Indemnification Provisions in Contracts

An indemnification provision, also known as a "hold harmless provision," is a clause used in contracts, including business agreements, to shift potential costs from one party to the other. You can have two types of indemnification clauses:

• Mutual indemnification: Both parties agree to compensate the other party for losses that are caused by the indemnifying party's breach of the contract.
• One-way indemnification: Only one party provides this indemnity in favor of the other party.

Indemnification provisions (or clauses) are generally heavily negotiated (and often heavily litigated) clauses.

Why Are Indemnification Provisions Used?

The primary benefit of an indemnification provision is to protect the indemnified party against losses from third-party claims related to the contract. The indemnifying party (the one providing the protection) agrees to take full responsibility for any costs that result from their breach of the agreement, and the indemnified (protected) party doesn't have to worry about paying any of these costs.

For instance, suppose your business rents out moving trucks and your rental agreement includes a mutual indemnification provision. One day, a customer renting out your truck rear-ends another car causing a car accident. The driver of the car sues you and your customer for damages to their car. Because you have a signed indemnification clause, your customer would be responsible for paying the costs related to the lawsuit you're now involved in, which can include:

• attorneys' fees
• court costs, and
• any damages that are awarded to the other driver.

Indemnification clauses are typically used in agreements where the risks associated with a party's non-performance, breach, or misconduct are high. For example, agreements that involve the sale of intellectual property rights often include an indemnification by the seller in order to protect the buyer against the potentially large liability associated with an infringement lawsuit by a third party.

What Does a Typical Indemnification Provision Look Like?

The following is an example of a basic mutual indemnification provision. Remember, any indemnity must be tailored to your specific needs.

You'd want to include additional language depending on your circumstances. For example, an indemnification can be limited to specific third-party claims (such as those related to a breach of warranty), or restricted to only those situations where a lawsuit has been filed or a final judgment has been rendered.

Notice requirements can also be included. For instance, a notice requirement can include: "This indemnity shall not cover any claims in which there is a failure to give the indemnifying party prompt notice, but only if and to the extent that such failure materially prejudices the defense."

If you're the party providing the indemnification, you'll want to make sure the clause is as narrowly tailored as possible to protect against the specific risk it's intended to protect against.

How Does an Indemnification Provision Work?

Let's say you commission a writer to prepare a speech for you on a work-for-hire basis. Instead of delivering an original speech as promised under the contract, the writer incorporates passages from a speech by another person. The other person who your hired writer copied then sues you for copyright infringement, claiming that their intellectual property was exploited without their consent.

Your agreement with the writer includes a representation and warranty that the work product provided under the contract is original. The contract also has a standard indemnification clause that promises to hold you harmless from any losses or damages, including attorney fees, incurred as a result of the writer's breach of the agreement.

As required under the indemnification clause, the writer would be obligated to handle the legal defense related to the other writer's intellectual property infringement lawsuit against you. The writer would also be required to cover all of the losses and expenses you incur as a result of the infringement claim.

What Is the Scope of an Indemnification Provision?

Before agreeing to an indemnification, read it carefully and make sure your obligations are limited to your own mistakes or misconduct. In the sample indemnification above, the term "to the extent arising out of" effectively provides this limitation. By way of comparison, the term "in any way arising out of or related to" is much broader, and could expose you to liability for the actions or inactions of others.

You should also take the following into consideration when negotiating and drafting an indemnification clause:

• Decide whether or not you're capable of handling the defense of any third-party claim before agreeing to do so under the contract.
• You can limit the right to seek indemnification to a specific time period (for instance, up to two years after the contract term).
• Be careful when agreeing to cover the indemnified parties' attorneys' fees as a reimbursable expense, as courts generally exclude their recoverability unless the contract specifically provides for it.
• You can request a cap on the total amount that you'd owe to the indemnified party (such as a maximum that can't exceed the total amount due under the contract).

Basically, every word of the indemnity must be vetted well. For example, having to defend against "all reasonable claims" is much better than having to defend against "all claims."

Are Indemnification Provisions Enforceable?

Indemnification provisions are generally enforceable. There are certain exceptions, however:

• Indemnifications that require a party to indemnify another party for any claim irrespective of fault (known as "broad form" or "no-fault" indemnities) generally have been found to violate public policy.
• Some states also prohibit indemnification provisions that provide for punitive damages. Check all applicable laws before drafting an indemnity.
• Courts have commonly held that a plaintiff can't recover damages under an indemnity clause to the extent that the damages are an unforeseeable and improbable outcome of the other party's breach, negligence, or misconduct (unless it can be shown that the indemnifying party had knowledge of the relevant circumstances).

Indemnifications should always be drafted clearly, as ambiguity is most often resolved by courts in favor of the indemnifying party. They should be broad enough to sufficiently address the parties' concerns, yet reasonable and equitable in all respects so that their enforceability isn't called into question.

Consulting a Business Attorney

If you're contemplating including an indemnification provision in your contract, you should consider consulting a business attorney. If you have experience writing business contracts and understand the legalese, you can probably draft your own indemnification clause. But it can still be a good idea—especially with a valuable or potentially risky business contract—to have a business lawyer review the clause. If the other side wants you to sign a one-way indemnification clause, you should also probably talk to an attorney. A lawyer can help you understand the risks of a one-way indemnification and can negotiate better contract terms on your behalf.