Indemnification Clauses: What Risks are You Actually Assuming? Jul 29, 2015
By: Craig Watrous
Indemnification clauses are particularly common in professional service, design, software and construction contracts. Often times these are the most disputed provisions in the contract negotiations of MSA’s (master services agreement), consulting agreements, and construction contracts. So what is an indemnification clause, and what is actually being contractually agreed to by the indemnifying party? It’s unfortunate, but all too often these clauses are accepted without fully understanding their scope and potential impacts.
Let’s start with what an indemnification actually is. Black’s Law Dictionary defines indemnification as: “The action of compensating for loss or damage sustained”, and indemnity as: “A duty to make good any, loss, damage, or liability incurred by another. 2. The right of an injured party to claim reimbursement for its loss, damage, or liability from a person who has such a duty.” The indemnitor is the party doing the indemnifying (the party accepting the risk). The indemnitee is the party being indemnified (the party shifting the risk).
Perhaps easier to understand is the following: an indemnification is a contractual risk transfer from one party to another. An indemnity is a contractual agreement whereby one party agrees to assume the liability of another party in the event of a claim (like a lawsuit) or a loss. While the concept of making the indemnified party (generally the client/owner) whole for losses caused by the contractor is rational, too often the provisions in indemnification clauses are too one-sided in favor of the client/owner and require the contractor to assume the liability of the client/owner regardless of actual fault. Contractors should be careful and should reject broadly written indemnity provisions and revise them so that the indemnity obligation is limited to the extent that damages are actually caused by the contractor’s negligent performance of services under the contract. If the indemnification clause is not appropriately negligence-based, the contractor may be exposed to liability far beyond what it is insured for and far in excess of the fee it received under the contract.
Before signing a contract with an indemnification clause make sure you review the scope of the indemnification. A few questions that should be considered:
- Who is indemnifying whom?
- What risks are you being asked to indemnify?
- Is the indemnification mutual or entirely one-sided?
- What risks are you being asked to indemnify? (typical provisions are intellectual property infringement, property damage, injury and/or death, economic loss, attorney fees, etc.).
- Is there a duty to defend? Meaning, do you have to front the litigation defense costs for the indemnified party? If so, do you get to choose the attorneys or do they? Who controls settlement decisions?
- Is there a limitation on liability?
- Is there a time frame/limit on identifiable claims?
- Are you being asked to indemnify the other party for their negligence?
- Is there a monetary limit on the extent of the indemnity?
- Are there insurance coverage requirements?
Ultimately, deciding how to respond to a broadly written indemnification clause will depend on a number of factors: negotiation power, prior experience with the other party, the value of the contract, evaluation of the potential risks, and insurance coverage.
Don’t review the indemnification clauses in a vacuum; be sure to review the other risk allocation provisions in the contract. Review the dispute resolution clauses and ensure that they are reasonable. Also, check the governing law provisions; courts hate to see negligent parties shift their liability on to others. Some states prohibit parties from indemnifying against another party’s negligence.
Indemnification clauses are complicated and can result in far-reaching, unintended liability for the uniformed party. An overly broad, one-sided indemnification clause can suck all the sweetness out of a deal. Review them carefully and negotiate them firmly and creatively.
Mallon Lonnquist Morris & Watrous, PLLC, is a business, employment, real estate, and litigation law firm. Craig T. Watrous is a Colorado transactional lawyer with Mallon & Lonnquist, based in Denver, Colorado. Craig regularly represents clients on both sides of indemnification clauses. Craig can be reached at firstname.lastname@example.org.