An Indemnification Agreement Overview
Indemnification agreements are contracts entered into between the obligor and obligee that depict, in varying degrees of detail, the intention of the parties as to how losses related to the matter giving rise to the agreement are to be allocated between them. They sometimes oblige one party to indemnify the other for losses regardless of the rights and obligations of the indemnified party, sometimes only if the indemnified party would not have incurred the losses but for the indemnifiable matters, and sometimes only if the indemnified party is liable to a third party for damages.
In the most generic sense, an indemnification provision states that in the event specified losses are incurred, the indemnifying party is obligated to pay all or a portion of those losses . The assumption of liability by the indemnifying party can be for injuries or losses of many different varieties, from tort liability to liability for warranty breach, antitrust violations, environmental contamination, patent infringement and other injuries and losses. An indemnification provision may also provide for the payment of direct out-of-pocket expenses such as costs of defense of litigation or indemnified claims and all other types of losses including consequential, special or punitive damages or amounts paid in settlement of claims. Indemnification obligations can be either primary or secondary, and can arise either because of losses incurred by the indemnified party or upon a liability of the indemnified party to a third party. It is not uncommon to see indemnification provisions that impose indemnification obligations upon the obligor whether or not the losses or liability would have occurred in the absence of all the matters giving rise to the obligations.
Indemnification Agreement: Key Provisions
An indemnification agreement is intended to, at the very least, offset and/or transfer liability. While each agreement is unique and should be customized for the parties involved, the following key components are typically found in indemnification agreements.
Indemnity Clause
The indemnity clause is a core provision, and although it appears simple at first glance, its interpretation and application can lead to costly disputes. A broad indemnity clause should cover not only direct liability, but also liability that flows indirectly from a third party’s action or omission that leads to liability. Further, the indemnity should not be limited to only certain causes of action. Both of these limitations run contrary to the broad intent of indemnification provisions.
Scope of Indemnification
Parties usually look to exclude certain types of liability from their indemnification agreement, such as instances of gross negligence, reckless misconduct or wilful misconduct. In contrast, indemnification agreements generally do not afford these same protections for liability arising from actions that are negligent or merely careless. When parties agree to limit the scope of indemnification, they usually focus their limitation on the indemnifying party’s gross negligence and/or wilful misconduct. However, it is even more common for parties to insert an exception for indemnification specifically for indemnification of indemnified losses that are attributable to the indemnified party’s own gross negligence, recklessness and/or wilful misconduct.
Parties should also be on the look-out for liability limitations that might apply depending on the manner in which the underlying loss was incurred. For example, one party’s insolvency might trigger different indemnification obligations than if the indemnified losses were incurred during performance of a contract. As a general rule, if the indemnity is given in connection with an assumed obligation under a contract, the indemnity should be limited to indemnity for losses that would not have been incurred but for the assumed obligation.
Parties should examine carefully whether the indemnity is limited to liabilities arising out of a certain industry or profession (e.g., the indemnity is limited to claims that could be brought by consumers of a certain product). Relatedly, parties look to exclusion clauses to limit the type of liabilities and losses that will be indemnified. For example, indemnification agreements might exclude from indemnification liabilities arising from a particular cause of action, such as product liability or patent infringement. However, the exclusion often cannot be broad enough to operate to exclude all liability arising from the underlying transaction. Rather, the exclusion is usually limited to only those particular types of claims and defenses that are foreseeable from the transaction.
Indemnification Agreement Example & Template
An example of a more basic indemnification agreement:
Indemnity Agreement. THIS INDEMNITY AGREEMENT (the "Agreement"), is made and entered into this _____ day of _____________, 20____, between _______________ of ________________________________ (the "Indemnitor"), and _______________ of ______________________________ (the "Indemnitee").
- Indemnification. The Indemnitor hereby agrees to indemnify, defend and hold harmless Indemnitee and its affiliates and their respective officers, directors, employees, agents, successors and assigns ("Indemnitee Group") from and against any action, claim, damage, expense, loss or liability (including but not limited to expenses of litigation, whether or not the action is prosecuted to judgment) ("Losses") arising out of any claim relating to the acts or omissions of Indemnitor, including without limitation any act, omission, situation, condition, event, misstatement, omission or other matter related to Indemnitor’s duties and obligations to Indemnitee, or to any of their respective officers, directors, employees, agents, affiliates or representatives, under the terms of that certain agreement dated ___________, 20___, between Indemnitee and Indemnitor (the "Agreement"). Indemnitee shall give notice to Indemnitor of any pending or threatened claim or action which might be subjected to indemnification hereunder; provided, however, that any failure of Indemnitee to give notice of claim to Indemnitor shall not reduce or otherwise affect the obligation of Indemnitor hereunder, except to the extent that Indemnitor can demonstrate actual material prejudice from such failure.
- Scope. This Agreement shall not in any way be deemed to modify or limit the rights and obligations of the Indemnitor as otherwise set forth in the Agreement. This Agreement shall not apply to any Losses resulting from acts or omissions constituting or arising out of willful misconduct, bad faith, fraud or gross negligence on the part of the Indemnitee.
- Miscellaneous. This Agreement shall be governed by the laws of the State of [INSERT THE STATE NAME]. This Agreement may be executed by either party hereto in several counterparts, and each such counterpart shall be deemed to constitute an original, but all such counterparts shall constitute one and the same instrument. This Agreement constitutes the entire understanding and agreement between the parties hereto with respect to the matters referred to herein. This Agreement may be modified, superseded or canceled only by written agreement of the parties hereto, and no modification, change or cancellation of this Agreement shall be binding upon the parties hereto unless the same shall be in writing and signed by the party to be charged therewith. Wherever the context so requires, the use of the singular or plural number shall be applicable to the Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written.
Indemnification Agreements in Other Industries
Indemnification agreements may vary across industries. For example, construction contracts frequently have stronger indemnification terms in favor of the general contractor and/or owner. Even jurisdictions that restrict the enforceability of broad indemnification clauses in construction contracts occasionally allow for a reasonable restriction.
In New York, indemnification agreements indemnifying a contractor from personal injuries occasioned by the sole negligence of the contractee are unenforceable. However, if the contractor can show that the agreement is a "reasonable" allocation of risk, it will be enforceable.
The issue of the enforceability of broad indemnification terms in construction contracts is under review in California. In 2018, the California Supreme Court in U.S. Dedicators, Inc. v. ACP, Inc., 5 Cal.5th 134 (2018), reviewed the enforceability of indemnification provisions between a general contractor and subcontractor that impose broad indemnity obligations on the subcontractor.
The California Supreme Court held that while the indemnification provisions relating to third party claims were enforceable, the indemnification provisions concerning indemnification for solely the general contractor’s own negligence or willful misconduct were not.
In healthcare, a medical equipment supplier will often try to limit its liability as much as possible. In agreements governing the relationship between an equipment supplier and a hospital, the equipment supplier will often try to include the following clause stating that the hospital agreement with the manufacturer of the equipment will provide for indemnification, and a limitation of liability for the equipment supplier:
"Supplier has no knowledge that Buyer’s [hospital] agreement with [the manufacturer of the equipment] [the "Manufacturer"] contains no limitation of liability for claims brought by Buyer against the Manufacturer. However, Supplier reserves the right to request evidence of the Manufacturer’s indemnity obligation…and, should supplier so request, Buyer must provide such evidence to Supplier within five (5) business days of such request. If the Manufacturer agrees to indemnify Supplier, Buy represents and warrants that the Manufacturer’s indemnity obligations in the event of a third-party claim shall be no less than [specify amount]."
While indemnity claims relate to future actions or omissions, releases relate to past claims. Although releases and indemnification agreements are not identical, they both relate to the allocation of the risks of future claims.
Relevant Law and Common Issues
It is important to understand the legal considerations and potential pitfalls that come along with entering into any indemnification agreement. One key consideration to keep in mind is that by entering into an indemnification agreement, you should not be giving away your authority to act with respect to your own rights or obligations under the contract unless you are comfortable with that result.
In addition to this overall principal, there are specific issues you need to still consider, depending on the type of agreement you are reviewing or drafting. For example, for many states generally, a broad indemnification agreement that, among other things, requires indemnification of intentional acts will be void against strong public policy – but that can vary from state to state. The more specific the indemnification agreement is in the topic areas covered by the indemnity, the more likely it is that it will be found to be valid and enforceable .
An indemnity agreement should not attempt to broaden the scope of damages that the party seeking indemnity is liable for, compared to what is provided for in the underlying contract. If an indemnity agreement attempts to provide for broad indemnification regardless of the fault of the parties and the scope of damages, that agreement will be ripe for challenge.
Finally, not all indemnity agreements are created the same, and not all contracts that use the word "indemnify" use it in the same manner. Some indemnity agreements are actually insurance policies. It is important to understand exactly what type of indemnity you are being asked to provide: is it "indemnity" for payment of damages or the cost of a settlement or judgment, or is it agreed upon or standard insurance coverage?
Careful attention should be paid to an indemnity agreement’s terms so that an indemnity agreement is not mistakenly added where insurance coverage would be the more appropriate (and less risky) risk allocation/budgeting measure.
How to Create a Proper Indemnification Agreement
A. Identify All Parties Involved
The i ndemnification agreement must clearly identify all parties involved in the dispute. The party who is indemnifying (indemnitor) and the party being indemnified (indemnitees). It should also include any third parties covered under the agreement.
B. Clearly Define What is Indemnified
A clear definition is key for an indemnification agreement. This will ensure that all parties are aware of what is going to be covered by the agreement and what is excluded. The most effective contracts will specifically list what is to be indemnified. This can include costs, losses and damages.
C. Determine When Indemnification Applies
An indemnification agreement should specify when the indemnification is applied. For example, will it apply when a third-party brings a claim or is it only applied if a lawsuit is filed?
D. Consider Choice of Law
It is important to consider where the indemnification agreement will be enforced. Will it be in the state where the indemnitor resides, the state where the indemnitees reside or the state where the indemnification agreement was drafted? The laws around indemnification agreements vary from state to state. Having a basic understanding of choice of law will help determine what terms and conditions are enforceable.
E. Consider Alternative Litigation Options
Being sued is never an ideal situation, and it may not be necessary if the proper steps are taken in the indemnification agreement. For this reason, alternative dispute resolution should be included.
Indemnification Agreement FAQs
In the realm of compensation agreements, there are a few questions that often overlap and lend themselves to similar responses:
1. When would a person or company be named in an indemnification agreement?
It is not unusual for an organization to be mentioned in the indemnification language of either a company or an individual. For example, it may be for an employee or an officer of the company.
2. What is the likely court where a dispute involving an indemnification agreement would take place?
Similar to other contracts , it would most likely be in the state where the agreement was established.
3. Is this agreement subject to arbitration?
Whether or not an indemnification clause is subject to arbitration would be established initially by the context of the agreement itself. This type of language typically has to be present in the principal agreement and would rather be determined by the original intention of the parties.
4. What happens if the damages referenced in the indemnification agreement exceed the insurance coverage in place by the defendant?
This would partly depend on whether the party being created the indemnification agreement was actually protected by the insurer. If not, the person being sued would have to bear responsibility for damages suffered by a plaintiff if any exceeding the limits of the insurance policy.