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What is an Indemnification Clause?

This is my second post describing contract sections that might seem overwhelming and irrelevant to the agreement itself, but actually serve an important purpose. I focus in this blog post on indemnification clauses. Here, I explain what an indemnification clause is, why it's often in agreements and why it can be important to keep in there.

An indemnification clause can help one of the parties (the indemnified party) to a contract if the other party's (the indemnifying party) actions cause a third-party to sue the indemnified party. The indemnifying party usually must either (a) commit a significant wrongdoing, either with or without knowledge of the wrongdoing, in relation to the contract; or (b) cause a significant breach of the contract's terms. If that happens, and a third party sues the indemnified party based on what the indemnifying party did/failed to do, then the indemnifying party must pay to defend the indemnified party and pay any of the damages and fees the third party is awarded.

For example, a consultant agrees to help develop and implement software for a company. However, the consultant provides significantly outdated software, even though the consultant's contract requires the consultant provide industry best software. Additionally, the consultant fails to review the software for critical errors. Because of the consultant's failures, the company suffers a breach and its clients' data is exposed. One of the company's clients sues the company. Because of the indemnification clause in the contract between the consultant and company, the consultant must pay for the company's defense against its client's lawsuit and must pay any damages the company suffers.

However, an indemnification clause may reduce the indemnifying party's liability to the indemnified party if the indemnified party's actions/inaction contributed to the problem. Looking back to the earlier example, suppose the company requested the consultant use older software because it was cheaper. That might have caused some of the company's damages and therefore the consultant would not have to pay for the entirety of the company's defense and damages.

An indemnification clause is an important tool if something goes wrong. Therefore, the party with more negotiation power may make an indemnification clause more favorable for their needs. It is important for a party to look at the indemnification clause before signing a contract to see whether it is one-sided.

Additionally, an indemnification clause is not one-size-fits all. There are many different paths parties to an agreement can take to tailor an indemnification clause to fit their specific needs. A party should to review the indemnification clause before signing a contract to see whether the potential situations that could occur are covered.

Although it might look unnecessary, parties should keep an indemnification clause in their agreements and make sure it is well drafted.

The information provided on my blog is not legal advice and should not be relied on as legal advice. Anyone reviewing this post should use it as only a first step in understanding how an indemnification clause works. You should consider consulting with a lawyer when drafting a contract.

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