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Indemnification 101

by | Oct 23, 2019 | Resources, The Term Reporter

This article provides an overview of indemnity clauses.  Lawyers use these to allocate risks in transactions.

Disclaimer: Indemnification provisions are complex.  This article is an introduction; it is not a substitute for a lawyer’s advice.

What is Indemnification?

Indemnification is the right of a party that is legally liable for a loss (the indemnitee) to shift that liability to another party (the indemnitor).1  The goal is usually to shift responsibility for any damages that occur from the party that is sued for such damages to the party that caused them.  Here’s an example:

In this transaction, ABC Motor Co manufactured the car, but Springfield Dealership sold the car to Joe.  If ABC’s act or omission harms Joe, such as a manufacturing defect or failure to install a safety feature which company should be liable?

Joe will likely sue both.  Springfield may lack the resources to defend the suit, and it should not have to because it did not design or manufacture the car.  However, as a condition of agreeing to be an ABC dealership, Springfield could insist on an indemnity clause to shift this risk to ABC.  Essentially, that clause would say, “If Joe is hurt and it’s your fault, you must defend us and pay any judgment Joe obtains against us.”

Indemnity provisions traditionally refer to claims brought by third parties, such as Joe in the above example, (third-party claims) but may also apply to claims between the parties (first-party claims or direct claims), if the provision clearly states the indemnity applies to first-party claims or is written so broadly that a court could interpret it that way.2  However, this is not typical, and in practice parties often limit indemnification to third-party claims and address liability for first-party claims (such as breach of contract) elsewhere in the contract (e.g., the limitation of liability and attorneys’ fees provisions).

What is a Duty to Defend?

An indemnity clause may include a duty to defend.  A duty to defend, if specified, requires the indemnitor to defend the indemnitee in a legal action. This could be critical because the indemnitee may lack the resources to defend a suit (like Springfield in our example), while the indemnitor may have the resources to fight the suit (like ABC).  An indemnitee with significant resources sued by a third party may prefer to defend itself and seek reimbursement from the other party for costs and attorney’s fees when the matter is resolved.  By the same token, the indemnitor may prefer to control the defense because the indemnitor will ultimately be liable for any losses the indemnitee suffers.  In such a case, the indemnitor will often include language in the indemnification provision requiring the indemnitee to hand over control of the defense if it wishes to be indemnified.

What Does “Hold Harmless” Mean?

An indemnity clause may sometimes include a promise by each party to “hold harmless” the other party.  Most courts treat the terms “indemnify” and “hold harmless” as synonymous, but a few have held that the words imply different obligations.3  The inclusion of “hold harmless” has also led to litigation over whether the indemnitor must advance defense costs to the indemnitee.4  “Hold harmless” language may also open the door to claims that one party agreed to release the other from responsibility for its own negligence.5

Things to Look for When Reviewing Indemnity Provisions 

Below is a list of some issues you should consider when reviewing an indemnity provision:

1. Does the provision cover only third-party claims, or does it also cover first-party claims? Courts may interpret provisions purporting to apply to “any claims” to apply to first-party claims. 6

Tip: Insist on clarity regarding whether the indemnity provision applies to first-party claims.  A simple way to eliminate ambiguity is to include a provision stating, “This indemnity provision applies only to third-party claims.”

 

2. Is the indemnity provision consistent with other provisions? A good indemnity provision makes clear that any limitations on liability elsewhere in the contract do not apply to the indemnity obligations. In the example above, if ABC’s act or omission harms Joe, there should be no limit on ABC’s liability to Springfield under the indemnity provision – ABC should pay Springfield the full amount of any damages Springfield suffered when Joe sued Springfield for injuries ABC caused. It’s also important to make sure the indemnity provision does not conflict with other contract provisions such as the insurance, contribution, or attorney’s fees provisions. 

Tip: To avoid potential conflicts between the indemnity provision and other provisions, consider including a statement such as this: “The parties do not intend this indemnity provision to alter any other provision in this Agreement.  If there is a conflict between this provision and any other provision, the other provision governs.”

 

3. Who are the indemnitees? Some indemnity provisions require the indemnitor to indemnify the other party and that party’s affiliates, e.g., shareholders, officers, directors, employees, agents, etc. If there are third-party beneficiaries to the contract, the contract should address whether they also get the benefit of the indemnity provision.

Tip: Define the indemnitees.  Consider a provision such as this: “Where this indemnity provision imposes a duty on a party to indemnify and defend the other party, the duty extends to the other party’s affiliates, including its shareholders, officers, directors, employees, and agents.”

 

4. What are the covered events? Does the duty to indemnify arise only from the indemnitor’s breach of the agreement or does it also arise from any act or omission of the indemnitor even if that act or omission is not a breach?

Tip: Insist on clarity regarding what acts or omissions will trigger the duty to indemnify.  Consider a provision such as this: “This indemnity provision is not limited to acts or omissions that constitute a breach of this agreement.”

 

5. What are the covered damages? It is important to identify what the indemnitor must pay. You may think, “” are redundant, but each has a different meaning.

Tip: Most courts strictly construe indemnification provisions against the indemnified party, so the parties should include language covering all types of damages they intend to cover.  In some cases, the parties may want broad language such as, “All damages, losses, liabilities, claims and causes of action of any kind.”  In other cases, they may want to narrow the scope of such language to particular types of claims such as personal injury and death, real and personal property damage, infringement of intellectual property, breach of confidentiality, and/or violations of the law.

 

6. How much connection is required between the event giving rise to the duty to indemnify and the indemnitee’s damages? Some indemnity provisions may contain broad language that establishes a duty to indemnity the other party for all damages “related to” or “arising from” the agreement. Others may be narrower and establish a duty to indemnify only for damages “caused by” or “resulting from” the indemnitor’s acts or omissions.

Tip: Generally, the indemnitee wants broad language such as “related to.”  The indemnitor wants more narrow language that excludes damages unrelated to the indemnitor’s acts or omissions. To narrow the duty, the parties may use phrases such as “caused by, “resulting from,” or “solely resulting from.”

 

7. Does the provision include a duty to defend? If it does, does it specify which party will choose the lawyer that will defend the indemnitee and which party will make decisions about the defense?

Tip:  Don’t settle for a vague provision regarding the duty to defend.  Insist on language that addresses which party will choose the lawyer that will defend the indemnitee and the level of control the indemnitor and indemnitee will have in such litigation.

 

 Conclusion

Indemnity provisions are common but require careful review.  In analyzing an indemnity clause, you should understand the difference between first-party claims and third-party claims.  You should also understand the distinction between the duty to indemnify and the duty to defend.  You should also check for “hold harmless” language that may result in unintended consequences.  Always consult a qualified lawyer if you have questions or concerns about a legal document.

TermScout can help

If you are a business or consumer and you are considering agreeing to a click-through vendor contract, consider having TermScout review the document for you first.  We distill complicated legal clauses like indemnification, risk allocation, limitations of liability, intellectual property, and many others into plain English.  We will even compare the important terms to the terms competitors use in the industry and rate how they stack up against one another.

Not only can we assist you in deciding whether to sign a document, but our products may also inform your decision on which vendor to choose.  Check out our website to learn more about the services we offer.

Disclaimer: We are not a law firm, and this information is not legal advice. We will not and do not represent you and the use of our services will never establish an attorney-client relationship or constitute legal advice.

1 American Transtech, Inc. v. U.S. Trust Corp., 933 F.Supp. 1193, 1202 (S.D.N.Y. 1996).
2 Hot Rods, LLC v. Northrop Grumman Sys. Corp.,  242 Cal. App. 4th 1166, 1170 (Cal. App. 2015); See also Hooper Assocs. v. AGS Computers, 74 N.Y.2d 487 (N.Y. 1989).
3 See, e.g., Queen Villas Homeowners Association v. TCB Property Management, 56 Cal. Rptr. 3d 528, 534 (Cal. Ct. App. 2007) (“Indemnify” is an offensive right allowing an indemnitee to seek indemnification. “Hold harmless” is defensive — the right not to be bothered by the other party itself seeking indemnification.).
4 See, e.g., Majkowski v. American Imaging Management Services, 913 A. 2d 572 (Del. Ch. 2006).
5 See, e.g., Rooz v. Kimmel, 55 Cal.App.4th 573, 582 (1997) (Hold harmless provision prevented plaintiff from recovering damages resulting from defendant’s negligence).  See also, U.S. v. Contract Management, Inc., 912 F. 2d 1045 (9th Cir. 1990).
6 Hot Rods, LLC v. Northrop Grumman Sys. Corp.,  242 Cal. App. 4th 1166, 1170 (Cal. App. 2015).

 

Authors

Mark Cohen

Advising Attorney, TermScout  

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