What are the key elements of an indemnification clause and how do you balance risk and liability?

Indemnification is a legal term that refers to the act of compensating someone for loss, damage, or injury. In business and legal contexts, indemnification provisions are often included in contracts to protect one party from potential liability or legal action that may arise during the course of their business dealings. Essentially, indemnification provides a means for transferring risk from one party to another, with one party agreeing to cover any losses or damages that may occur as a result of a particular action or situation. It can be an important tool for managing risk and protecting your business interests.

Keep in mind that the indemnity clause can extend the usual contract breach statute of limitations which runs from date of the breach, while indemnity clause breach runs from date of refusal to indemnify in many jurisdictions. Indemnities clauses are the relatives that won't leave your house! Such clauses might also allocate risk in a way that could make you the defacto insurance company for the indemnitee. As a seller, you must remember "risk vs reward" and remind the buyer that you are not Allstate.

Be mindful that in certain property transactions, such as leases, the document may contain a waiver of subrogation provision, which provides that each party agrees to look to its property insuror for recovery of property loss, even though the loss may have arisen from the negligence of the other party. In that case, you should specify that the indemnification provision is subject to the waiver of subrogation; otherwise, the two concepts will be in conflict with each other.

If you wish to be indemnified in the event of harm or loss, you need to consider the costs associated with defending yourself. Generally speaking the right to be indemnified may not include the obligation to defend you so it would be prudent to include language requiring the indemnitor to defend you in the event of a lawsuit or arbitration. You may also want to get the final say on who is representing you in a dispute and not leave it up to the sole discretion of the indemnitor. The indemnitor, on the other hand, does not want to write a blank check and would want some controls over the costs of representation and defense.

Be mindful that an indemnification clause also often includes the obligation to defend and hold harmless. This means that the indemnified party may require that the indemnifying party represent the indemnified party in the defense of a claim (vs. engage their own defense counsel). In this case, additional provisions regarding cooperation and consent for settlement must also be considered.

I limit indemnification to 3rd party claims and strike any duty to defend, unless there are detailed procedures governing how that duty to defend will operate (immediate notice, etc.). Additionally, if a limitation of liability is included in the agreement, then a carve-out for indemnification obligations is necessary.

In addition to indemnifying the other party, consider carefully whether to include a duty to defend the other party in any legal proceedings related to the contract. This may help ensure that the other party is protected and their interests are safeguarded. This clause may also necessarily constrain or burden you or your client. Consider thinking through possible scenarios this may become an issue and your interests when this arises.

It is always important to utilize benchmarking best practices to utilize lessons learned within your industry. Each contract specialist will have their own negotiating techniques, but I recommend always being the aggressor in regards to proposing terms and conditions to ensure your priorities are being addressed. Keep a knowledgeable legal resource on speed dial in case negotiations stall.

Negotiations becomes more complex when we are dealing with capital projects involving many contractors working at same locations and posing third party risk to other contractors. So based on situation, scope of the contract and interface indemnification clause has to be agreed.

One thing that I have found useful is to consider limits on indemnification based on elements such as the net present value of the transaction and risks associated with the targeted business sector. You may want to also review your partner’s financials and insurance policies to ensure they have the means to fund any and all claims.

Consider reviewing the financial impact of the indemnification clause and consider whether the indemnification obligations are reasonable and proportional to the potential risks involved. I find it very helpful to root all commercial discussions and negotiations, whether internal or external, in commercial realities and financial impact.

Keep in mind that any negotiated terms will most likely be reciprocal so be cautious in what you ask. It’s uncommon to have different terms for each party.

The indemnification obligations should be proportional to the level of risk and liability involved in the contract. For example, if the contract involves a high level of risk, the indemnification obligations should be correspondingly high.

I try to make LOL consistent with the indemnification clauses. I exclude Client's liability for indirect damages (punitive, consequential, and incidental). Generally, I suggest no cap on direct damages. But keep in mind if vendor has sufficient assets to cover any claims. If not, then document it to obtain a risk acceptance approval. Sometimes I agree to a super cap for certain liabilities if the risk exposure isn't high but negotiate carveouts for indemnification obligations, confidential, proprietary and privacy obligations, negligence and intentional misconduct. A cap on direct damages can be an "Aggregate" or "Total Cumulative" limit or a "per claim" limit. I factor in data privacy, cyber and information security breaches too.

Be careful about the carveout for the indemnification clause, from the Limitation of Liability clause in a contract. It is important to ensure this if your company is seeking indemnification such as IPR indemnification.

If you are on the receiving end of an indemnification clause, always insist on limiting the liability arising therefrom. Depending on how it is compiled it usually doesn't require any causal nexus so the only way to manage your exposure is by limiting it (as insuring it will also not be an option).

Similarly, the insurance clause should be coordinated with the indemnity and limitation of liability clauses. They may have great insurance, but it doesn’t matter if the indemnity isn’t there or is limited. Sometimes you can negotiate exceptions for insured losses from the limitation of liability.

Yes, it is particularly important for contractors as they need to provide performance bonds when securing large value contracts. Contractors need to review all the relevant clauses in the best interest of all parties, negotiate the terms of liability, and ensure necessary negotiated amendments are in place before signing off the contract.