An indemnity clause transfers risk from one contractual party to the other in the event of loss or damages as a result of certain events.

About Indemnity Clauses

Indemnity clauses are common in contracts, and they shift risk and potential costs from one contractual party to the other.

Specifically, an indemnity clause states the conditions under which one party has to compensate the other contractual party for claims, unintentional harms, or other liability that could befall the indemnified party (i.e., the one to be compensated). This is usually due to the fault of the indemnifying party.

What it means to indemnify a party is to absorb the losses that party caused. You'll absorb them instead of trying to get compensation from the party. Likewise, you agree to compensate the other party if your actions (or inactions) cause them to suffer loss or damages, including being served a lawsuit by a third party.

The last part of this — protection from third-party lawsuits — is what's most significant about indemnity clauses because even without the clause, parties are usually able to recover losses and damages for their own harms.

Indemnification clauses are usually closely associated to warranties or representations, which are basically promises that things are a certain way.

Indemnifying another party can be expensive, particularly when a warranty contains broad language and the clause makes a party responsible for paying all claims, no matter their merit. The contract usually includes a formula that computes the appropriate amount of compensation in the event of indemnification.

Indemnity states that the injured party has the right to claim compensation or reimbursement for damages or losses from the other party. This is usually applied in civil lawsuits concerning negligence claims.

Indemnity may also refer to the legal exemption from damages or loss. In that case, the general meaning of indemnity is “hold harmless.”

Understanding Indemnity Clauses

When you go over a contract, read the indemnity clause carefully, as well as the rest of the document. Make sure you understand the contract's language. For instance, it's easy to gloss over the big difference between "defending against a reasonable claim" and all claims if you're going over a contract too quickly.

You may want to do any of the following to limit your risk and responsibility for loss or damages:

  • Limit the warranty, and thereby limit the scope of an indemnity clause. For example, say you're a software developer. You're asked to promise (or warrant) that your product doesn't infringe on a third party's IP rights, knowingly or unknowingly. You might want to rephrase this clause to state you'll only provide a warranty for known infringement.
  • Put a cap on the amount you'll pay in the event of indemnification. If the other party insists on a higher liability cap or broader warranty, negotiate a higher price for yourself in exchange for those demands.
  • Buy professional indemnity insurance, which will cover damages and legal costs associated with a breach in professional duty. Basically, it indemnifies you against another party's claims.

Fair Contracts

It's very important to fully understand all of the nuances contained in an indemnity clause. Otherwise, you may be shifting too much risk or liability to your own business. However, because these clauses can be so arcane and mundane, business leaders can easily overlook them when they review a contract.

Still, it pays to carefully read the indemnity clause. You should especially make sure the clause is:

  • Fair
  • Mutual
  • Balanced
  • Limited
  • Within your control

If the indemnity clause doesn't meet all of the above factors, you really shouldn't sign it. Instead, do your best to negotiate and revise the language so you have essential protection.

Contracts are full of provisions, clauses, and fine print. Because you can be risking a lot by signing one, it is vital that you know what you're agreeing to beforehand. Becoming proficient in the art of contract negotiation is one way to ensure you get a good deal on just about anything. If you're having a hard time understanding all of the various legal terms and their implications, consult with an attorney, preferably one who's experienced in contract law.

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