An indemnity clause is a common element of contracts, used to shift potential costs from one party to another. Indemnity clauses can be confusing and intimidating, so let’s talk about how to navigate them.
An indemnity clause typically states that one party agrees to “indemnify” (and often also to “hold harmless” and “defend”) the other party. To indemnify someone is to absorb the losses caused by that party, rather than seeking compensation from that party, or to compensate that party if something you do (or fail to do) causes them to experience loss, damages, or a lawsuit from a third party. It’s this last part — protecting the indemnified party against third-party lawsuits — that is the real significance of an indemnity clause, since even without the clause, a party can usually recover damages and losses for their own harms.
Let’s say you are a freelance software developer and you agree to indemnify your client against copyright claims related to the code you are writing for them. After the client deploys the software, they get sued by another company claiming that the software is a copy of theirs. Per the indemnity clause, you would be obligated to cover your client’s costs in defending against this lawsuit, and you would be responsible for your client’s damages if they were found liable to the third party.
Indemnification clauses are often closely tied to representations or warranties, which are promises that certain things are a certain way. For instance, your phone, like many products, is probably warranted to be free of manufacturing defects. In the software developer example, your contract with the client may have required you to warrant that the software you were developing was original. Your breach of that warranty would give the client the right to invoke the indemnification provision if they were sued by a third party for a copyright violation.
Indemnifying can be costly, especially if the warranty is broadly worded and the indemnity clause has you paying for all claims, regardless of their merit.
If you’re asked to indemnify another party in a contract, here are some tips that can help:
- Read the indemnity clause (and the rest of the contract) carefully and make sure you’re clear on its language. For example, there’s a huge difference between “defending against reasonable claims” and “defending against all claims,” but it can be easy to gloss over it.
- Limit the scope of the indemnity clause by limiting the warranty. For example, if you’re a software developer being asked to warrant that your software does not infringe on any third party’s intellectual property rights, with or without your knowledge, you may want to rephrase the warranty to state that you will only warrant known infringement.
- Place a cap on the amount you will pay out to the other party in the event of indemnification.
- If the other party wants a broader warranty or a higher liability cap, negotiate a higher price in exchange for it.
- Purchase professional indemnity insurance, which covers the legal costs and damages associated with a breach in professional duty (i.e. it indemnifies you against claims by other parties).
- Consult a lawyer if you’re having a tough time untangling the terms and their implications.