What is an Indemnification Clause and why is it important for my business?

What is an indemnification clause?

An indemnification clause provides that a party agrees to compensate an individual if they suffer a loss as a result of a specific event such as breach of contract etc.

It is an important clause to have in a business contract because it allocates the risks associated with the contract by shifting the liability, to pay for the losses, to the indemnifying party. For this reason, it is one of the most negotiated clauses and you should definitely consider negotiating for one. It is strongly recommended to have your lawyer draft an indemnification clause that fits your business.

Example: If you sell your business to another business owner, the indemnification clause can require the seller to indemnify for losses arising out of employee’s lawsuits within 12 months. This protects the new owner from suffering losses before taking over the business.

The essential elements of an indemnification clause

• An obligation to indemnify; this is the obligation to pay for the losses incurred
• The Indemnitor; the person who has the obligation to indemnify (pay for losses)
• The Indemnitee; the person receiving the benefits from the indemnification obligation

Why it is important

• Parties can determine and allocate risks associated with the contract

• They protect you from lawsuit actions as it is guaranteed that the indemnifier (person paying the losses and providing the indemnity) bears the legal and financial consequences

• Protects your business from risks involved in the transaction and reduces your liability for unforeseen damages/losses that may arise in future

• Provides certainty to your exposure to liability and allows you to run your business accordingly, without constantly worrying about repaying financial losses

• It is a precautionary measure for the indemnifier to understand their potential liability

Reasons to not include an indemnification clause

• It is difficult to predict future events as many contributing factors are impossible to control
• The indemnity clause may be too broad, resulting in one party undertaking unlimited risks

This clause is often one-sided i.e. one party assumes the liability for the losses suffered by another. Therefore, if you are the indemnifier in the contract then you must consult a lawyer and understand how you can limit the scope of the indemnity clause.

Example of an Indemnification Clause

“The indemnifying party is not obligated to indemnify the Indemnified Party for any claim arising out of or in connection with the Indemnified Party’s own negligence, willful misconduct, or culpable act or omission.”

Here, the indemnitee is only entitled to indemnification from the Indemnitor if the indemnitee had the intention to cause harm. This requires a higher standard of care.

What do I look out for in an indemnification clause?

• The Cap; usually, the damages will be limited to avoid the party undertaking unlimited risk. This should be negotiated to protect businesses from over-indemnifying and ensure the risk undertaken is appropriate
• The Period; there will be varying periods of indemnification. It could either last until the agreement ends or even last beyond the contract expiration date.

Common Mistakes

• Having ambiguous clauses that are not a true reflection of the parties’ true intentions
• Over-complicating the clause with unnecessary details, making the provision  less specific

Key Takeaways

• The indemnity clause usually protects you from losses/damages that may arise as a result of the other party’s actions, especially in cases of sub-contractors
• Pay attention to the level of risk being allocated, for how long the clause will be valid, and how the claim will be made and paid.
• The indemnification clause can be complex and difficult to understand. It is advisable to have a lawyer review/draft an indemnity clause that best suits your business requirements.

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