Understanding Indemnification Clauses

Businesses enter into contracts for a range of purposes. While they may give a lot of attention to terms like price, quality, and delivery, there are other clauses in a contract that may be important. One such clause is the indemnification clause, which can be triggered if a dispute arises. An indemnification clause can have a significant impact on a business because it controls who will ultimately bear the cost of the dispute.

Indemnification means to compensate someone for their loss. One party agrees to pay the other for certain costs and expenses they incur for covered events, usually for claims brought by third parties. However, indemnification may also cover claims brought by one of the parties against the other.

Indemnity is a contract by which one engages to save another from a legal consequence of the conduct of one of the parties, or of some other person. Indemnity provisions are among the most aggressive risk shifting provisions because they can require a party to assume liability for the mistakes of another.  As a result, Texas courts require indemnity provisions to comply with the Fair Notice Doctrine in order to be enforceable in Texas. [1] Dresser Ind., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508 (Tex. 1993). The Fair Notice Doctrine requires that indemnity provisions (1) be conspicuous and (2) expressly state the scope of the risk allocated in order to be enforceable.

An indemnification clause is a provision in a contract that protects one party from liability if the other party or a third party is harmed. The party agreeing to indemnify is responsible for compensating the indemnified party for losses or damages they incur. The indemnification clause may require the indemnifying party to defend the indemnified party by paying for attorney fees and other costs for matters included in the indemnification provision.

An indemnification clause protects one party from the other’s actions. Indemnification clauses shift liability from one party onto the other, which gives them greater control over the potential risks involved. If a dispute does arise because of the actions involved in the contract, the indemnified party can be compensated for their loss.

Indemnification clauses protect contracting parties from damages or legal claims that are more likely to arise because of the other party’s actions.  They also allow a person to determine how much risk they are – and are not – willing to accept for a particular business deal.

Indemnification clauses are used in a wide variety of contracts. They are used to guarantee products and to support professional service agreements. For example, the University of Texas uses indemnification provisions when it enters into contracts with vendors, software license agreements, sponsorships, technology license agreements, and product guarantees. 

Other common uses of indemnification clauses include: 

• Construction contracts so that one party is not blamed for the poor craftsmanship for another

• Partnership agreements so that a partner is not responsible for the personal actions of the other partner

• Insurance contracts that protect an insured in case of their liability 

• Product liability contracts so that the seller is not held responsible if a customer is injured by the product

 

Some of the most important terms that may be included in an indemnification provision or contract are:

Obligation to Indemnify 

The obligation to indemnify goes to the heart of the indemnification provision. This term should include the identity of the parties, what the duty to indemnify includes, what damages the indemnifying party must cover, and whether any advance payments it must make to the indemnified party. 

Obligation to Defend

The obligation to defend may indicate that the indemnifying party is responsible for: 

• Reimbursing attorney fees and other defense costs
• Paying defense costs in advance
• Controlling the defense of the action and legal strategy 

 

The duty to defend applies even if the third-party’s claim has no merit or the third party loses the case.

Covered Events

The covered events section should specify when the duty to indemnify applies, such as in the event of:

• Breach of contract

• Negligent conduct 

• Physical injury or death

Some indemnification clauses may state that the indemnification provision will apply if the indemnified party breaks any laws, but some states prohibit this. 

Hold Harmless

Some states treat a “hold harmless” clause differently than an indemnification clause. In these states, a hold harmless clause requires the indemnifying party to pay costs in advance to the indemnified party. Otherwise, the indemnifying party is not responsible for losses until the indemnified party has paid them.

Damages Clause 

The indemnification clause should also specify the damages that the indemnified party can recover. For example, the damages might cover:

• Losses – Losses may include court judgments, settlements, attorney fees, legal expenses, and associated costs. 

• Liabilities – Liabilities include debts and other legal obligations. 

• Claims – Claims are damages arising from a third-party lawsuit. 

• Causes of action – Causes of action damages involve those resulting from a right to seek relief. 

 

These terms are negotiated between the parties. Careful consideration should go into them.

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