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Elements of a Contract: What is Indemnification?

Welcome to our new mini-series, Elements of a Contract, where we go over the basic terms you find in most contracts but may not fully understand.

In this edition of elements of a contract, we’ll discuss what indemnification is and look at a few variations.

The Basics with Examples

If I say that I will indemnify you, that roughly means “I’ve got your back.” If anyone tries to sue you, I’ll take care of it. It’s a way of shifting risk.

Here’s a generic, “one-way” indemnity clause:

Adam agrees to indemnify and hold harmless Brian from all claims, including attorneys’ fees and costs, relating to the subject matter of this Agreement. *

If some outside party sues one of the people who negotiated this contract, or whoever is defined as a party, then the other one will pay for a defense or settlement of that claim.

Sound too good to be true? It’s not. Indemnity clauses track the power relationship between the parties, like most terms. Commonly, the party with more power requires indemnification from the weaker one.

But you may encounter a mutual clause. For example:

Adam agrees to indemnify and hold harmless Brian from all claims, including attorneys’ fees and costs, relating to injuries on Brian’s Premises. Brian agrees to indemnify and hold harmless Adam from all claims, including attorney’s fees and costs, relating to delivery delays. *

Here, each party indemnifies the other. That may sound circular, but it’s not because indemnification is protection from outsiders to the contract (AKA third parties), not protection from one another’s claims.

Controlling Incentives

You might ask yourself, if one party knows that someone else will cover its harmful conduct, isn’t there an incentive to take big risks or simply be sloppy?

Not quite. Many clauses (not those above) specify that only “negligence” is covered, not recklessness or intentional wrongdoing.

Another catch is that some indemnity clauses say they will pay for the damages after a claim has been litigated or settled, but they won’t pay for the upfront expenses of defending against the claim. So, the covered person finds themselves spending lots of money to defend the claim and has to wait until the very end for the other party to pay the plaintiff whatever he is due. This can still be very expensive.

Finally, many clauses grant the party who’s left on the hook with some extra control. For example, it’s wise to require the indemnitor (the person doing the covering) to approve any settlement agreements the indemnitee (the person who is covered) wants to enter into. This way there is still a way for the indemnitor to keep his or her costs low. 

You can contact the author here, and follow @revolvethis and @gerritbetz on Twitter.

* These examples are just that—examples. I made them up specifically for the purpose of this blog post. Don’t use them for anything other than learning.