All elements of a contract are important, however, some are more confusing than others. The indemnification clause is often one of those. Basically, to indemnify means to compensate an injured party for some damage or loss caused. However, in the contracts, how these losses are defined and the ways to compensate them are critical but rarely expressed clearly.
Below, we explain everything you need to know about the indemnity clause.
What is an Indemnification Clause in a Contract?
An indemnity clause or indemnification provision serves to protect one party from harm or loss where such harm or loss is attributable to another party. The clause has the effect of transferring liability to the party causing the harm.
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A supplier sells gas canisters to a distributor, who in turn sells the canisters to consumers; if the product is faulty and causes harm to the consumer, the consumer may choose to sue the distributor for injuries. In this situation, the distributor can rely on a product liability indemnity clause to demand that the seller defend the distributor in any lawsuit and pay all damages awarded, together with all costs and expenses incurred by the distributor.
Alternatively, a developer may sell a software license to a customer. However, the software contains intellectual property owned by another company and that company brings a lawsuit against the customer for breach of their property rights.
Again, the consumer can demand that the developer defend the claim and pay for any losses incurred by the customer.
An indemnity clause may contain two distinct elements:
- An obligation to “hold harmless”. The obligation to “hold harmless” is a legal term requiring a party to compensate the indemnified party for any losses.
- A duty to defend. The term “defend” requires the indemnitor to actively defend or pay for the defense of any claim brought against the indemnitee.
Why Are Indemnity Clauses Important?
In all business relationships, there are risks to one, both, or multiple parties. An indemnification provision protects the parties from losses, negligent acts or damages that may occur. Going even further, this clause allows the parties to customize the type of risk to which they are subjected within business contracts.
It’s important that these clauses are negotiated before being added to a contract.
What Are the Types of Indemnity Clauses?
There are different types of indemnity clauses, the main ones being the following:
Bare Indemnity
Here, the supplier must compensate the affected party to cover losses caused by circumstances predefined in the contract. It’s a simple type of indemnity that provides general protection without limiting liability.
Third-party Indemnity
A third-party indemnity applies to third-party claims made against one of the parties.
Inter-party Indemnity
An inter-party indemnity occurs when a party brings an indemnity claim against another party. Becoming common, but not advised as, the parties have a common law right of damages and other remedies that may be limited by the inter-party indemnity.
Inter-party Indemnity Example
A number of commentators raise concerns about the overuse of inter-party indemnities.
For example, the website IP Draughts notes that their lawyers negotiated contracts “where it appeared that an indemnity was included merely because it formed part of the template agreement on which the draft contract was based, and where the other party had no convincing reason for including the provision.”
From the perspective of the party benefiting from the indemnity, they have common law rights to damages in the event of a breach of contract and do not need an indemnity to recover such damages. However, some may argue that the indemnity gives them the right to recover attorney’s fees, as this is an expense arising from the harm.
From the perspective of the indemnitor, the clause may increase their exposure because the benefiting party does not have to show that the loss was not too remote from the breach or seek to mitigate their losses as required for common law right to damages.
In addition, the right of defense by the indemnifying party makes little sense when the indemnitee is the other party to the agreement. In this bizarre circumstance, the indemnifying party could take control of the defense against itself. Of course, for this reason, interparty indemnities are limited to recovery of losses and do not include the right of defense.
What Are the Elements of an Indemnity Clause?
An indemnity clause covers the following elements:
- Who is indemnifying whom? An indemnification provision may be mutual or one-way.
- Arising from what events or circumstances? Third-party indemnities typically cover intellectual property infringement or product liability. Inter-parties may cover all forms of breach of contract, such as non-performance or breach of any contract terms.
- Covering what types of losses? Losses typically include any damages awarded by the court, plus attorney's fees and other legal costs.
- What are the qualifications for indemnity? The indemnified party is required to notify the indemnifying party of a claim and permit the indemnifying party to control the defense.
- What are the exceptions to indemnity? In most cases, the indemnity will not cover situations where the indemnified party modifies the product or service or fails to use it in compliance with its requirements.
Indemnity Clause Examples and Language
Indemnification is a conditional obligation. Most agreements, however, draft the clause as a statement burying the condition in an implicit form.
A typical indemnity clause may read:
Traditional Sample
“Seller will indemnify, defend, and hold harmless [Buyer] and its Customers from all claims, suits, actions, awards (including, but not limited to, awards based on intentional infringement of patents known to Seller at the time of such infringement, exceeding actual damages, and/or including attorneys' fees and/or costs), liabilities, damages, costs and attorneys' fees related to the actual or alleged infringement of any United States or foreign intellectual property right (including, but not limited to, any right in a patent, copyright, industrial design or semiconductor mask work, or based on misappropriation or wrongful use of information or documents) and arising out of the manufacture, sale or use of Products by either [Buyer] or its Customers.”
Note that this clause has a Flesch-Kincaid readability grade level of 52, meaning that the reader will require 52 years of education to understand, which is far beyond any reasonable level of education.
Modernized Example (IP Infringement)
X. Indemnification
x.1. Indemnity Obligation. If a third party brings an intellectual property infringement claim against [PARTY B] alleging that the Services infringe the third party’s intellectual property rights, [PARTY A] will (a) defend [PARTY B] against such claim and (b) reimburse [PARTY B] for any damages that it suffers as a result. In this context, “damages” means all costs that [PARTY B] incurs in defending itself against such claim, including any attorney fees and court costs awarded against it.
Note that this clause has a Flesch-Kincaid readability grade level of 19 or the equivalent of graduate level education.
x.2. Indemnity Qualifications. [PARTY A]'s indemnity obligation is conditional on [PARTY B] giving [PARTY A] (a) prompt written notice of the third party’s claim, (b) sole control of the defense and settlement of the claim, and (c) all reasonable assistance, at [PARTY A]'s expense.
x.3. Indemnity Exceptions. If the alleged infringement is caused as a result of [PARTY B] (a) modifying or altering the Services, or (b) combining the Services with products or services not supplied by [PARTY A], [PARTY A] is not required to indemnify [PARTY B] unless in either case [PARTY A] gave its prior written consent.
x.4. Indemnity Mitigation. [PARTY A] may at no cost to [PARTY B] (a) modify the Services so that they are no longer claimed to infringe and conform to terms of this agreement, (b) obtain a license for [PARTY B]’s continued use of the Services in accordance with this agreement, or (c) terminate the agreement and refund [PARTY B] any prepaid fees.
Alternative Forms of Indemnity
In a contract, there will be different indemnity variations. The most common are:
Product Liability
x.1. Indemnity Obligation: If a third party brings a claim against [PARTY B] alleging that a defect in the Goods supplied by [PARTY A] caused loss or harm to such third party, [PARTY A] will (a) defend [PARTY B] against such claim and (b) reimburse [PARTY B] for any damages that it suffers as a result. In this context, “damages” means all costs that [PARTY B] incurs in defending itself against such claim, including any attorney fees and court costs awarded against it.
Customer IP Indemnity
x.1. Indemnity Obligation: If a third party brings a claim against [PARTY A] alleging that [PARTY B]’s use of the Service or material provided by [PARTY B] infringes that party’s intellectual property rights, [PARTY B] will (a) defend [PARTY A] against such claim and (b) reimburse [PARTY A] for any damages that it suffers as a result. In this context, “damages” means all costs that [PARTY A] incurs in defending itself against such claim, including any attorney fees and court costs awarded against it.
Breach
x.1. Indemnity Obligation: If a third party brings a claim against [PARTY B] alleging that [PARTY A]’s breach of this agreement caused loss or harm to such third party, [PARTY A] will (a) defend [PARTY B] against such claim and (b) reimburse [PARTY B] for any damages that it suffers as a result. In this context, “damages” means all costs that [PARTY B] incurs in defending itself against such claim, including any attorney fees and court costs awarded against it.
Performance
x.1. Indemnity Obligation: If a third party brings a claim against [PARTY B] alleging that [PARTY A]’s performance under this agreement caused loss or harm to such third party, [PARTY A] will (a) defend [PARTY B] against such claim and (b) reimburse [PARTY B] for any damages that it suffers as a result. In this context, “damages” means all costs that [PARTY B] incurs in defending itself against such claim, including any attorney fees and court costs awarded against it.
In short, the indemnity clause protects one party from damages or losses that may be attributed to another party under a contract. There are two types of indemnity, as well as elements to consider when creating or revising a contract.
At Akorda, we help you simplify the process of creating, analyzing and executing contracts. So if you need help in this area, don't hesitate to request a demo or contact us.
Kingsley Martin
Kingsley is a founder of Akorda. He holds law degrees from Oxford University (First Class Honours) and Harvard Law School, and has 30 years of experience in the practice of law, software design and development, strategy, and management. Kingsley pioneered the new discipline called contract analysis. He is a founder of KMStandards and has developed software capable of automatically analyzing legal agreements and creating contract standards.
