Contracting Pitfalls Part Eleven: Indemnification

Even the most innocuous agreement may contain language that will require one party to indemnify the other party. Usually, this is a clause that uses words like “indemnify, defend, and hold harmless”. When you see these words—watch out.

A contract of indemnity is generally an attempt by one party to expand the liability of the other beyond the usual range of liability for breach of an agreement. Indemnification clauses are generally very complicated to read and the law in this area is complex and varies widely from jurisdiction to jurisdiction. This is one area where legal counsel should almost always be engaged in order to determine the scope of the risk. However, a few general points may be made.

First, as noted, the request for an indemnification provision is an attempt to shift risk from the party that would ordinarily have it to another. Obviously, there is a business consideration involved in whether or not this is a risk that you are willing to accept. The scope of that risk can only be determined by a very careful reading of the particular language involved. You cannot generalize what the risk might be.

Second, not only are you generally taking on more risk than you would ordinarily have under the contract, you are also taking on an obligation for paying the defense costs of the other party. Sometimes this defense can be provided by you. However, some clauses allow the indemnified party to select its own counsel and send you the bills. These defense costs can be substantial.

Finally, you may be taking on risks that you cannot insure. Generally speaking, commercial liability insurance will only pick up indemnification liability if the policy specifically provides. You should check with your insurance agent to understand the scope of the coverage you have for indemnification liability. You may have to buy additional insurance to pick that up. But, in any event, the language defining the scope of the indemnity may be broader than the risks for which you can even obtain insurance. For example, you generally cannot buy insurance for intentional torts. A broadly drawn indemnity provision can pick up intention tort liability. Thus, you could be obligated to pay a claim arising from an intentional tort but would have no insurance coverage to help cover defense costs or pay a judgment.

The only general comment that may be safely made about indemnification clauses is that they can be extremely dangerous and must be carefully negotiated. The risk resulting from the language needs to be fully understood before even the simplest contract should be signed that contains such a provision.

Terry Farmer