Indemnification agreements are usually used in commercial contracts as a tool to manage third-party risk exposure. If they aren’t managed properly, indemnity agreements can be the bane of your life. If you reach the litigation stage and you have to battle it out with another party because you’ve missed something or breached a contract, you can easily wrack up massive attorney fees, general legal fees, and court costs, which isn’t pretty.
Indemnification agreements will either expose you for wrongdoing or protect you against liability. So it’s wise to have a good idea about when you should have indemnity agreements and what you can do to better manage them in your business so that you’re protected as best you can be. With that said, let’s talk about what an indemnification agreement is and when you might see them.
What Is an Indemnification Agreement?
An indemnification agreement can also be known as an indemnity agreement or a hold harmless agreement. It is a contract between businesses that gives one company protection against any damages, losses, or lawsuits.
An indemnity agreement doesn’t have to be its own contract; it could also be a clause within another contract. The party that is protected by the contract or clause is known as the “indemnified party” or the “indemnitee,” and the party giving the protection is called the “indemnitor.”
The indemnification agreement ensures that a company is not held liable for issues that may come from third-party claims that are outside of its control. (We’ll give some examples of this shortly.)
There are different types of indemnity clauses, like reverse indemnity, which allows companies to file claims when a third party fails to pay, or third-party indemnity, where liability is assigned to another party. Typically, an indemnity agreement will be made as part of an insurance policy or liability insurance, such as part of auto, health, life, or business insurance.
Let’s look at an example. A real estate indemnity agreement is where the buyer promises to take on any financial losses, like property damage or lawsuits, that may have been caused by the seller.
Let’s say a buyer is purchasing a property that has structural damage that could cause serious harm to people if it is not repaired. An indemnification agreement confirms that the buyer is responsible for future potential omissions so that the seller is protected if later down the line (once the house has been sold) someone tries to make a claim for injuries.
Aside from real estate, there are so many different examples of indemnifications, like in relation to manufacturers, for example. Let’s say that a nursing home has contracted a manufacturer to supply wheelchairs. The two parties may enter into an indemnification contract confirming that the manufacturer cannot be held liable if a resident sues the nursing home for any injuries suffered.
An indemnity agreement is usually a good idea when you get into a contractual relationship with a party that brings some risk. This could be a supplier, provider, contractor, stakeholder, or vendor.
If you’re the indemnitor, your company will be held liable if anything goes wrong, such as breaches of contract. Or, if you’re the indemnitee, you’ll want as much protection as you can legally get. This is why it’s beneficial to hire a reliable law firm to draft a robust indemnification provision so that you can take legal action where necessary.
What Does an Indemnification Clause Look Like?
An indemnification agreement or an indemnification clause has two integral purposes: an obligation to indemnify (so that any losses can be reimbursed) and an obligation to defend.
As part of an indemnification agreement, usually liability is subject to certain events that are covered by the agreement, like a breach of contract, negligence, injuries, or not complying with governing laws. Typically, the damages that are recoverable include loss, liability, claims, and causes of action.
The crucial parts of an indemnification contract are:
- The parties affected by the agreement (the indemnitors and indemnitees)
- An explanation of the damages, losses, or burdens that the indemnitor is responsible for
- The protection that the indemnitee is covered by
- The length of time the agreement is in place (when it expires)
For example, an indemnity agreement in third-party proceedings may typically include the following wording, according to an Advanced Micro Devices agreement archived with the SEC:
- “The Company shall indemnify and hold harmless the Indemnitee in accordance with the provisions of this Section.”
- “Pursuant to this Section, the Indemnitee shall be indemnified and held harmless to the fullest extent permitted by the applicable law against all expenses, judgments, liabilities, fines, penalties, and amounts paid in settlement.”
- “If the Indemnitee acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and had no reasonable cause to believe that his conduct was unlawful …”
4 Ways to Better Manage Your Indemnity Agreements
Drafting a watertight indemnity agreement is one thing, but managing your agreements and making sure you are able to avoid liability or successfully claim when you need to rely on the agreement is another thing.
In the case Towergate Financial Ltd v. Hopkinson, an indemnity agreement that protected against professional negligence on the condition that the seller was notified “in writing” and “as soon as possible” could not be relied on because the buyer was found not to have acted “as soon as possible.”
This case highlights the need for detailed drafting and careful contract management. In this instance, the indemnitee waited too long to raise the claim, which frankly shot them in the foot. Perhaps they didn’t monitor their agreements efficiently enough or their team members missed the deadline, either way, they suffered losses and had no way of being compensated.
If you handle a large number of indemnity agreements, successfully managing them is key. It can not only help protect you against liabilities, but it will also increase your risk intelligence. Juggling all your agreements and making sure that you and the other party are remaining compliant and adhering to the terms is a big task. Here are a few ways you can make the process easier.
1. Have Your Agreement Checked by an Attorney
This is an obvious one, but getting legal advice is something we should mention nevertheless. Before you even begin to manage your contracts, you need to make sure that they are bulletproof. This includes checking with your legal counsel or legal team to review the entire agreement.
Indemnity clauses can be easily misused. For example, if the wording is too broad, it probably won’t be possible to cover every potential breach. Instead, it will actually make the limitation clause worthless so it cannot be relied on.
If you’re the one potentially liable for anything that goes wrong, you want to definitely make sure that the agreement is written in a way that doesn’t make liability unlimited, for instance.
A common misconception is that indemnity clauses cover absolutely all of the losses regardless of whether they were reasonably foreseeable or whether the other party was partly to blame. For example, if a wheelchair manufacturer actually puts the chairs together in a faulty way and misses fundamental components, then they have contributed to some of the risks. You need to make sure that your attorney considers all these possibilities.
2. Set Up an Automatic Agreement Template
Once you have a reliable agreement in place, you can create templates to automatically draft agreements, including using clause libraries that help you automatically insert certain clauses into contracts. This will save you time and human resources and help you avoid potential errors. You can use a platform like Certa to help you create templates and apply them to different types of agreements.
3. Create Automatic Workflows
When you have so many indemnity agreements to handle and they’re all at different stages — whether it’s the negotiation, review, agreement, or execution stage — you can’t possibly use a manual system to manage everything. This puts you at risk of legal liability, financial losses, and reputational damage.
Automatic workflows let you create a system whereby all teams are aware of which stage all contracts are at and whether anything needs to be done. For instance, a workflow may be set up to notify your legal team to check and review an indemnity agreement before being signed.
Usually, when you’re negotiating the terms of an indemnity agreement, there will be a lot of redlining because key parts will likely be changed a lot throughout the reviewing stage. Using automatic workflow software will make everything much easier by letting you know what has been changed and automatically saving the most up-to-date version.
You can also be notified when an agreement needs to be renewed and updated to avoid doing business with a party without being protected by the agreement because it has gone under the radar.
4. Regular Automatic Monitoring
An automatic monitoring system or a platform that notifies you when agreements are due to be reviewed, renewed, or checked can be vital to managing your risk exposure. This may form part of your ongoing risk management strategy. You can measure the performance of the contracts, whether they continue to protect your business or whether they need to be updated to match changes in business relationships, for instance.