Indemnification clauses in commercial contracts are essential provisions that allocate risk and provide financial compensation for damages and losses. These clauses establish the obligation of one party (the indemnitor) to indemnify and hold harmless the other party (the indemnitee) from any liabilities, expenses or damages arising from the contract or any breach of its terms.
Why are they necessary?
Indemnification clauses protect parties from potential financial losses, and they can shift risk so the parties intentionally decide who bears certain costs. The clause provides assurances that would not otherwise be in the contract, shifting the burden of certain claims or events from the indemnitee to the indemnitor. For example, if Party A breaches the contract by not disclosing a third party with a claim and Party B incurs legal, accounting and other costs defending against the third-party claims, the indemnification clause can require Party A to fully compensate Party B for all of its expenses.
Indemnification clauses can be beneficial to provide fuller protection against breaches of representations and warranties in a contract, undisclosed liabilities, known contingent liabilities or other potential expenses or losses. They can also cover additional amounts, such as consequential losses and punitive damages. By including proper indemnification provisions in business contracts, parties have the means to recover damages and mitigate potential financial harm.
Allows parties to customize their risk
Indemnification provisions are a commonplace mechanism in business contracts that allow parties to manage and allocate risk. These provisions are designed to protect parties from potential damages and lawsuits that may arise after the contract closing occurs.
One of the key benefits of using indemnification provisions is that they allow parties to negotiate the amount of risk they are willing to undertake. By including specific language in the contract, the indemnifying party agrees to bear the financial burden of the specified potential losses or damages suffered by the indemnified party. Indemnification provisions often have limits to cap the maximum amount the indemnifying party must pay.
Covers related costs
Indemnification provisions can provide a mechanism for recovering attorney’s fees and other legal costs incurred in defending against claims. Often, these amounts would not normally be available in a straight breach of contract action. They can allow a party to recover more than they would be able to recover without the indemnification provision in place.
Limiting exposure to liability
Indemnification provisions often incorporate liability limitations, which can protect both parties from excessive financial exposure. These limitations can include thresholds below which no claim can be made, monetary caps on damages and exclusions for certain types of claims, losses or damages.
There are wide-ranging applications
A contract can identify any exception to the indemnification provisions. These might include:
- The indemnifying party’s negligence or intentional wrongdoing
- Consequential or punitive damages
Each party should protect its interests
A well-drafted contract is the foundation of any vital business agreement. Those that address the needs and wants of the clients can contribute to continued success. Working with a business attorney who understands their client’s business priorities is usually best when weighing indemnification clauses and negotiating contracts.