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.

6 thoughts on “When to Provide for Indemnification”

  1. I was surprised that you seemed to assume without discussion that indemnity covers first-party losses. I would suggest that many, if not most, well-drafted indemnities these days exclusively address third-party claims. Common-law claims between the parties are typically just subject to the limit of liability, with carveouts where appropriate (in which section one would also see caps and baskets – an indemnity isn’t needed to create those).

    I’ve never seen an indemnity of the type you describe in the “deep pockets” description – in my experience, that’s typically just handled by a mechanism like a parent guarantee.

    I think you actually missed the most-important part of the indemnity, which is shifting responsibility for third-party claims. Sophisticated parties understand that limits of liability are appropriate and necessary and are willing to assume some risk that their own losses from the counterparty’s breach will exceed the LOL, but aren’t willing to “insure” the losses their counterparty’s breaches cause third parties (see, e.g., an IP indemnity, which you’d be crazy not to include in any licensing deal or almost any services deal).

    As between the parties and their performance/warranty issues, everything you described could be handled with a thoughtful limit of liability provision with exceptions.

  2. Random: Invoking “well-drafted indemnities” is entirely conclusory.

    I think it’s best to address the fact that claims can come from two sources. For what it’s worth, the discussion of indemnification procedure in “Negotiating and Drafting Contract Boilerplate” takes the same approach.

    As to the relative merits of accessing deep pockets though indemnification or a guarantee, that’s something I’ll have to ponder. I welcome any input.

    I’m not sure that I missed the notion of limiting liability for nonparty claims. I mention capping liability, and that can be handled in any number of ways.


  3. From a tactical perspective, it can be a mistake to include in a first draft an indemnity benefiting your client — even if a one-sided indemnification section is arguably reasonable under the circumstances. It’s a fairly sure bet that the draft will be returned to you containing the same provisions turned back on your client. If the benefit of indemnification to your client is on par with the cost of giving a reciprocal provision, it may be better to just leave it out to begin with.

    In commercial contracts, indemnification provisions are often negotiated out of all proportion to their likely value to the parties. I think that the reason for this may be that you don’t have to be a great attorney or a great communicator to present your client with a parade of horribles, offer to make the other side pay to keep them at bay and then go to the mat for your position (all at the usual hourly rate, of course). (That’s not to say that the same isn’t often entirely appropriate zealous representation.)

  4. I fully agree with the general notion that indemnity provisions are not suitable in all circumstances, but I’m having trouble with some of the arguments put forth in the blog post.

    First of all I fail to see how you can bring in “deep pockets” through an indemnity clause in the contract for performance. You are contracting with the subsidiary company and, normally, it does not have authority to commit the parent. My knowledge of common-law may not be completely accurate, but it is my understanding that in order to get access to the deep pockets, you will need a one-sided commitment from the parent. In order for the commitment to be inforcable, it must be executed as a deed, commonly known as a “parent company guarantee”.

    Also, I fail to understand why a “sole remedy” clause is required. In oil and gas, the arrangement of “mutual indemnity” is the guideline. Under that arrangement, my company commit to release the other party from any claim my company may have, and indemnify him from any claim a member of my company’s group may have, in relation to any damage the other party causes to the property of my company’s group. Isn’t that sufficient to exclude any other remedy I may have?

    Maybe my failure to understand is due to lack of experience with other types of indemnity, or lack of knowledge of common-law, but this I spend a lot of time arguing for “mutual indemnity”, particularly with US customers, so I would very much like to get this clarified.

  5. Havard: To bring in a deep pocket, you’d need to make them a party to the contract, if only for a limited purpose, namely indemnification. But as I noted in a previous comment, I have to consider the relative merits of indemnification and guarantee.

    The idea behind exclusivity is that indemnification might restrict remedies available under common law (such how how long you have to bring a claim, or the amount you might recover), and those limits would be pointless if an unhappy party could choose to circumvent them by bringing a lawsuit grounded in a common-law cause of action. Does this make sense? I should explore further how this plays out in a civil-law context.


  6. I don’t know if it is an American thing, but even without an indemnification clause, a limitation of liability clause provides the defendant with a cap on their liability. Plus without resorting to an indemnity, it requires the defendant to mitigate their damages, whereas an indemnity may not.


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