Fred the Founder has little experience with the concept of indemnification and often gets confused with how and when it applies. Over the next few weeks, Fred will take a deep dive into the world of contracts and explore the often misunderstood concept of indemnification clauses, including its use in the following contexts:
Service Provider Agreements
Software/Licensing
Manufacturing
Mergers & Acquisitions
Corporate Officers/Directors
Before Fred embarks on this journey, though, he must start by mastering the basics.
What is indemnification?
At its core, indemnification shifts and allocates liability between contracting parties. But to better understand indemnification, it is helpful to consider how it is often written in agreements. A common example of how indemnification may be found in an agreement is “Fred agrees to indemnify, defend and hold harmless Party A …”
“Indemnification,” “defend,” and “hold harmless” are each separate but related obligations. Indemnification is the obligation to reimburse the losses, expenses and other related amounts of a party if certain events occur. A party’s obligation to defend is the obligation to “step into the other party’s shoes” to defend against a claim, typically stemming from the duties, obligations and/or performance under a contract. A party holds another party harmless by releasing that party from liabilities and obligations arising from a claim, duty or obligation. When used in concert, an obligation to indemnify, defend and hold harmless helps one party reduce the total risk and exposure it faces under a contractual agreement.
Indemnification is often helpful to protect against liabilities that may arise under an agreement, but that would not otherwise be reimbursable without an indemnification clause.
Some examples of where indemnification might step into play:
What happens if a counterparty breaches an obligation?
What happens if my company is sued because the IP my developer incorporated belonged to a third party?
What happens if a regulator goes after me for a counterparty’s violation?
A Simple Example of Indemnification
Consider this - Barry the Builder buys materials from Sally the Supplier and uses those to build a house. Barry turns around and sells the house to Hank the Homeowner. Three weeks later, the roof of the house falls down and Hank is injured. Who is liable for Hank’s injuries?
Well…..it depends.
Was there an indemnity provision between Barry and Sally?
If so, what did it say?
Did Barry contribute to the house falling down?
Did Sally sell Barry a defective product?
All of the above questions are critical (as are other variables). But, there is little doubt that Fred the Founder can see why indemnification is important - it helps avoid unexpected doom!
In other words, it forces Fred and other founders to think through all that could go wrong in a potential business relationship, who could suffer damages, and who should assume the risk of such liability. Carefully crafted indemnification language can help both parties fully understand what risks they are agreeing to assume, and what the potential costs could be, in the unfortunate event that something goes wrong.
Over the next few weeks, we will be expanding upon the concept of indemnification and how it applies in certain key contexts.
*This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.*