just the businesses that are legally ‘party’ to the contract or it may also cover a wide range of related parties such as officers, directors, employees, affiliates, and anyone else the other company’s legal counsel thought to include.
What triggers the obligation? In some cases, triggering indemnification could be really narrow, such as the alleged violation of third-party intellectual property rights. In other cases, what triggers this clause could be exceptionally broad, such as any lawsuit or claim against the other side that has anything to do with the subject matter of the contract and/or related business transactions.
Is there a carveout from the indemnification obligation for matters resulting from the fault of the other side? For example, if the fault rests with the other party, have you made sure that your company can’t then be sued by them for any losses or damages they may have suffered as a result of their own actions?
What are the indemnification procedures? If you are subject to an indemnification clause, is there clear language saying you have control over the defense of any matter (i.e. you, the party paying the legal bills, get to pick the lawyer that gets used)? This can be incredibly important because if you are responsible for all the costs involved in defending the other side in your contract against a lawsuit, you don’t necessarily want the other side hiring the most expensive lawyers they can find and sticking you with the bill!
It is often worth consulting legal counsel before signing any contract, especially if you aren't sure or don't fully understand the terms of contractual points such as the terms and specific meanings included in indemnification clauses.
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