Corporate attorney, Adam Chelminiak discusses the importance of indemnification provisions in commercial contracts.
Indemnification provisions are included in nearly every commercial contract. They are an important tool for allocating risk between the parties in the event something goes wrong under the agreement. But indemnification clauses are often complex and full of technical language. As a result, despite their ubiquity and importance, indemnification provisions can be easily glossed over as boilerplate “legalese” by business people who are focused on documenting the economic terms of the deal, but also by experienced lawyers who default to using language from prior agreements without considering whether it is appropriate under different circumstances.
Perhaps the greatest source of this insufficient attention to detail involves the use of “indemnify, defend, and hold harmless.” That phrase is commonly interpreted as a hendiatris – a rhetorical device used for emphasis, in which three words are strung together to express a single idea. In the case of indemnification provisions, the phrase “indemnify, defend, and hold harmless” is often read as simply imposing a single obligation to indemnify. And in many cases, the intent when using “indemnify, defend, and hold harmless” may genuinely have been to impose a single obligation to indemnify. In reality, however, each of the terms in that phrase can have distinct legal meanings that, when used in concert, impose multiple duties that are related but are not necessarily synonymous.
In general, the obligation to “indemnify” can require the indemnifying party to compensate the other party for direct claims by the other party, third-party claims, or both. Indemnification involves reimbursement for paid covered expenses and losses as well as possibly advancing payment for covered expenses and losses that have been incurred by not yet paid. In contrast, the obligation to “defend” involves a responsibility to reimburse and advance costs and expenses related to a third-party claim, and possibly a right of the indemnifying party to assume control of the defense. Crucially, the obligation to defend is triggered merely by allegations of claims covered by indemnity rather than the ultimate merits of the claim. Accordingly, an obligation to defend can be significantly broader than an obligation to indemnify. Similarly, the obligation to “hold harmless” may impose a duty beyond a simple obligation to indemnify. A hold harmless obligation may require advancing payment for unpaid costs and expenses even when the indemnification provision limits recoverable damages to losses that were actually paid and excludes liabilities that are incurred but not yet paid. Adding an additional layer of complexity, the meaning of “indemnify, defend, and hold harmless” varies depending on applicable state law.
And while important, clarifying the range of obligations is only one aspect of drafting an indemnification provision. Parties should also consider, among other things, issues such as: Is the indemnification obligation unilateral or mutual? Do the rights and obligations extend to any third-party beneficiaries? Should the nexus phrase linking recoverable damages to covered events be broad (“related to”) or more narrowly tailored (“caused by” or “solely resulting from”)? Should there be caps or thresholds limiting the total potential indemnification liability?
Accordingly, although careful consideration of an indemnification provision may not be the most exciting aspect of contract negotiation, it can have tremendous practical implications for the parties to the agreement in the event something goes wrong in the future. A properly drafted indemnification clause can limit a business’s exposure to having to pay to fight a lawsuit or satisfy a judgment that isn’t a result of its own fault on the part of the business. However, a mistake in drafting, or the reliance on boilerplate language, may cost a business significant expense.
If you would like any additional information about how to protect your business through indemnification rights and obligations, please contact the attorneys in Parker McCay’s corporate department.
The content of this post is for informational purposes only and should not be construed as legal advice or legal opinion. You should consult a lawyer concerning your specific situation and any specific legal question you may have.