When business partnerships are formed, boiler plate contract terms (those standard found in every contract) are often glossed over, but when things go sour, the first thing that both executives and lawyers want to know is who will pay to solve the issue.
The “indemnity clause” typically provides the answer, as it is a contractual safeguard which places an obligation on one or both parties to the contract to compensate the other party for any harm, liability or loss arising out of the contract. In other words, when something goes awry (e.g. a claim of patent or software infringement, product malfunction, personal injury resulting from the product or in the location of business, etc.), having a solid indemnity clause in place will help you determine who will pay for the costs of fixing the issue or repaying the injured party.
A standard or “blanket” indemnity clause may look something like:
- Party A (Indemnitor) agrees to and shall indemnify and hold harmless
- Party B (Indemnitee), its employees, agents and subcontractors, from and against all claims, causes of action, lawsuits, including those brought by third parties, including reasonable attorneys' fees, damages and losses asserted against and alleged to be caused by Lessor's performance, negligent performance or failure to perform its obligations under this contract.
This language seems to cover a very wide range of possible claims and losses, includes attorneys' fees, does not contain a cap on costs the Indemnitor is obligated to pay. Instead, it kicks in at any stage in which the Lessor has performed, regardless if the performance was done in an acceptable manner.
A "blanket" indemnity clause gives a lot of protection to the Indemnitee, unless the Indemnitor effectively considers risk-allocations and negotiates a customized clause at the on-set.
Rather than using a standard indemnification clause or “copying and pasting” from a prior contracts or forms, businesses and their contracts specialist should consider the particular circumstances, issues and needs that may arise in each transaction and draft the clauses accordingly. Specifications and considerations to evaluate in each new contract include:
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Understand, Customize and Define the Basic Terms:
- Indemnitor: the party(ies) who is obligated to pay in case of breach or loss
- Indemnitee: the party(ies) harmed and entitled to receive the payment
- Indemnification Period: the period under which the Indemnitor will be liable to the Indemnitee (i.e. “Except in connection with the non-disclosure obligations of this Agreement, Right to Indemnity will remain in full force for a period of five (5) years after receipt of services/goods specified in this Agreement.”)
Specify “Who” may Recover for What “Types of Losses” Subject to Indemnification
- Should only one party agree to indemnify the other or should both agree to indemnify each other, depending on what gives rise to a claim?
- Types of losses
- Breach of representation or warranty or agreement
- Specific conditions that give rise to losses
- Claims of Intellectual Property Infringement or Misappropriation
- Product Defect or Liability Claims
- Network Breach or Software Virus Claims
Limitations of Liabilities
- Do you want to set a “cap” on indemnity liabilities?
- e.g. “Total liability shall not exceed the fee that Indemnitee actually paid to Indemnitor for the services giving rise to the liability”
- Do you want to explicitly rule out covering attorneys’ fees?
- Depending on the laws of each state, some permit attorney’s fees or other defense costs as part of the indemnity, where it is not expressly stated in the contract (e.g. California), while in others (e.g. Illinois), attorney’s fees must be expressly stated in the contract.
- Do you want to bar consequential and punitive damages from indemnity recovery?
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Specify the “Performance” That Triggers a Duty to Indemnity
- Alleged Breach vs. Actual Breach: In alleged breach, duty to indemnify is triggered once there is an alleged breach, regardless of “actual breach” being found. If actual breach is specified, the duty becomes enforceable upon a decision placing fault of breach on the Indemnitor.
- Negligence: failure to exercise a level of reasonable or prudent care that an “ordinary, reasonable person” would exercise under the same circumstances
- Gross Negligence: a conscious and voluntary or reckless disregard to use reasonable care for the safety or lives of others
Intellectual Property Representation: typically asserts that the party offering its intellectual property in whole or in part in a deal:
- “Owns or has valid licenses to all its intellectual property;
- Has taken adequate steps to protect its intellectual property;
- Has sufficient intellectual property necessary to conduct its business;
- Is not conducting its business in a manner that infringes the intellectual property of others”
Related Article: 3 Ways to Protect Your Business's Intellectual Property
Do You Want to Include the "Duty to Defend?"
- Duty to Defend is separate and independent of the duty to indemnify. It requires the Indemnitor to immediately and actively defend (through its own counsel or the defense counsel chosen by the Indemnitee) against any claim or litigation upon notice.
- Note: Most states do not impose an immediate duty to defend unless the contract specifies. In contrast, a minority of states automatically impose the duty if the contract is silent. Check with the Choice of Law State.
- In matters involving Intellectual Property Rights a company should seriously consider affirmatively providing for the exclusive right and power to defend infringement claims against its own IP (patents, trademarks, copyrights). This is because there is no better advocate of the science and background knowledge of one’s I.P. than those who created it.
In essence, although often overlooked, the Indemnity Clause of every contract should be viewed as a risk-shield or risk-transfer tool that can help protect your business from potential future losses. Ensuring each Indemnity Clause is tailored to the possible issues that can arise in each business relationship or transaction at the onset of a relationship can avoid much costly litigation down the line.