An indemnification clause is inserted into a contract to transfer risk between the contracted parties. In most cases, these clauses are used to make sure that a potential loss will be compensated. If you are the party covered by this clause, it means that the other contractual party is promising to compensate you if their actions cause you to suffer a loss. For instance, such a party might commit an action that results in you being sued by a third-party.
The words indemnify, hold harmless, and defend are almost always included in an indemnification clause. Essentially, hold harmless and indemnify are synonymous.
This particular clause is often associated with significant confusion, anxiety and hesitation among operators when negotiating contracts. Rightly so, indemnification is an extremely heady concept that can effectively shift risk—that is, shift liability—from one party to another. Obviously, not just anybody can impose their legal issues onto another party to side-step liability. Instead, indemnification works through carefully-worded clauses that are usually included in larger contractual agreements. We highly recommend that operators have a complete understanding of indemnification provisions before signing any sort of binding contract with another business or third party.
Owners that unknowingly sign contracts with strongly-worded indemnification provisions, may in-fact be agreeing to take responsibility for all types of legal claims (and truthfully, signing-over liability is not a matter to take lightly). Liability claims, especially those that involve serious injury or medical carE, can result in losses of tens, if not, hundreds, of thousands of dollars for the legally responsible party. Amounts of this size might be enough to put a company out of business essentially overnight.
Indemnification Defined
Indemnification is a term that might be defined differently in different texts. Traditionally, the word was used interchangeably with “compensation” or “reimbursement”. More recently, however, indemnification has been used to describe the transfer of responsibility from one potentially at-fault party to another.
In terms of business ownership, indemnification provisions are commonly included in contractual agreements between businesses and other businesses, businesses and third party contractors, or even between businesses and their customers. Essentially, they specify who is at-fault in the event of an accident.
For example, imagine that an entrepreneur needed to license a critical piece of technology to build her technology platform. She might contract with a third party to license that technology. Before executing the license agreement, the entrepreneur may want to include an indemnification provision stating that any lawsuits resulting from software that infringes someone else’s intellectual property are the responsibility of the third party, and not the responsibility of her company.
Such a structure is not only legal, but also quite common; worth noting, however, is that the third party technology company can, and often times will, propose an indemnification provision that deems just the opposite: that all that any lawsuits or damages arising out of our entrepreneur’s use of the technology should stay with her (the licensee). In reality, this later scenario would be more common.
Three Things to Know Before Signing any Agreement
It may seem obvious, but business owners must know of what they are agreeing to before signing any contracts. In an effort to minimize risk, 3rd party entities will write indemnification provisions into contracts to deceive owners into absorbing mass amounts of liability and risk. If you’re not sure whether your agreement includes language on indemnification, always assume that it does. Likewise, consulting an attorney is could be very helpful. A qualified attorney that is well-versed in business law will be able to read through the agreement and disentangle which party is liable under which circumstances.
As a business owner, here are three points to know about indemnification provisions before signing a contractual agreement:
1. Indemnification Clauses are Usually Buried in Larger Contracts and Often Overlooked as Simply Legalese
Indemnification agreements can, in-fact, be stand-alone documents (in which case it’s relatively easy to identify the provisions that shift liability). The majority of times however, these clauses are inconspicuously buried within larger contractual agreements. “Burying” these clauses is no coincidence; many third parties purposefully try to conceal these terms, and thus have individuals unknowingly sign an agreement that legally binds them to mass amounts of responsibility. Frighteningly, a 100-page contract may contain only 1-2 paragraphs on indemnification provisions. But if the provisions are strongly-written, they can effectively shift all responsibility onto the signee.
2. Understand and Appreciate the Language of Indemnification
Perhaps the most important thing to know is the language and terminology of indemnification provisions. As stated above, only a few paragraphs—and really, only a few key words and phrases—have incredible power in terms of defining and shifting liability. Here are a few phrases to bewear of:
– …to hold harmless
– …to secure against loss or damage
– …an obligation to defend
It’s imperative to look for these key-phrases when reviewing your agreement, as any one of them may hold you partially or completely responsible for a wide-range of claims. To a non-professional, this type of phrasing is often-times like another language. An attorney will be of great assistance in identifying the legal jargon of indemnification.
3. Mind the Scope and Specificity
Before signing an agreement with indemnification provisions, it’s important to understand exactly who is responsible, their extent of liability, and under which circumstances they will be held accountable. Again, a business law representative will be helpful in deciphering the language of the agreement and answering these questions.
The Takeaway
When signing a contractual agreement with a 3rd party, understand the power of indemnification provisions. Other parties will always try to minimize their legal risk by shifting liability onto you. Don’t be vulnerable; contact an attorney with a background in business law to review the agreement before signing.
These provisions are often-times carefully worded and buried embedded into larger contracts – perhaps frequently overlooked as simply excess verbiage. Identifying and understanding the terms of these provisions will help avoid time-consuming liability claims and expensive legal fees.
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