Indemnification Cheat Sheet
Indemnification provisions are present in countless commercial contracts and also happen to be one of the most frequently negotiated terms. But what is indemnification? What are some of its features and how is it typically portrayed in a contract?
Indemnification is the agreement by one party to compensate another party (or parties) for certain costs and expenses. It is imposed either by law or contract.
State law supports indemnity as a “back-stop” remedy arising out of pre-existing relationships. Contractual indemnity, by contrast, is specifically designed on the front end of a contractual relationship to customize the allocation of risk.
Contractual indemnity provisions most often include an obligation to indemnify, defend, and hold harmless, or any combination thereof. But what do each of those obligations mean?
The obligations to indemnify, defend and hold harmless commonly require a party to reimburse another party for certain covered costs and expenses and to advance payment for other covered but unpaid costs and expenses. These costs and expenses almost always arise out of or relate to certain specified events (e.g., a contractual breach, or negligent behavior) and they can relate to direct claims by the indemnified party against the indemnifying party or third party claims. In addition, the obligation to defend is coupled with a right of the indemnifying party to assume control of the defense, typically applies in the context of third party claims and arises in accordance with allegations asserted in a complaint regardless of their merit.
As common as indemnity provisions are to all sorts of contracts, both negotiating parties are well-served to navigate the provisions with a close eye. Parties should take care to define the scope of the indemnity to make sure it is appropriately responding to the risks inherent in the events and consequences of the transaction. Events that trigger the indemnity obligation (e.g., breach of the agreement, negligence) should be clearly identified, as should corresponding recoverable damages. Added to this should be carefully chosen linking language between indemnifiable events and recoverable damages. An indemnified party will negotiate for broader linking language (e.g., damages “related to”) while an indemnifying party will try to narrow that link to further confine its duty (e.g., damages “to the extent arising out of” or damages “solely resulting from”).
Another way parties commonly tailor indemnification coverage is through the negotiation of various controls, for example: specific exceptions to the obligation (e.g., gross negligence or willful misconduct), deductibles, caps, and qualifiers such as materiality. It is also not uncommon to see specific waivers of non-direct damages, such as consequential, incidental and punitive, all of which remove the indemnifying party’s responsibility to pay.
With that in mind, it is important to note that indemnity is only as effective as the indemnifying party’s ability to satisfy its promise to pay. Indemnified parties should always ensure that indemnifying parties, especially if a credit risk, carry sufficient insurance to satisfy their indemnity obligations. Alternatively, indemnified parties may negotiate for a portion of the purchase price to be held in escrow pending the duration of the indemnity obligation or may even condition the purchase price on fulfillment of certain other conditions.
For assistance with these matters, please contact a member of our Business practice.
This publication is intended as an information source for clients, prospective clients, and colleagues and constitutes attorney advertising. The content should not be considered legal advice and readers should not act upon information in this publication without individualized professional counsel.
McConville Considine Cooman & Morin, P.C. is a full service law firm based in Rochester, New York, providing high quality legal services to businesses and individuals since 1979. With over a dozen attorneys and a full paralegal support staff, the firm is well-positioned to right-size services tailored to each client. We are large enough to provide expertise in a broad range of practice areas, yet small enough to devote prompt, personal attention to our clients.
We represent a diverse range of clients located throughout New York State and New England. They include individuals, numerous manufacturing and service industry businesses, local governments, and health care professionals, provider groups, facilities and associations. We also serve as local counsel to out-of-state clients and their attorneys who have litigation pending in Western New York courts. For more information, please contact us at 585.546.2500.