Indemnity clauses are common in contracts, bills of sale and purchase orders. They are often buried deep in legalese in the contract or may be in small print on the reverse of a form document.
Unless a party to the contract has hired a lawyer to review the contract, an indemnification clause will rarely be discussed or negotiated by the parties.
The risk to which an indemnification clause exposes a business varies widely according the language of the particular indemnification clause.
A business should approach any contract with an indemnification clause with caution. A business must employ some person who is responsible for reviewing contracts or contract documents and identifying problematic terms and conditions for risk review internally or review by an attorney. With a little practice, anyone can spot an indemnification clause. The following are all examples of indemnification clauses:
- Vendor agrees to indemnify and hold the Purchaser harmless against all liability claims or demands for injuries or damages including but not limited to attorney’s fees to any person or property arising out of the performance of the purchase order by Vendor.
- Client agrees to fully indemnify and hold harmless Contractor and its officers, directors, employees, agents, representatives and subcontractors from any and all claims, losses, costs, attorney’s fees, expenses, awards, actions, judgments or other liabilities of whatever type arising out of or in connection with Contractor’s employment for and performance of the services.
- Seller shall indemnify Buyer and save Buyer harmless from any and all claims, demands, and causes of action asserted against Buyer which arise from or relate to (i) any breach or failure of any other obligation which is assumed by Seller herein, and (ii) Seller’s operation of the Business prior to date of Closing. Seller shall also indemnify Buyer and save Buyer harmless from any and all losses, liabilities, damages, and injuries incurred or suffered by Buyer, including attorney’s fees, which may arise from any of the foregoing, or from Seller’s failure to perform hereunder.
The first clause was copied from a purchase order placed with a seller by a buyer of a piece of machinery. The second was copied from an agreement for the performance of services by a contractor. The third was copied from a contract for the purchase and sale of a business. An indemnification clause will usually include a variant of the word “indemnify,” or some combination of “save” or “hold” along with the word “harmless.”
A business usually understands that if it makes a mistake or its product is defective, the business should do what it takes to fix the mistake or make the product work. A business usually understands and agrees that if it does not make good on the product or services it agreed to provide, it will be liable for the difference in value between what the business promised to provide and what it actually provided.
Assume that a business agrees to provide the buyer with a certain gear by Aug. 6. The business is not aware that if the buyer fails to receive the gear on Aug. 6, the buyer won’t be able to operate the buyer’s factory, which will expose the buyer to catastrophic liabilities on contracts the buyer has with third parties. In most circumstances, because the seller had no reason to suspect such catastrophic damages, the seller will likely not have to pay the catastrophic damages incurred by the buyer. However, if there is an indemnification clause in the contract, the seller may be responsible for the catastrophic damages, even though the seller was unaware of the potential for such large liability.
A business that wishes to avoid such a surprise should negotiate to remove an indemnification clause from a contract prior to signing it. If a business doesn’t have the bargaining power to remove an indemnification clause, it may negotiate a cap on its indemnification liability or have the indemnification clause drafted to narrowly define the losses indemnified.
A business that receives a purchase order or order with an indemnification clause should timely send written notice of objection to the party that sent the document containing such clause.
“Four Rivers Business Journal,” July 2013