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EXCERPT FROM

UNDERSTANDING AND NEGOTIATING SALES CONTRACTS MANUAL

UNDERSTANDING THE INDEMNITY CLAUSE

You’re probably painfully familiar with this contract clause. The Indemnity Clause is generally the longest paragraph in the contract consisting of one 56 line run-on sentence. It’s often the clause that causes the contract to get stuck in the legal department for weeks (or months?) with no end in sight.

How can you facilitate resolution of this clause?

FIRSTLY: Understand what INDEMNITY means. “To Indemnify” means to reimburse and protect against loss.

Perhaps the best way to get a better idea of how indemnity works is to look at the following example.

You sell a valve to your customer, a tractor company. Your valve is integrated into your customer’s tractor. The tractor is sold to an end-user. The tractor malfunctions and causes injury to the user. The subsystem containing the valve is thought to be the cause of the defect. Your company, together with the tractor company, is sued by the injured user. During trial, it is determined that the tractor company incorrectly installed your valve, and that this incorrect installation caused the defect. Your company incurs costs and attorneys fees in defending the lawsuit against it.

Without an indemnity provision in your contract with your customer, your company would be responsible for all costs and attorneys’ fees it incurs in connection with the lawsuit. With an indemnity provision, your customer would have to compensate your company for costs and expenses you incurred if a third party sues your company for claims “arising out of” the improper use of the valve.

If it’s that straightforward, then why is the language so complicated?

While the concept of Indemnity seems simple enough, it’s the highly legal language and nuances that cause the difficulty in understanding the clause. By the way, the reason for the highly legal language is NOT because attorneys get paid by the word…..(actually, we get paid by the hour!)

The reason for the complicated language is this: Over the years the language has been tested in courts and found to provide the protection for which the company was looking. Because indemnification is a broad responsibility, the courts scrutinize the language and are careful to enforce the clause only if it meets certain criteria.

Companies have discovered this the hard way. Indemnity clauses have been the subject of lawsuits, and have been interpreted differently from what the company intended because they were incorrectly or insufficiently written.

Most business people will seek help from their legal department with these clauses. They certainly require practice in order to understand and negotiate them. However, do keep an important issue in mind: The bottom line regarding indemnity is that it involves who will be financially responsible, for what specific situations and when they will be responsible.

SECONDLY: Work with your lawyer in resolving the indemnity clause.

THIRDLY: If you agree to indemnify your Buyer, understand the financial ramifications of how much money and the method by which your company will pay. This is where insurance plays an important role. Often, the method by which companies ensure that funds are available is by maintaining insurance such as product liability insurance (which protects against claims of injury resulting from the use of a product), and general liability insurance (which protects against losses caused by injuries to persons or damage to property.)

Before we look at some INDEMNIFICATION language, note the following:

The typical indemnity clause uses language such as “Seller agrees to indemnify, protect, defend, and hold harmless”. “Hold harmless,” “protect,” and “indemnify” all basically mean to protect against loss and be financially responsible. “Defend” refers to the obligation of the Seller under this provision to defend the Buyer in a legal claim against the Buyer by a third party.

It’s important not to over-commit. By that we mean, we want to make sure that if we are the indemnifying party, we are responsible only for our own acts and not the acts of anyone else. A way to avoid responsibility for any third party’s actions or negligence is to specifically exclude that from the indemnity clause. An even more optimum approach is to require indemnity from the other contracting party for injuries resulting from their actions or negligence.

Since the indemnity clause involves the payment of money, you’ll want to limit your liabilities for consequential and incidental damages (see above).

The following is an example of an Indemnification clause that is narrowly written so as not to over-commit the Seller. The second paragraph is an indemnity from the Buyer to the Seller, and while the optimum approach, may not always be possible to obtain from your Buyer.

Seller will indemnify, defend and hold Buyer harmless from and against all liabilities, losses, damages, costs and expenses, including reasonable attorney’s fees which Buyer may be required to pay by reason of injury or death to any person or damage to property arising from any acts or omissions caused by Seller’s negligence. In no event will Seller be liable for any lost profits, loss of business, incidental, or other consequential damages arising out of any breach of its obligations under this Agreement.

Buyer will indemnify, defend and hold Seller harmless from and against all liabilities, losses, damages, costs and expenses, including reasonable attorney’s fees for any claims by any party resulting from any acts or omissions of Buyer.