Indemnification Provisions in Contracts

An indemnification provision allocates the risk and expense in the event of a breach, default, or misconduct by one of the parties.

An indemnification provision, also known as a hold harmless provision, is a clause used in contracts to shift potential costs from one party to the other. In a mutual indemnification, both parties agree to compensate the other party for losses arising out of the agreement to the extent those losses are caused by the indemnifying party's breach of the contract. In a one-way indemnification, only one party provides this indemnity in favor of the other party. The primary benefit of an indemnification provision is to protect the indemnified party against losses from third party claims related to the contract. Indemnification provisions are generally heavily negotiated (and often heavily litigated) clauses. They 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.

"Each party agrees to indemnify, defend, and hold harmless the other party from and against any loss, cost, or damage of any kind (including reasonable outside attorneys' fees) to the extent arising out of its breach of this Agreement, and/or its negligence or willful misconduct."

You would 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 example: "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 are the party providing the indemnification, you will want to make sure the clause is as narrowly tailored as possible to protect against the specific risk it is intended to protect against.

How an Indemnification Works

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 who then sues you for copyright infringement, claiming that his intellectual property was exploited without his consent. Your agreement with the writer includes a representation and warranty that the work product provided under the contract is original. It also has a standard indemnification provision that promises to hold you harmless from any losses or damages, including attorney fees, incurred as a result of any breach of the agreement. Pursuant to the indemnity, the writer would be obligated to handle the legal defense related to the other writer's intellectual property infringement lawsuit against you and cover all of the losses and expenses you incur as a result of the infringement claim.

The Scope of an Indemnification

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 set forth 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. Additionally, decide whether or not you are capable of handling the defense of any third party claim before agreeing to that contractually. You can also limit the right to seek indemnification to a specific time period. 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. 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." You can also request a cap on the total amount that you would owe to the indemnified party (such as a maximum that can not exceed the total amount due under the contract).

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 (‘broad form' or ‘no fault' indemnities) generally have been found to violate public policy. Certain states also prohibit indemnification provisions that provide for punitive damages. Check all applicable laws before drafting an indemnity. Additionally, courts have commonly held that a plaintiff may not 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 is not called into question.

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