Revisiting “Indemnify”

[Adjusted 4:30 p.m. EDT, July 28, 2012, to implement the recommendations made by A. Wright Burke in his comment; revised 7:00 a.m. EDT, July 31, 2012, to overhaul the section on indemnify and hold harmless; revised August 13, 2012, to add paragraph “Recover for External Events or Circumstances”.]

Over the past four years I’ve considered indemnification in half a dozen posts, and I thought it high time that I consolidate my thoughts in one overlong post. So here you go.

FUNCTION

If a party makes an inaccurate statement of fact in a contract or fails to comply with a contract obligation, the counterparty would have remedies available. In common-law jurisdictions, it would be able to bring a claim for damages under the contract or in tort.

But it might benefit contract parties to address in their contract how specified claims are to be handled. That’s the function served by indemnification provisions. The potential benefits are described below.

Indemnification Can Benefit a Party Bringing a Claim

Bring In Deep Pockets. If the other party to a transaction has limited resources, that party wouldn’t be a promising target for a lawsuit seeking common-law remedies. In indemnification provisions, you could arrange for someone more substantial—typically a parent company—to be responsible for any liabilities of the primary party.

Recover for Disclosed Liabilities. If the other party has disclosed a given problem—for example, environmental contamination—you couldn’t base a common-law cause of action on that problem, given that it had been disclosed. Indemnification provisions would allow you to arrange for the other party to compensate you if the disclosed problem causes you to incur losses or liabilities.

Recover for External Events or Circumstances. Indemnification provides one way to allocate risk for occurrence of events or circumstances that at least to some extent aren’t under the control of the indemnifying party, for example failure to obtain a permit.

Recover for Losses Caused by Nonparties. If Acme incurs losses or liabilities due to a claim brought by a nonparty that’s related to the subject matter of the contract—for example, purchased assets—but that isn’t due to the counterparty’s having failed to comply with an obligation or made an inaccurate statement of fact, Acme couldn’t bring a claim against the other party to the contract unless the other party had agreed to provide indemnification for any such losses.

Recover Attorneys’ Fees and Expenses. In any litigation in the U.S. seeking common-law remedies, it’s the norm that the plaintiff isn’t entitled to recover attorneys’ fees and expenses. Indemnification provisions could specify otherwise.

Indemnification Can Benefit a Party Subject to a Claim

Can Provide for a Cap. Common-law remedies aren’t subject to a cap on liability. In indemnification provisions, the parties can agree to cap indemnification liability.

Can Provide for Shorter Time Limits. A plaintiff could seek common-law remedies until the applicable statute of limitations expires. In indemnification provisions, the parties could agree to shorter time limits for bringing claims.

Can Provide for a Basket. A plaintiff could bring a common-law claim for a relatively trifling amount. In indemnification provisions, the parties could agree on a minimum that would have to be reached before indemnification kicks in—in other words, a “basket,” whether of the “threshold” or “deductible” variety.

Indemnification Adds Predictability

In indemnification provisions, you can specify the procedures to be followed in the event of a direct claim for indemnification by one party against another or a claim for indemnification arising out of a proceeding against a party brought by a nonparty. That makes for greater predictability than simply leaving such matters to be figured out in litigation.

But predictability is assured only if a given set of indemnification provisions specifies that indemnification constitutes the exclusive remedy for any such claims.

When You Can Do Without Indemnification

If you’re not worried about gaining access to deeper pockets; if you don’t need to address the consequences of disclosed liabilities; or if your being subject to nonparty claims isn’t a major concern (either because they’re a remote possibility or because any claims would likely be for modest amounts), then indemnification would probably be more trouble than it’s worth.

That’s because remedies otherwise available would likely address your needs, so including indemnification provisions in your contract would add significant verbiage with little benefit.

And if your main concern is allowing the prevailing party in a dispute to recover attorneys’ fees, you could address that issue outside of indemnification provisions.

So before you provide for indemnification in a contract, ask yourself whether the claims that might arise warrant lumbering the contract with full-blown indemnification provisions.

What Kinds of Claims

The discussion above anticipates that indemnification provisions can—but don’t have to—cover claims between the parties as well as nonparty claims against one or other party. Many practitioners are under the impression that indemnification provisions serve primarily, or exclusively, to address nonparty claims.

Whatever the historical practice, currently it’s unexceptional to have indemnification cover claims between the parties. In fact, in mergers-and-acquisitions transactions it’s standard. And in defining indemnify, Black’s Law Dictionary refers to “a loss suffered because of a third party’s or one’s own act or default” (emphasis added).

But if you want indemnification to cover claims between the parties, you have to make that clear in the indemnification provisions themselves or risk having a court hold that they cover just nonparty claims. For an example of a court in Canada doing just that, for debatable reasons, see the opinion of the Alberta Supreme Court, Appellate Division, in Mobil Oil Canada Ltd. v. Beta Well Service Ltd. (1974), 43 D.L.R. (3d) 745 (A.B.C.A.), aff’d 50 D.L.R. (3d) 158 (S.C.C.). See also NevadaCare, Inc. v. Dep’t of Human Services, 783 N.W.2d 459, 470 (Iowa 2010), reh’g denied (June 22, 2010) (“Currently, there is a split of authority as to whether an indemnification provision applies to claims between the parties to the agreement or only to third-party claims.”).

WHETHER TO SAY “HEREBY INDEMNIFIES”OR “SHALL INDEMNIFY”

Black’s Law Dictionary says that indemnify means both “To reimburse (another) for a loss suffered because of a third party’s or one’s own act or default” and “To promise to reimburse (another) for such a loss.” So indemnify can be used in both language of obligation (Acme shall indemnify Widgetco) and language of performance (Acme hereby indemnifies Widgetco). Review of an informal sample of contracts filed by public companies on the U.S. Securities and Exchange Commission’s EDGAR system suggests that drafters greatly prefer indemnify as language of obligation rather than language of performance.

Although both usages are adequate to accomplish the intended purpose, there’s some value to uniformity, so this manual recommends that you hasten the demise of hereby indemnifies by using shall indemnify.

“INDEMNIFY AND HOLD HARMLESS”

It’s commonplace for drafters to use the phrase indemnify and hold harmless (or save harmless). As explained below, it’s much clearer and safer to use just indemnify.

Meaning

Black’s Law Dictionary treats indemnify and hold harmless as synonyms, in that it defines hold harmless as follows: “To absolve (another party) from any responsibility for damage or other liability arising from the transaction; INDEMNIFY.” (For the Black’s Law Dictionary definition of indemnify, see 12.131.) Garner’s Dictionary of Legal Usage, at 444, collects other dictionary definitions to the same effect, concluding that “The evidence is overwhelming that indemnify and hold harmless are perfectly synonymous.”

Some courts have come to the same conclusion, notably the Delaware Court of Chancery. In Majkowski v. American Imaging Management, LLC, 913 A.2d 572, 588–89 (Del. Ch. 2006), then-Vice Chancellor Strine suggested that many transactional lawyers would be quite surprised to learn that by adding hold harmless to indemnify they had been creating additional rights. He continued, “As a result of traditional usage, the phrase ‘indemnify and hold harmless’ just naturally rolls off the tongue (and out of the word processors) of American commercial lawyers. The two terms almost always go together. Indeed, modern authorities confirm that ‘hold harmless’ has little, if any, different meaning than the word ‘indemnify.’” See also Paniaguas v. Aldon Companies, Inc., 2:04-CV-468-PRC, 2006 WL 2788585 (N.D. Ind. Sept. 26, 2006) (holding that hold harmless is synonymous with indemnify); Consult Urban Renewal Dev. Corp. v. T.R. Arnold & Assoc., Inc., CIV A 06-1684 WJM, 2007 WL 1175742 (D.N.J. Apr. 19, 2007) (same); In re Marriage of Ginsberg, 750 N.W.2d 520, 522 (Iowa 2008) (same); Loscher v. Hudson, 182 P.3d 25, 33 (Kan. Ct. App. 2008) (“[A] hold harmless provision in a separation agreement is the same as an indemnity agreement.”).

Nevertheless, some commentators have seen fit to endorse a distinction between indemnify and hold harmless.For example, Mellinkoff’s Dictionary of American Legal Usage, at xx, says that “hold harmless is understood to protect another against the risk of loss as well as actual loss.” It goes on to say that indemnify is sometimes used as a synonym of hold harmless, but that indemnify can also mean “reimburse for any damage,” a narrower meaning than that of hold harmless.

Some courts have done likewise. For example, in United States v. Contract Mgmt., Inc., 912 F.2d 1045, 1048 (9th Cir. 1990), the Ninth Circuit Court of Appeals noted in dicta that “the terms ‘indemnify’ and ‘hold harmless’ refer to slightly different legal remedies.” And in Queen Villas Homeowners Association v. TCB Property Management, 56 Cal. Rptr. 3d 528, 534 (Cal. Ct. App. 2007), the court fabricated a distinction—that indemnify is an “offensive” right allowing an indemnitee to seek indemnification whereas hold harmless is a “defensive” right allowing an indemnitee not to be bothered by the other party itself seeking indemnification.

And in the Canadian case Stewart Title Guarantee Company v. Zeppieri, [2009] O.J. No. 322 (S.C.J.), the Ontario Superior Court of Justice held, without providing any support, that “the contractual obligation to save harmless, in my view, is broader than that of indemnification,” in that someone having the benefit of a hold harmless provision “should never have to put his hand in his pocket in respect of a claim” covered by that provision.

Eliminating Risk

So the redundancy in the phrase indemnify and hold harmless is pernicious, in that disgruntled contract parties might seek to have unintended meaning attributed to hold harmless. And any given court might decide to distinguish indemnify from hold harmless, prompted by the judicial rule of construction that every word in a provision is to be given effect.

To stay out of trouble, never use hold harmless. Using just indemnify is no obstacle to saying whatever you want to say. For example, all it takes to ensure that indemnify is given the broader meaning contemplated by Mellinkoff and the Stewart Title court is to have Acme agree to indemnify Widgetco against both losses and liabilities. Black’s Law Dictionary defines loss as “the disappearance or diminution of value, usu. in an unexpected or relatively unpredictable way,” and it defines liability as “A financial or pecuniary obligation.” If you use both these words, Acme would be indemnifying Widgetco against both the risk of loss and actual loss. It would be redundant to have Acme also hold Widgetco harmless, whatever that might mean. If you wish, you could be even more explicit than that.

“Defend”

Drafters routinely tack defend on to indemnify and hold harmless, but that doesn’t begin to address how defense of nonparty claims is to be handled. To avoid uncertainty and the possibility of dispute, address that explicitly in provisions governing indemnification procedures.

“INDEMNIFY” AS A TERM OF ART

If you encounter aversion to the notion of indemnification, try using the formulation Acme will be liable to Widgetco for instead of Acme shall indemnify Widgetco against. That may allow you to establish the contract relation you want without getting tied up debating the doctrinal implications of indemnification.

Many contracts professionals are skittish about assuming indemnification obligations, particularly for purposes of commercial contracts. The concern is that a claim for indemnification provides the claimant advantages not available to a breach-of-contract claimant.

More specifically, some courts and commentators believe that whereas in connection with a breach-of-contract claim the court determines how much to compensate a nonbreaching party for nonperformance by the breaching party, an obligation to indemnify (particularly if unrelated to an underlying breach of a contract) actually constitutes an obligation to pay an amount of money if certain specified events occur and as such isn’t subject to the rule-of-reasonableness standards to which breach-of-contract claims are subject. See Glenn D. West & Sara G. Duran, Reassessing the ‘Consequences’ of Consequential Damage Waivers in Acquisition Agreements, 63 Business Lawyer 777, 785–88 (2008) (PDF copy here).

It’s not clear how much of an issue this is, and whether it can be drafted around. But the aversion to indemnification is real, and any drafter who encounters it should consider using an alternative that’s less loaded than indemnify. The likeliest candidate is the formulation Acme will be liable to Widgetco for. You can make that switch because indemnify is a term of art fraught with doctrinal implications that are irrelevant for purposes of establishing contract relations.

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.