An indemnification clause is used to shift risk in a contract between the two parties.

What Is Indemnification?

When an indemnification clause is inserted into a contract, it is meant to transfer risk between the contracted parties. In most cases, these clauses are used to make sure that a potential loss will be compensated. If you are the party covered by this clause, it means that the other contractual party is promising to compensate you if their actions cause you to suffer a loss. For example, they may commit an action that results in you being sued by a third-party.

The words defend, hold harmless, and indemnify must be included in an indemnification clause. Essentially, hold harmless and indemnify mean the exact same thing.

When you indemnify another person, you are covering their losses that you have caused. The benefit of this is that it prevents the damaged party from seeking compensation in a lawsuit. You will have the option of absorbing these losses yourself or providing direct compensation to the person that was harmed by your action.

The most important part of an indemnification clause is that it protects the indemnified party from lawsuits filed by third parties. This protection is important because damaged parties are still able to pursue compensation for their losses even if this clause isn't in the contract.

If the word "defend" is included in an indemnification clause, it means that the contracted party that caused the harm is responsible for defending the indemnified party from lawsuits. However, many indemnified parties request that this word is left out so that they retain the right to defend themselves.

When the contracted party suffers a loss due to the actions of the other party, they can still pursue damages under the tort or breach of contract legal theories. Therefore, the primary purpose of indemnification clauses is shifting the expense of defending one party from third-party lawsuits.

There are different types of indemnification clauses that can be inserted into a contract. For instance, if your contract includes a mutual indemnification clause, it means that both contracted parties have agreed to cover losses that result from a breach of contract. With one-way indemnification, only one party is indemnified, meaning only their losses would be covered. However, the party that is indemnified will often have responsibilities that they must fulfill.

In some cases, the clause may state that it is the only solution for the damaged party to be compensated for their losses. If this is the case, the clause should also define how a claim can be brought, including:

  • The scope of the claim.
  • The maximum amount of liability that can be covered.
  • The time periods when the party may bring a claim.

Tips for Indemnification Clauses

If you're considering entering into a contract that contains an indemnification clause, there are a few tips that you should follow to make sure you are legally protected. First and foremost, you need to read the clause so that you can be certain that you fully understand its language. For instance, if the clause includes language about defending against claims, you need to be sure whether this means you will be defended from all claims or just reasonable claims.

If the indemnification clause is being used in a warranty, you should make sure that indemnity is limited by limiting the warranty.

Let's assume that you are a software developer and you need to guarantee that your program is not infringing on the IP rights of a third-party. You should make sure that the language of the warranty states you are only guaranteeing you haven't infringed on known IP rights. If you are not the indemnified party, you should make sure that the clause includes a cap on the number of losses that you will be required to cover. Should the other party request a larger cap, you should only give it to them in exchange for a higher price.

You should also consider investing in professional indemnity insurance. If you have one of these insurance policies, damages and legal costs will be covered if you breach a contract. If you're having trouble understanding the language in the indemnification clause, or the contract as a whole, you should consult an attorney before signing the contract.

If you need help understanding the indemnification clause, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.