Indemnification Clause

What is an indemnification clause?

An indemnification clause (sometimes referred to as an indemnity clause or a hold harmless clause) is a provision in a contract that establishes when and to what extent one party will assume liability for the losses of another. These may be losses directly suffered by the party protected by the indemnity or, as is more often the case, they may be losses associated with lawsuits or other claims advanced by third parties. Although the specific risks covered by an indemnification clause will depend on a variety of factors (e.g., the type of contract, the relationship between the parties, etc.), the clause itself can address pretty much any risk or eventuality the parties may contemplate. Common risks covered by an indemnification clause include those related to breach of contract, product liability, property damage, environmental contamination, infringement of intellectual property rights, negligence or willful misconduct, and non-compliance with applicable laws or standards.

Indemnification clauses thus operate a bit like an insurance policy, where the party providing an indemnity (the indemnifier) is akin to an insurer and the party benefiting from an indemnity (the indemnitee) is akin to a policyholder. One difference between an indemnification clause and an insurance policy is that the indemnifier is generally directly or indirectly responsible for causing the losses of the indemnitee; whereas an insurer is generally not responsible for causing the policyholder’s losses. Also, the indemnitee does not pay anything akin to a premium for the indemnity. Instead, that party “pays” for this protection through the promises it makes under the agreement (which may include providing a similar indemnity of its own).

Why does the indemnification clause matter?

Perhaps the best way to illustrate the importance of the indemnification clause is to consider what it would be like if these clauses did not exist. For the purposes of this thought experiment, let’s use the following examples: (i) a factory owner who leased its premises is now neck-deep in lawsuits, fines and other claims as a result of water contamination caused by a careless tenant; and (ii) a wholesaler is faced with significant damages claims for breach of contract because of supply-chain interruptions caused by its own suppliers’ negligent disregard for their contractual obligations. In a world without indemnification clauses, the factory owner and wholesaler would likely have to choose from one or more of the following undesirable options: (1) engage in potentially expensive and protracted litigation to recover their losses, while also managing a costly process to defend themselves against all these third party claims; (2) rely on insurance coverage to recover their losses, but risk making the cost of on-going insurance coverage prohibitively expensive; or (3) declare bankruptcy. In such a world, the potential costs of entering into a contract would be so excessive that people might ultimately be discouraged from forming otherwise beneficial legal relationships. Accordingly, the mere fact that parties can identify and allocate risks among themselves through the indemnification clause helps remove barriers to contracting. Beyond that, however, the increased certainty these clauses give parties regarding contract-related liability exposure is of pivotal importance, as it allows them to plan and conduct their affairs without the constant spectre of financial ruin looming over them.

Because of this critical risk-management function, indemnification clauses tend to be among the most heavily negotiated at contract formation. The problem is that parties tend to forget about them after the contract is negotiated because they are designed to cover unintended and unexpected outcomes. Indeed, many contracts expire or are terminated without the indemnification clause ever being engaged. Only when disaster strikes do many businesses discover how effective safeguards like the indemnification clause are in protecting them from liability exposure. The devil, as they say, is in the details, and businesses may discover only too late that loopholes in their indemnification clauses expose them to more financial risk than they had anticipated. As a precautionary measure, therefore, businesses would be well advised to pay careful attention to the details of any indemnification clauses in their contracts to ensure they have a firm understanding of the scope of their own potential liability as indemnifier and any limitations on protection afforded them as indemnitee.

How do you review indemnification clauses in contracts?

The first step in the review is locating all the indefinication clauses in each contract, which may be easier in some cases than in others. Some legal agreements will have standalone indemnification clauses (see examples 1 and 2 below), which makes them relatively easy to find. More worrisome, however, is the standalone indemnity’s elusive cousin, which may be lurking in almost any section of the agreement, surreptitiously inserted at the end of sentences or in the middle of dense paragraphs where it can easily go undetected (see example 5 below, which is from the same agreement as example 4; and also see example 6). Indemnification clauses of this kind require careful attention to spot and failure to do so can lead to unpleasant surprises down the road.

Key pieces of information to focus on when reviewing an indemnification clause include:

  1. Who is indemnifying who. In some indemnification clauses, there may be several indemnities provided, so it is critical to ascertain for each indemnity who is the indemnifier and who is the indemnitee. In particular, consider the class of indemnitees: Is it limited to just a particular party? Or does it include the party’s affiliates and/or directors, officers, employees, agents, etc.? Many indemnification clauses tend toward a more broadly defined class of indemnitees (see examples 1 and 2 below). Note, as well, whether the indemnifications are mutual (i.e., the parties indemnify each other for the same thing) or unilateral (i.e., only one party is providing the indemnity). In example 3 below, section 9.1 contains a mutual indemnity; whereas section 9.2 contains a unilateral indemnity.
  2. What the indemnity covers. There are two parts to this aspect of the indemnification clause: (i) the risks covered by the indemnity and (ii) the scope of the liability assumed. In both cases, the language used tends to be broad and inclusive so as to minimize the risk of any gap in coverage. Example 1 below, for instance, states that each “Indemnified Person” is protected against “all liabilities and expenses”; it then goes on to qualify this with “including but not limited to” followed by a more particular, non-exhaustive list of liabilities and expenses, which helps provide greater certainty about the intended breadth of liability protection. Perhaps more important to note, however, is any language that limits the scope of either the risks covered or the liability protection provided. Returning to example 1 below, despite the inclusive language describing “all liabilities and expenses”, note that financial recovery is limited to the “Trust Assets” (a point made even clearer by the wording of paragraph (c)); furthermore, note the more subtle financial constraint in that same paragraph, which limits an Indemnified Person’s recoverable attorneys fees and costs to those that are “actually and reasonably incurred by the Indemnified Person.”
  3. Qualifications and Limitations. These are the features of any indemnification clause that require the most attention, since they play an important role in shaping the scope of any indemnity. Qualifying or limiting language may constrain the scope of financial recovery for the indemnitees, as was the case with the “Trust Asset” example mentioned in point 2 above. It may also disqualify certain claims that would otherwise be eligible for indemnification. Often things like an indemnitee’s gross negligence, fraud or willful misconduct will be included as grounds for disqualification (see examples 1, 2 and 4 below). Proving that an indemnitee was grossly negligent, etc. can be challenging, but this kind of qualifying language at least helps protect an otherwise innocent indemnifier from having to bear the burden of losses incurred in bad faith. Qualifications and limitations may even encourage efficiency in the indemnification process - e.g., requirements that the parties “reasonably cooperate” or that a party’s consent “not be unreasonably withheld” (see examples 1, 2 and 4 below). Finally, in addition to any express qualifications or limitations in the indemnification clause itself, pay close attention to any limitation of liability clause elsewhere in the agreement that may also constrain its scope.
  4. Indemnification Procedures. Some indemnification clauses may specify procedures for triggering a claim for indemnification and also for managing that claim thereafter (see section 9.3 of example 2). Be sure to note any notification requirements and refer to the notice section of the agreement to confirm the manner in which notice must be given. Also, as mentioned in point 5 below, pay attention to language describing each party’s obligations with respect to things like third party claims.
  5. Handling of third party claims. A common phrase in indemnification clauses is “indemnify, defend and hold/save harmless…” (see examples 2 and 4 below). Including the word “defend” in this phrase generally means that the indemnifier, in addition to shouldering the financial burden of the indemnitee’s losses, also has a responsibility to help the indemnitee actively defend against lawsuits and other claims advanced by third parties (note that, in some jurisdictions, this obligation to defend may automatically flow from the promise to “indemnify”). Sometimes this means that the indemnifier will step into the shoes of the indemnitee and assume control of any such third party claim or proceeding. In example 2 below, for instance, section 9.3 clarifies that the indemnifier (or “Indemnifying Party”) has sole control over the defense of any claim, though the indemnitee has a right to participate at its own cost and its written consent must also be obtained before certain settlements can be reached or actions taken. For the indemnifier, the benefit of having control over the defense of a claim is the ability to manage the timing and cost of the proceeding, which may help limit its financial exposure. For the indemnitee, delegating defense of any such claim to the indemnifier helps free up its resources to focus on other matters.
  6. Survival Language. Finally, some indemnification obligations may survive the termination of the contract (see example 7 below). Be sure to read the indemnification clause carefully for any such survival language. Also, check any survival clause in the agreement to see if it refers to sections containing indemnification clauses.

When reviewing an indemnification clause, it’s also important to be aware of other contractual provisions that may affect its interpretation. Some of these - such as the notice, limitation of liability and survival clauses - are discussed above. Guarantee clauses are another useful provision to look out for when evaluating indemnification. These provisions help with determining total liability from the indemnifier’s perspective, or total protection from the indemnitee’s perspective, as related companies or individuals who are not party to the contract may nevertheless have committed to guaranteeing one or more parties’ financial obligations, including those associated with the indemnity provisions. Similarly, an insurance clause in a contract will set out the parties’ obligations, if any, to maintain certain specified insurance coverage, which may also provide financial safeguards. Finally, because indemnification claims are often contentious, it’s important to review any dispute resolution provisions in the contract that may limit a party’s avenues for resolving conflict - for example, a contract that requires all disputes be resolved through binding arbitration may impede or preclude a party from taking the matter to court (where it may secure a more favourable outcome).

Examples of indemnification clauses

Example 1: From a Trust Agreement

4.9 Indemnification. Each Trustee and Person appointed or employed by the Trustee pursuant to Section 4.2(c), and the directors, officers, employees and agents of each such Person (each an “Indemnified Person” and collectively the “Indemnified Persons”), shall be indemnified out of the Trust Assets against all liabilities and expenses, including but not limited to amounts paid in satisfaction of judgments, in settlement (if such settlement is approved in advance by the Trustee, which approval shall not be unreasonably withheld), as fines and penalties, and attorney’s fees and costs, actually and reasonably incurred by the Indemnified Person as follows:

(a) If an Indemnified Person is or was a party or is threatened to be made a party to any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Trust, Trustee or any Beneficiary to procure a judgment in its favor) by reason of the fact that the Indemnified Person is or was the Trustee or a director, officer, employee or agent of the Trustee, or by reason of any action or inaction on the part of an Indemnified Person while being or having been such a Trustee, employee or agent including, without limitation, any alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act of any such Trustee or Person in such capacity (and in the case of any director, officer, employee, or agent of any such Person, by reason of any such Person exercising or failing to exercise any right or power hereunder); provided that the Indemnified Person shall not be entitled to such indemnification with respect to any matter as to which the Indemnified Person shall have been finally adjudicated to have acted with gross negligence, fraud or willful misconduct knowingly and intentionally committed in bad faith.

(b) If an Indemnified Person was or is a party or is threatened to be made a party to any threatened, pending or completed action or proceeding by or in the right of the Trust or any Beneficiary to procure a judgment in its favor by reason of the fact that the Indemnified Person is or was the Trustee or a director, officer, employee or agent of the Trustee, or by reason of any action or inaction on the part of Indemnified Person, except that no indemnification shall be made (i) in respect of any claim, issue or matter as to which an Indemnified Person shall have been finally adjudicated to be liable to the Trust or any Beneficiary in the performance of such Indemnified Person’s duty to the Trust and its Beneficiaries, unless and only to the extent that the court in which such action or proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, the Indemnified Person is fairly and reasonably entitled to indemnity for expenses and then only to the extent that the court shall determine, (ii) of amounts paid in settling or otherwise disposing of a pending action without court approval or (iii) of expenses incurred in defending a pending action which is settled or otherwise disposed of without court approval.

(c) The rights accruing to any Indemnified Person under these provisions shall not exclude any other right to which the Indemnified Person may be lawfully entitled; provided that no Indemnified Person may satisfy any right of indemnity or reimbursement granted herein, or to which the Indemnified Person may be otherwise entitled, except out of the Trust Assets. The Trustee may make advance payments in connection with indemnification under this Section 4.9, provided that the Indemnified Person shall have given a written undertaking to repay any amount advanced to the Indemnified Person and to reimburse the Trust only if, and to the extent that, it shall ultimately be determined that the Indemnified Person is not entitled to be indemnified as authorized herein. The advances to be made hereunder shall be paid by the Trustee to the Indemnified Person within 20 days after delivery of a written request therefor by the Indemnified Person to the Trustee. Nothing contained herein shall restrict the right of the Trustee to indemnify or reimburse such Indemnified Person in any proper case, even though not specifically provided for herein, nor shall anything contained herein restrict the right of any such Indemnified Person to contribution under applicable law.

Example 2: From a Supply Agreement

9.1 Indemnification by Product Co. Product Co shall, at its own expense, indemnify, defend, and hold harmless Sales Co and its Affiliates, and their respective officers, directors, employees and representatives, from and against any claim, demand, cause of action, liability, expense (including attorney’s fees and costs), or damages to the extent arising from a third-party claim with respect to:

(a) Products supplied by Product Co, including any claim alleging product liability, injury to property or person or infringement of intellectual property rights (except to the extent that Sales Co is obligated to provide indemnification for such infringement claim under the License Agreement or Asset Purchase Agreement);

(b) any breach by Product Co of this Agreement;

(c) any material violation by Product Co of a domestic or international law or regulation relating to relating to the manufacturing, import or export of Products; and

(d) any negligence or willful misconduct of Product Co or its agents, employees, directors or officers.

9.2 Indemnification by Sales Co. Sales Co shall, at its own expense, indemnify, defend, and hold harmless Product Co and its Affiliates, and their respective officers, directors, employees and representatives, from and against any claim, demand, cause of action, liability, expense (including attorney’s fees and costs), or damages to the extent arising from a third-party claim with respect to:

(a) Products supplied by Sales Co., including any claim alleging product liability, injury to property or person or infringement of intellectual property rights;

(b) any breach by Sales Co of this Agreement;

(c) any material violation by Sales Co of a domestic or international law or regulation relating to relating to the manufacturing, import or export of Products; and

(d) any negligence or willful misconduct of Sales Co or its agents, employees, directors or officers.

9.3 Procedures. The party seeking to be indemnified pursuant to this Article IX (as applicable, the “Indemnified Party”) shall be entitled to indemnification hereunder only (i) if it gives written notice to the party obligated to provide such indemnification hereunder (the “Indemnifying Party”) of any claims, suits or proceedings by third parties which may give rise to a claim for indemnification with reasonable promptness after receiving written notice of such claim (or, in the case of a proceeding, is served in such proceeding); provided, however, that failure to give such notice shall not relieve the Indemnifying Party of its obligation to provide indemnification, except if and to the extent that the Indemnifying Party is actually and materially prejudiced thereby, and (ii) once the Indemnifying Party confirms in writing to the Indemnified Party that it is prepared to assume its indemnification obligations hereunder, the Indemnifying Party has sole control over the defense of the claim, at its own cost and expense; provided, however, that the Indemnified Party shall have the right to be represented by its own counsel at its own cost in such matters. Notwithstanding the foregoing, the Indemnifying Party shall not settle or dispose of any such matter in any manner which would require the Indemnified Party to make any admission, or to take any action (except for ceasing use or distribution of the items subject to the claim) without the prior written consent of the Indemnified Party, which shall not be unreasonably withheld or delayed. Each party shall reasonably cooperate with the other party and its counsel in the course of the defense of any such suit, claim or demand, such cooperation to include using reasonable efforts to provide or make available documents, information and witnesses and to mitigate damages.

Example 3: From a Fulfillment Agreement

  1. HOLD HARMLESS.

9.1 Each party shall hold the other harmless from and against and shall indemnify the other from any liability, loss, costs, expenses or damages, however caused, by reason of any injury (whether to body, property or personal or business character or reputation) sustained by any person or to any person or to property by reason of any act, neglect, default or omission of such party or any of its agents, employees, or other representatives, and it shall pay all sums to be paid or discharged in case of an action, demand, claim, or any such damages or injuries. If either party is sued in any court for damages by reason of any of the acts of the other party referred to herein, such other party shall defend said action (or cause same to be defended) at its own expense and shall pay and discharge any judgment that may be rendered in any such action; if such other party fails or neglects to so defend in said action, the party sued may defend the same and any expenses, including reasonable attorney’s fees, which it may pay or incur in defending said action and the amount of any judgment which it may be required to pay shall be promptly reimbursed upon demand. Nothing herein is intended to nor shall it relieve either party from liability for its own act, omission or negligence.

9.2 Marketer shall hold Distributor harmless from and against and indemnify Distributor for all liability, loss, costs expenses or damages howsoever caused by reason of any Products (whether or not defective), or any act of omission of Marketer, including but not limited to any injury (whether to body, property, personal, or business character or reputation) sustained by any person or to any person or to property, and for infringement of any patent rights or other rights of third parties, and for any violation of municipal, state or federal laws or regulations governing the Products or their sale, which may result from the distribution of the Products by Distributor hereunder. Marketer hereby appoints the Secretary of State of the State of Nevada as its agent for service for process in connection with any action brought by UDS against Marketer under this Agreement.

Example 4: From a Commercial Lease Agreement

10.1 INDEMNITY. Tenant agrees to indemnify, defend and save harmless Landlord, Bankers Insurance Company any property manager(s) engaged by Landlord or Bankers Insurance Company and each of their affiliated companies, partners, shareholders, agents, directors, officers, and employees (collectively, “Indemnitees”) from and against any and all liabilities, damages, claims, suits, injuries, costs (including court costs, attorneys' fees and costs of investigation, and actions of any kind arising or alleged to arise by reason of injury to or death of any person or damage to or loss of property occurring on, in, or about the Leased Premises or by reason of any other claim whatsoever of any person or party occasioned or alleged to be occasioned in whole or in part by any act or omission on the part of Tenant or any invitee, licensee, agent, employee, director, officer, contractor, subcontractor, or tenant of Tenant, or by any breach, violation, or nonperformance of any covenant of Tenant under this Lease (collectively “Liabilities”) even if such Liabilities arise from or are attributed to the concurrent negligence of any Indemnitee. The only Liabilities with respect to which Tenant’s obligation to indemnify the Indemnitees does not apply is with respect to Liabilities resulting from the sole gross negligence or willful misconduct of an Indemnitee. If any action or proceeding is brought by or against any Indemnitee in connection with any such Liabilities, Tenant shall defend such action or proceeding, at Tenant’s expense, by or through attorneys reasonably satisfactory to Landlord. The provisions of this paragraph apply to all activities of Tenant with respect to the Leased Premises or Building, whether occurring before or after the Commencement Date of the Term and before or after the expiration or termination of this Lease. Tenant’s obligations under this paragraph are not limited to the limits or coverage of insurance maintained or required to be maintained by Tenant under this Lease.

Example 5: From a Commercial Lease Agreement

16.1(a) Enter upon and take possession of the Premises. In such event, Landlord shall have the right to remove all persons and property from the Premises and store such property in a public warehouse or elsewhere at the cost and risk of and for the account of Tenant, and all such persons shall quit and surrender possession of the Premises to Landlord. Tenant hereby waives all claims for damages which may be caused by the entry of Landlord and taking possession of the Premises or removing and storing the furniture and property and hereby agrees to indemnify and save Landlord harmless from any loss, costs, damages or liability occasioned thereby, and no such entry shall be considered or construed to be forcible entry or construed to be a termination of the Lease unless Landlord expressly elects to terminate this Lease. Should Landlord elect to enter, as hereby provided, or should Landlord take possession pursuant to legal proceedings or pursuant to any notice provided by law, Landlord may then or at any time thereafter terminate this Lease pursuant to Paragraph 16.1(c), below:

Example 6: From a Reseller Agreement

D. Prices and payments due to NovaCharge are exclusive of any sales, use, excise, value-added, withholding, or similar tax of any kind. Reseller agrees to pay and to indemnify and hold NovaCharge harmless from any sales, use, excise, value-added, withholding or similar tax levied on any Product arising out of the use or sale of the Product by or to Reseller, other than taxes measured by NovaCharge’s income, corporate franchise, or personal property ownership. Any and all taxes imposed on the sale of the Products to Customers are the responsibility of Reseller to collect and pay to the appropriate taxing authorities.

Example 7: From an Employment Agreement

10.11 Indemnification. The Executive shall be entitled to the same indemnification rights as other executive officers of the Company pursuant to the Company’s Articles of Incorporation and By-laws, as in effect from time to time, and shall be covered under any directors and officers’ insurance coverage maintained by the Company with respect to its executive officers. Without limiting any other provision of this Agreement, this Section 10.11 shall survive the termination or expiration of this Agreement for any reason whatsoever.