What Is an Indemnification Contract?
An indemnification contract clause is an agreement of one party to assume the liability in the event of a loss.3 min read updated on February 01, 2023
An indemnification contract clause is an agreement of one party to assume the liability in the event of a loss. This generally involves shifting the risk from one party to the other.
What Is Indemnity?
Indemnity is one's duty to make good the liabilities, damages, or losses that are incurred by another party. The general meaning of indemnity is to hold harmless — one party holds the other harmless for damage or loss.
There are some variations for the meaning of indemnity, including the right of an injured party to claim compensation or reimbursement for damages or losses. It may also refer to compensation for damages resulting from another party's actions or a legal exemption from damages or losses.
About Indemnification Contract Clauses
Indemnification clauses have more liability implications than any other clause in a professional services agreement. For example, if a design consultant agrees to indemnify a client, the consultant may assume some or all of the client's liabilities, whether they're actual or potential.
Insurance may not cover assumed liabilities. Sometimes, indemnity clauses obligate a party to defend against certain claims it makes against a client.
Providing a defense may include retaining lawyers and experts, as well as paying a client's defense costs. Another way to provide defense may involve reimbursing a client for defense costs and lawyer fees. The parties will negotiate the method of payment and its timing.
Most liability insurance policies for professionals don't provide defense coverage. This differs from general liability insurance for contractors, which often covers defense cost claims for the following:
- Property damage
- Bodily injury
An indemnification provision distributes expense and risk when one party commits any of the following:
- Contract breach
An indemnification provision is also called a hold harmless provision. In a contract, it moves costs from one party to the other.
In case of mutual indemnification, both parties come to an agreement to provide compensation to the other in the event losses arise from a breach by the indemnifying party. In one-way indemnification, just one party gives this indemnity.
The main benefit that an indemnification provision provides is protection for the indemnified party against losses from claims made by third parties. In general, heavy negotiations are involved in indemnification provisions. They're also heavily litigated.
You typically find them in agreements where risks are high if a party doesn't perform to the contract, commits some misconduct, or otherwise breaches the contract. For instance, sellers often include an indemnification provision in contracts involving intellectual property rights. This protects a buyer against a potentially large liability that could result if a third party brought an infringement lawsuit.
What a Typical Indemnification Provision Looks Like
When drafting a contract, tailor an indemnity clause to fit your specific situation. Following is a paraphrased example of the type of language you may find in a mutual indemnification provision:
"The parties agree to hold harmless the other party from any damage, loss, or cost of any kind (this includes reasonable lawyer fees) to the extent a breach occurs or willful misconduct or negligence."
You may include additional language based on your circumstances. For instance, you may limit indemnification to specific third-party claims or restrict it to situations where a party has filed a lawsuit or a court has issued a final judgment.
You might also want to include notice requirements. For example, it could read something like: “This indemnity shall only cover claims in which the parties receive prompt notice, only if and to the extent a failure to notify could prejudice the defense.”
If you're the one providing the indemnification, you want the clause to be as narrowly tailored as possible. This gives you the most protection against the specific risk you want to be protected against.
When writing a contract, it's important to include provisions that benefit all parties as equally as possible. To make sure you're not being taken advantage of in an agreement, it's best to consult with a legal professional, preferably one who's skilled in contract law. He or she can explain any confusing legal terms so that you're fully aware of what you're agreeing to.
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