Indemnity clauses are in lots of contracts. For some, they are wonderful. For others, they are not! Before we get into that though, it is important to understand what they are.
An indemnity is an assurance whereby one party agrees to secure another party against an anticipated loss brought by a third party. Indemnity agreements often go hand-in-hand with hold harmless agreements, i.e. an agreement not to sue another party.
A simple practical example is helpful to illustrate how an indemnity agreement works. Let’s say that I hire my neighbor to mow my lawn. I have my neighbor sign a written lawn mowing services contract with an indemnity agreement, of course, because I am a lawyer…. The indemnity agreement reads something to the effect of: “Neighbor agrees to defend and indemnify home owner against any and all damages that arise out of this lawn mowing services agreement.” A tragic accident subsequently occurs, and the pet rabbit in the neighborhood gets slaughtered by the lawn mower. The pet rabbit owner sues me as the property owner. Because of the indemnity clause, my neighbor pays for an attorney to defend me and pays out the settlement I eventually reach with the pet rabbit owner. Or in the case it goes to trial, my neighbor pays out any verdict that may be obtained against me.
Clearly, the indemnity agreement was great in the above-referenced case for me, but not so great for the neighbor….
Indemnity agreements can be stand-alone contracts, but most often are a clause in a larger agreement between parties. Indemnity agreements can be one-sided (meaning only apply to one party) or can be mutual (meaning they may apply against either party, depending on which party’s conduct gives rise to the claim against the other).
The key to understanding and negotiating an indemnity agreement is to define the scope of conduct or activity that will be covered by the indemnity. In the example above, for instance, my neighbor is responsible to indemnify me for anything that happens that is related to the lawn mowing services. Thus, if the lawn mower malfunctioned and blew up due to no fault of my neighbor, my neighbor would still be responsible for the damages that may result from the explosion. On the other hand, the indemnity agreement could have been drafted in any of the following manners:
• Neighbor agrees to defend and indemnify home owner against any and all damages that arise out of neighbor’s willful misconduct related to this lawn mowing services agreement.
• Neighbor agrees to defend and indemnify home owner against any and all damages that arise out of neighbor’s willful grossly negligent conduct related to this lawn mowing services agreement.
• Neighbor agrees to defend and indemnify home owner against any and all damages that arise out of neighbor’s negligent conduct related to this lawn mowing services agreement.
• Neighbor agrees to defend and indemnify home owner against any and all damages that arise out of neighbor’s willful misconduct or negligence related to this lawn mowing services agreement.
As you can see, all of these versions of the indemnity agreement are better for my neighbor than the original example I gave because they are drafted more narrowly. For the person being asked to provide the indemnity assurance, narrow is good; although, not as good as no indemnity at all. For the person receiving the indemnity assurance, the broader the better.
Another key item to keep in mind is whether the party providing the indemnification (i.e., the indemnitor) to the party receiving the assurance (i.e., the indemnitee) has the financial resources available to make good on the assurance. The indemnitee should attempt to obtain a provision in the agreement that the indemnitor will add the indemnitee to the relevant insurance policie(s) as a named insured. For the indemnitor, this may also be a good idea if you are going to be stuck with an indemnity agreement so that you have insurance coverage in the event of a claim. However, be aware that the cost of insurance will go up with additional named parties insured.
There are numerous other considerations when negotiating and drafting an indemnity agreement. For example: Is an indemnity agreement permitted under the law for your circumstances? Is additional consideration warranted to increase the likelihood of enforceability? Should the indemnity clause specifically cover more people than just the party to the contract, such as a company’s owners, employees and agents as well as the company itself?
This article is intended to familiarize you with the importance of an indemnity agreement and get you started thinking about the issues implicit with indemnity. It is strongly recommended that you consult with an attorney about your specific situation and how an indemnity agreement could apply.