Our clients often ask, “What is indemnification?” An indemnification provision is one of the most common and frequently used provisions when negotiating any type of contract, and yet the parties to a contract often don’t understand the meaning.
Indemnity is defined by Black’s Law Dictionary as “a duty to make good any loss, damage, or liability incurred by another.” Indemnity has a general meaning of holding one harmless; that is to say, that one party holds the other harmless for some loss or damage.
But what does that mean in practice?
When does indemnity come into play and in what context?
Contractual Shift of Monetary Responsibilities
The concept of indemnity usually arises in contracts where there is a possibility of loss or damage to one party during the term of, or arising from the circumstances of, the contract.
One of the best examples of indemnity can be found in the context of insurance, where an insurance company insures a homeowner from damage to their home—the insurer indemnifies the homeowner . In the business context, an indemnification provision protects one party against damages and expenses caused by the other party’s failures and mistakes. For example, if a seller promises their tax preparation software is free from defect and indemnifies the buyer, the buyer can recover if the software used the past-year’s tax tables.
When an indemnification provision is triggered, one party pays the expenses, judgments, settlements, attorney fees, costs, and penalties of the other party.
Preventing Personal Liability
Indemnification can also be seen in the context of shielding directors and officers of a business from personal liability (i.e., act as a protective barrier) for debts incurred and decisions made on behalf of the company. In other words, a director/officer of a company is not responsible (if properly maintained) for the company’s debts or obligations.
Indemnification Provisions are Powerful!
Indemnification provisions can be a very powerful form of protection for a business. When drafting or negotiation a contract, make sure to consider the value of including an indemnification provision, and be wary of offering indemnification if you don’t understand the risks.