Indemnification: A Misunderstood Concept

[Updated 3:00 p.m. EST, January 10, 2011:

In this post, I propose revised indemnification language. I’ll chew over whether still to offer as an option in Koncision’s confidentiality agreement the alternative language I offer below.]

[Updated 9:50 a.m. EST January 7, 2011:

The question of how the elements of a claim for indemnification relate to the elements of a claim for breach of contract has created enough of a stir that I can see that it might be counterproductive to incorporate indemnification language in Koncision’s confidentiality agreements. If I could cite authority to the effect that indemnification can be benign, then I’d be more of a champion for indemnification. But the fact is that I haven’t seen any authority either way on this issue.

I could try to be cute and simply say “shall pay” or “shall reimburse” instead of “shall indemnify.” But that would have zero substantive effect—anyone concerned with indemnification language should find such a switch equally problematic.

So now the question is how to articulate that the recipient is liable for unauthorized disclosure by its representatives (if that’s what the drafter elects to provide for). I remain lukewarm on “shall cause” when the party in question doesn’t actually have control. So here’s an alternative I came up with, with the input of Koncision editorial board member Chris Lemens:

Unauthorized Disclosure or Use by Representatives. If the Disclosing Party incurs any loss or liability arising out of disclosure or use of any Confidential Information by any one or more Representatives of the Recipient other than as authorized in this agreement, that disclosure or use will be deemed to have been by the Recipient for purposes of determining whether the Recipient breached any of its obligations under this agreement.

I’d be happy to hear what you think. But the most important point I take away from this discussion is that when you have three alternative ways of articulating an idea and none of them is perfect, it might be best to let the drafter choose. That’s currently what I’m contemplating doing.]

In this recent blog post I explained why I’m not a fan of imposing on a contract party an obligation that it doesn’t have control over. Rather than engage in that sort of indirect and counterintuitive risk allocation, I’d rather make my risk allocation explicit. One way to do that is by providing for indemnification.

My previous blog post was prompted by a confidentiality-agreement issue—what’s the best way to protect the disclosing party against losses caused by unauthorized disclosure by representatives of the recipient? I had pretty much opted for indemnification, but among those that I’ve consulted that has proved an unpopular choice, to an extent that has surprised me. The notion of indemnification has somehow become fraught with baggage; let’s look into that further.

Indemnification can be helpful in two ways. First, it allows you to replace a regime of contract claims with something more customized. For example, indemnification can help a party more likely to be subject to a claim by allowing it to specify time limits for bringing claims and put caps on liability. Second, indemnification can help a party more likely to bring a claim by, among other things, allowing it to bring in deep pockets and allowing it to provide a remedy for losses caused by nonparties.

I discussed the role of indemnification in this August 2009 AdamsDrafting blog post. What prompted me to write that post was the sense that drafters are too quick to throw indemnification provisions into a contract without considering whether a contract cause of action would be adequate.

That excessive use of indemnification may be what has prompted the resistance to indemnification that I’m now encountering. But I think we’re at risk of throwing the baby out with the bathwater. For example, it’s perhaps unhelpful to say that indemnification provisions don’t belong in confidentiality agreements. That’s like saying that representations don’t belong in confidentiality agreements. Instead, you have to look at how indemnification provisions are used.

I propose including in Koncision’s confidentiality agreements indemnification language that provides a remedy for losses incurred by the disclosing party that are caused by any representative of the recipient, for example a lawyer at its law firm. (This remedy would be in addition to any other contract claims.)

Here’s how that indemnification might be articulated:

Indemnification for Actions of Representatives. In addition to any other remedies available to the Disclosing Party, the Recipient shall indemnify the Disclosing Party against any losses and liabilities arising out of disclosure or use of any Confidential Information by any Representatives of the Recipient other than as authorized in this agreement.

That seems simple enough to me. And there are no hidden subtleties, in that the word indemnification, and the verb indemnify, don’t convey any hidden magic-word meanings. Instead, they simply serve to flag that the parties are providing for alternative causes of action, ones not otherwise arising out of the contract. I’m aware of  no basis for suggesting that, for example, the class of losses subject to indemnification is broader than the class of losses subject to contract claims, or that defenses to a claim for indemnification are drastically different from defenses to a claim for breach of contract.

And when determining whether any given any given losses or liabilities are covered by indemnification, you’d have to consider the same issues of foreseeability that you’d have to consider when determining whether any given losses and liabilities fall within the scope of a claim for breach of contract.

Suspicion of indemnification can perhaps be attributed in part to the tendency to see all sorts of doctrinal significance in what are in fact straightforward contract notions. (Represents and warrants, anyone?) And the fact that drafters clog up indemnification provisions with all sorts of extras shouldn’t undermine their essential utility.

Demonizing indemnification comes at a cost: it forces you to be less efficient in how you articulate risk allocation. This sort of categories-of-contract language issue is at the heart of MSCD, and I’m not particularly inclined to compromise.

But I am entirely open to being proved wrong. Have at it.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.