DON’T IGNORE THE INDEMNIFICATION PROVISIONS IN YOUR CONTRACTS!

In commercial contracts, indemnification provisions serve as a tool to designate who bears the cost of potential losses or damages typically for third-party claims; these provisions are powerful because they can transfer risk from one party to another. For this reason, it is essential to negotiate and draft indemnification provisions with your business and its risk-bearing capacity, the type of transaction, the partner with whom you are conducting business, and third parties to keep the contract in mind. Parties may choose between a one-sided indemnity or a mutual indemnification where desired. You may see indemnity provisions in documents such as Non-Disclosure Agreements, Construction Contracts, Purchasing Contracts, and Commercial Leases.



What is an Indemnification Provision? 

To indemnify means to make compensation for incurred hurt, loss, or damage. Therefore, an indemnification provision is an agreement between two (or more) parties obligating one party (the indemnifying party) to compensate the other party (the indemnified party) for losses or damages that may result from the transaction taking place. 

Why do Indemnification Provisions Matter?

1. Clarity: Indemnification provisions are important because they outline the party’s obligations to each other when losses or damages are incurred, with clear parameters on who, what, where, when, and why a party to the contract must or must not act. The benefit here is a lower likelihood of misunderstanding and disputes between the parties. Having allocated their responsibilities, the parties can fully attend to the transaction at hand and confidently grow their business relationship. 
2. Protection for the Indemnifying and Indemnified Party: Because indemnification provisions can be mutual, both parties on each indemnity obligation can benefit from such risk allocation. Furthermore, indemnity provisions can be used by indemnifying parties to cap their liability to reduce their financial exposure if an anticipated loss or damage occurs. A limitation on liability promotes peace of mind since the indemnifying party knows ahead of time the (presumably negotiated) maximum it would potentially lose should the indemnified party incur a loss. 

What does a Typical Indemnification Provision Include? 

1. Definitions: Take advantage of the definitions section to specify whose claims the indemnifying party will cover, the types of specific events and recoverable damages, and the exclusions to those definitions.
   
2. Terminology/Words of Obligation: An indemnification clause should include words evidencing the indemnifying party’s obligation to “indemnify, defend, and hold [the indemnified party] harmless” for certain claims. Note that in some states, “hold harmless” may expand the scope of the indemnity obligation.
   
3. Nexus: Nexus refers to the causal link between the subject of the contract and the harm for which the indemnity is sought. Examples of nexus phrases include: “arising from or relating to, directly or indirectly,” “solely and exclusively caused by,” and “resulting from.”

Conclusion

It’s common for business owners to skip over indemnity provisions in contract negotiations. However, the bottom line is that having well-drafted indemnity provisions in your contracts will promote peace of mind in conducting business by protecting each party from potential loss or damages. Remember that you should negotiate your indemnity obligations based on the types of potential losses or damages, the amount of risk you are comfortable assuming, and the transaction at hand. 

The S.J.S. Law Firm can help your small business draft effective indemnification clauses whether you are the indemnifying or indemnified party. For a complimentary consultation, please get in touch with us at (202) 505-5309.