When to Provide for Indemnification

[Updated January 5, 2011]

Now that my summer is officially over …

I suspect that many drafters think that an indemnification section should appear in contracts as a matter of course, much like a governing-law provision. But before you include an indemnification section, consider the pros and cons.

Indemnification Can Benefit a Party Bringing a Claim

Bring In Deep Pockets. If the other party to a transaction doesn’t have deep pockets, that party wouldn’t be a promising target for a lawsuit seeking common-law remedies. In an indemnification section, 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. An indemnification section would allow you to arrange for the other party to compensate you if the disclosed problem causes you to incur liabilities.

Recover for Losses Caused by Nonparties. If a party incurs losses due to actions by a nonparty, it couldn’t recover those losses from the other party unless the other party had agree to provide indemnification for those losses. The other party could instead assume an obligation to cause the nonparty to behave in a manner that would preclude any such losses, but that wouldn’t make sense if the nonparty weren’t directly under the control of the other party.

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. An indemnification section 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 exposure. In an indemnification section, the parties can agree to cap indemnification liability.

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

Can Provide for a Basket. A plaintiff could bring a common-law claim for a relatively trifling amount. In an indemnification section, 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 an indemnification section, 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 non-party. That makes for greater predictability than simply leaving such matters to be figured out in litigation.

But …

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 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 a comprehensive indemnification section would be about three pages long. And making it significantly shorter would require cutting into flesh and bone, so in terms of contract verbiage, indemnification is pretty much an all-or-nothing proposition.

(And incidentally, bare-bones indemnification sections commonly omit an essential provision—the one that says that indemnification constitutes the exclusive remedy.)

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

An Indemnification Fragment

One element of a complete indemnification section can be of use outside of indemnification, namely the provision allowing for recovery of attorneys’ fees and expenses—it could be of applied to common-law claims too.  So even if a transaction isn’t substantial enough to bother with indemnification, you might want to consider adding something along the following lines:

In any proceedings between the parties arising out of this agreement, including any tort claims, the prevailing party will be entitled to recover, in addition to any other relief awarded, all expenses it incurs in that proceeding, including attorneys’ fees and expenses.

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.