Indemnification: what it is, and why you should care

In this blog post I want to discuss an important provision in many business contracts, but one that businesspeople usually skip over.  This is the indemnification provision.  Indemnification is a big topic, far too big to discuss in detail in a blog post.  However, I want to highlight its importance so that when you see it in a contract, you will be sure to read it and ask questions if you don’t understand it.

Indemnification is a method of shifting risk between the parties to a contract. It creates an obligation by one party to compensate the other for certain types of losses. Depending on the nature of the transactions, many different types of losses may be included. They can be mutual or run just one way. Where the obligations ends up depends on various factors, such as relative negotiating leverage, who can better bear the loss, etc.

These provisions often read something like the following:

Each party shall indemnify, defend, and hold the other party harmless from and against any and all claims, actions, suits, demands, assessments, or judgments asserted, and any and all losses, liabilities, damages, costs, and expenses (including, without limitation, reasonable attorneys’ fees) alleged or incurred arising out of or relating to any operations, acts, or omissions of the indemnifying party or any of its employees, agents, and invitees in the exercise of the indemnifying party’s rights or the performance or observance of the indemnifying party’s obligations under this agreement.

This is a simple example, but indemnification provisions can get very complex.  The bigger the transaction, the more the parties will negotiate (or fight) over the terms of indemnification.

Basically, a provision like this means that Party A, the indemnifying party, must pay Party B, the indemnified party, if Party B incurs the types of costs listed as a result of something that Party A did or did not do.  Those costs can include legal costs to defend a suit, damages if Party B loses a suit, fines, etc. One indemnification provision may say “any and all” claims, like the one above, but another may say “reasonable” claims—there is a big difference, so the wording is important!

The causes leading to the obligation to indemnify are listed in the contract provision; they could be negligence by Party A resulting in injury or damage, some representation being untrue (such as earnings or quality of goods sold).   For example, let’s say a manufacturer of lawnmower blades supplies faulty blades to a lawnmower retailer, and one of those blades flies off and hurts a consumer who bought the lawnmower.  If the consumer sues the retailer for damages due to the faulty blade, the retailer may be entitled to indemnification from the blade manufacturer, depending on their contract.  The retailer would be able to demand compensation from the supplier without having to initiate its own lawsuit against the manufacturer.

In another example, if you license software to use in your business, you will want an indemnification provision in the license agreement that requires the company selling the software to indemnify you if some third party sues you, saying that it owns the software and you are infringing its rights.  Since you had no reason to suspect that, the company selling you the software should compensate you for any costs you suffer in dealing with such a claim.

Indemnification provisions can also include an obligation to defend. This means that the indemnifying party must pay for the legal costs and expenses of the other party to defend against a third-party claim. It may also allow that indemnifying party to take over the defense. Note, however, that this obligation to defend is broader than the obligation to indemnify. This is because the obligation to defend (and the costs associated) kick in even if the third-party loses. The obligation to indemnify only arises if there is an actual loss or damages that must be paid. For this reason, it is important to review the language of an indemnification provision to see what it requires.

As you can see, indemnification provisions can be quite complicated, and if you run across one in a contract to a transaction, it’s important to read and understand it. If you have indemnification provisions in your own company’s contracts, you may want to have an attorney review them periodically to make sure they are up to date and are protecting your interests.

If you have questions about indemnification, please feel free to contact me at mark@spitzlegalcounsel.com or 720-575-0440.  Wishing everyone a happy and healthy 2023!