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Indemnity: A Clause Worth Reading


Thursday, October 25, 2007


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Nearly every contract contains an indemnity clause. These clauses are so common, that many don't even read them, assuming that they are inconsequential boilerplate. Nothing could be further from the truth. The existence and scope of an indemnity clause could affect your very survival as a viable entity.

As a gross oversimplification, an indemnity clause allows you (the "indemnitee") to seek reimbursement ("indemnity") for money you are forced to pay to a third party as a result of an injury, physical or monetary, caused by the party from whom you seek the reimbursement (the "indemnitor"). For example, one of your consultants carelessly leaves some equipment lying around. A visitor trips over the equipment and injures herself. She sues you because the injury occurred on your property, even though it was the consultant's act, not yours, which led to the injury. If there was an indemnification clause in the contract between you and your consultant, you could seek to have the consultant reimburse you for monies that you might have to pay to the injured party. In its purest form, therefore, indemnity is a means of shifting the ultimate responsibility for payment to the party who caused the injury.

Indemnity is not necessarily limited to personal injuries or property damage. It can also apply to contractual obligations. For example, you incorporate a consultant's work into a report that you are preparing for a client. The consultant's work is inaccurate and you carry that mistake through into your own work product. You get sued by your client for breach of contract. If you have an indemnity clause, you have a means to seek reimbursement from your consultant for the damages you might have to pay to your client as a result of the error in your consultant's report.

The language of the indemnity clause is very important.. For example, when does the obligation arise? Does it cover legal fees or just damages? What happens if more than one party is at fault? There is no exact formula to answer these questions. You need to look at the language itself. For example, a typical broad indemnity clause might say:

Contractor agrees to indemnify and hold harmless Owner of and from any and all claims, demands, losses, causes of action, damage, lawsuits, judgments, including attorneys' fees and costs, arising out of or relating to the work of Contractor.

Clearly, this language seems to cover every possible type of potential loss, and kicks in even at the demand stage. It also covers attorneys' fees and makes no accommodation for the possibility that someone else might also be responsible.

A narrower version of this clause might say:

Contractor agrees to indemnify and hold harmless Owner of and from any and all claims, demands, losses, causes of action, damage, lawsuits, judgments, including attorneys' fees and costs, but only to the extent caused by, arising out of, or relating to the work of Contractor.

This additional language suggests an apportionment of relative fault.

Maybe you want to cap your exposure. The indemnity might read:

Contractor agrees to indemnify and hold harmless Owner of and from any and all claims, demands, losses, causes of action, damage, lawsuits, judgments, including attorneys' fees and costs, to the extent caused by or arising out of or relating to the work of Contractor. In no event shall the maximum liability hereunder exceed the sum of $ _________.

Or, "In no event shall the maximum liability hereunder exceed the amount actually paid to Contractor under this contract."

If you do have to pay, do you also have to defend? In other words, if the indemnity is triggered, who actually handles the defense of the claim? Again, this depends on the language of your clause. The obligation to indemnify and the obligation to defend are two separate concepts. The general rule is that unless the indemnity clause also includes an express obligation to defend, the party who is providing the indemnity has no obligation to provide, nor ability to insist on providing, the defense. This is a double- edged sword. Because the underlying claim is asserted against you, perhaps you may want to control the defense of the litigation. On the other hand, if you are the party that's going to ultimately have to pay for the defense, maybe you want to hire the lawyers and control the defense. After all, it's coming out of your pocket. Both these arguments have merit, and this should be a product of negotiation.

As you can imagine, the scope and extent of indemnity has spawned hundreds of lawsuits and in some jurisdictions statutes, which limit the breadth of an indemnity clause or affect indemnity clauses utilized in specific industries. Each state has its own nuances. For example, in Massachusetts there is a statute sharply limiting the scope of indemnity which a general contractor can impose on a subcontractor in a construction setting. Other states have limits applicable to other settings. Sophisticated drafters have devised ways to avoid or limit the effects of statutory or decisional law on indemnity clauses. Depending on the verbiage, there may or may not be insurance coverage for an indemnity obligation. The availability of insurance will have a large impact on what type of an indemnity obligation you are willing to assume or need to insist upon. Similarly, the financial means of the indemnitee must be taken into account: even a broad indemnity obligation is worthless if there is no ability to pay.

Because the indemnity obligation in your contract could have immense financial repercussions, you cannot take it for granted. Each indemnity clause must be tailored to your specific situation and the laws of the jurisdiction in which you work must be taken into account. It is important to read and understand what that clause provides, even if is non-negotiable, so that you go into a relationship with your eyes wide open.

This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.