Indemnify against all liabilities to protect your business assets when a particular loss occurs. Also known as “hold harmless” clauses, they are typically found in commercial contracts. It guarantees the other party to a predetermined amount of money in the event you breach the agreement you entered into with them. In most cases, they cover direct losses, which are incurred by the damaged party. However, your indemnity provision can even pay for what are termed “indirect losses,” which occur when the damaged party has liability obligations to a third party.

Unfortunately, there is a common misconception that an indemnity provision is a panacea that can cure all ills arising from a breach of contract by another party. This is only true when an indemnity clause applies to the collection of a debt. Otherwise, the extent of protection that an indemnity provision offers often comes down to the exact language that is found in the provision itself, especially if the claim is made in respect to a breach of the contract.

There are specific areas where indemnity provisions are considered advantageous because two issues found in common law contracts do not apply:

  • Remoteness of damages. Simply put, remoteness of damage places a burden on the damaged party to establish that in the event of a breach of contract, the damage was foreseeable. Without an indemnity provision that provides for a guaranteed amount in the event of a breach, if it is determined by a court that the event was not foreseeable, then recompense may be limited.
  • Duty to mitigate. This element of common law contracts says that if a party has been wronged, it has verifiable steps to limit the effect of that wrong. This burden of proof does not apply in cases where the loss has been indemnified.

Key Considerations for Indemnities

As stated above, indemnities do not necessarily cover contingencies for every loss or breach of contract that may occur. For that to happen, the indemnity provision must be a component of any well-drafted indemnity provision.

  • To avoid both remoteness and mitigation, it’s recommended to state a specific sum of money that will be awarded in the case of a breach of contract.
  • All general indemnity for a damages claim should specify the losses that will be covered.
  • Expressly state that the obligation to mitigate does not apply in the case of a breach of contract (expect the inclusion of this language to be contested by the other party).
  • Expressly state that even if the breach occurs to due to your own negligence, you can still make a claim under the indemnity provision (expect the inclusion of this language to be contested by the other party).

How Indemnity Clauses Affect Business Transactions

Negotiations are an accepted practice whenever two parties seek to create a definitive agreement after reaching an agreement in principle. This is especially true when one business seeks to purchase shares of another. One of the most contentious issues in a negotiation is quite often the seller’s indemnity and setting the seller’s limitation of liability thereunder.

The buyer, naturally, wants a strong indemnity in order to discourage the seller from committing a breach of contract, while the seller will seek to minimize its liability. The key is to find a middle ground where each feels their interests are protected.

However, even a strong indemnity provision against a breach by the seller may not be enough to protect the buyer’s interest if after the agreement is reached, the seller does not have sufficient capital to meet its liability. Therefore, in order to further protect itself, the buyer should also require the shareholders of the seller, who individually may have profited from the sale, to also provide an indemnity.

There are three ways a seller can limit its liability even if the buyer insists on strong indemnity language by attaching the following terms to the indemnity:

  • Survival Period. This sets a time period during which claims can be made. If the time period expires, no damages can be pursued.
  • Knowledge Qualifiers. The seller can include language such as “to the best of its knowledge” or “in all material respects” to protect itself against breach claims.
  • Monetary Limitations. Establishing a limit as to what a seller will pay in the event of a breach can at least provide assurances as to the extent of liability.

Indemnity provisions can have long-term repercussions. It is recommended that you consult an attorney experienced in contract law before entering any agreement for which the other party demands an indemnity provision be included.

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