Tips for Succeeding at the Indemnification Dance

Businesses Should Never Overlook The Importance of Clearly Drafted Indemnification Provisions

While sometimes mistakenly dismissed as “boilerplate,” businesses should never overlook the importance of clearly drafted indemnification provisions. In interpreting your contracts, you should be aware that an indemnification clause is to be desired if you are being indemnified, and to be avoided, if possible, if you are being asked to indemnify.

Indemnification Basics

The definition of “indemnity” is that you have a legal duty to make good on any loss, damage or liability incurred by someone else. So, when you agree to accept an obligation to indemnify, for example, in a finance or sale transaction contract, the risk shifts from the other party to the contract directly onto your back. Below is an example of a basic indemnification provision, with the caveat that many are far more complex:

“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 attorneys’ fees) to the extent arising out of its breach of this Agreement, and/or its negligence or willful misconduct.”

Not only are indemnification clauses capable of radically shifting risk from one contracting party to the other, they can also be used as a threat in litigation. Consequently, they are at once both the most desirable of “boilerplate” provisions in commercial contracts and the toughest to negotiate. Other than price and terms, indemnification clause negotiations are the most common deal breakers in contract negotiations and the most hotly contested clauses when there is a dispute and litigation arises.

Negotiating Indemnification Clauses

Indemnification clauses are commonly found in agreements where the risks associated with a party’s non-performance, breach, or misconduct are great. While you may not be able to avoid all indemnification liability, it is possible to limit the scope. For instance, clauses may be drafted to cap liability at a certain amount, to require advance notice, to restrict liability to third-party claims or other specified losses, or to restrict the right to indemnification to a limited time period.

Negotiating the indemnification “dance” involves maneuvering the other party into accepting broad potential liability while keeping yourself clear of as much risk exposure as possible. While relative bargaining power is a key factor, other considerations include affordable liability insurance and the nature of the business risks.

Poorly Drafted Indemnification Clauses Can Be Costly

Contracts often include a reference to indemnification for the legal fees and costs arising from a future issue. We recently defeated such a claim that a major international bank brought against our client in federal court, seeking indemnification of over two million dollars in legal fees and costs incurred by the bank in a litigation over a denial of funding. The court agreed with my argument that the indemnification clause was so broadly worded that our client would have had to pay the bank’s legal fees, even if the bank’s claim for indemnification was defeated.

As this case highlights, ambiguous contract provisions can often lead to business litigation. If you are seeking to be indemnified, don’t make the same mistake that the bank’s counsel made – be clear and specific about what is and what is not being indemnified. If not, it will be the court, rather than the parties, that decides how to interpret the agreement.

If you are being indemnified too broadly, when push comes to shove, a court may find the indemnification too loosely drafted to be enforceable. Therefore, it is imperative to work with an experienced business attorney to make sure that all provisions are clear and unequivocal.

Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.