Indemnification is a common clause in contracts, used to shift potential legal fees and other costs from one party to another.
After recently speaking about contracts at WordCamp Orlando, I realized a lot of business owners still have a lot of uncertainty and questions relating to indemnification clauses so I want to clarify what the inclusion of this clause can mean for you and your clients.
An indemnification clause typically states that one party agrees to “indemnify” (and often to “hold harmless” and “defend”) the other party. Indemnifying someone means you agree to be responsible to them if something you do (or fail to do) causes them loss, damages, or a lawsuit from a third party. Protecting the indemnified party against third-party lawsuits — is the truly significant part of an indemnity clause because a party can usually recover damages and losses for breach of a duty, even without the clause, and attorneys’ fees and costs can often be more expensive than the amount of damages.
Let’s say you are a freelance web developer and you agree to indemnify your client against copyright claims related to the code you are writing for them (this is less an issue in the open source community that cannot copyright many aspects of code, but is meant for illustrative purposes). After the site goes live, your client is sued by another company claiming that the site’s code infringes on their intellectual property rights. Per the indemnity clause, you would be obligated to pay to defend this lawsuit and you may be responsible for your client’s damages if code you created infringed on the third party’s intellectual property rights.
Similarly, you could require your client to indemnify you against intellectual property infringement claims for content they supply you. Your client may supply images, logos, slogans, or copy that they warrant is original; in the event a third party sues you for creating a website incorporating infringing material, your client indemnifies you and agrees to be responsible for the legal costs, damages, etc. from you having to defend the suit based on infringement for material they supplied.
Indemnification clauses are often closely tied to representations or warranties, which are promises that certain things are done, provided, excluded, etc. in a certain way. For instance, you may warrant code or a website you develop is original content and not third party property, or your client may warrant they own any and all content they provide you, and their ownership does not infringe on anyone else’s rights.
Indemnification can be expensive, especially if the warranty is broadly worded and the indemnity clause makes you responsible for 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 understand the language and responsibility you are accepting. For example, there’s a huge difference between “defending against reasonable claims” and “defending against all claims.”
- Limit the scope of the indemnity clause by limiting the warranty. For example, if you’re a web developer being asked to warrant that site you create does not infringe on any third party’s intellectual property rights, with or without your knowledge, you may want to rewrite your warranty to state that you will only warrant known or intentional infringement.
- Cap the amount you will be responsible for and 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 of a contractual obligation or professional duty.
Because indemnifications can have costly consequences, if you’re still unsure, consult an attorney and have them review your contract to make sure you’re protected and your liability is limited. It’s cheaper to prevent a lawsuit than it is to defend against one.