Contract Tip: Indemnity Clause

They say a picture is worth a thousand words. If you’re a business leader, and you’ve hired a vendor to repair something outside your premises, requiring a contractor and a ladder … what does this picture speak to you? An Indemnity Clause may be the only thing protecting you from liability.

An Indemnity Clause represents language in a contract, to manage and apportion risk between contracting the parties. More specifically, an indemnity clause will specify under what conditions one party must compensate the other party (i.e. indemnify) for unintentional harms, claims or other liability that may befall the party to be indemnified (i.e. party to be compensated), usually associated with some fault of the other party (i.e. indemnifying party).

If you’ve hired a vendor to repair something outside your store, you may not have paid any attention to the contract or repair order you signed. If an accident befalls the contractor, such as depicted in the picture, aside from caring about his safety and wellbeing, you will eventually care about the very specific language in that contract you didn’t think twice about.

Think about that.

Who should be responsible for the injuries sustained by the contractor in the picture? Your company or the vendor you hired?

Responsibility is Dictated by the Contract

No one cares about the contract, until there is a problem. In this case, it’s really important to understand the nuances of the indemnity clause in the contract you signed, and to make sure you’re not shifting too much risk or liability to your business. Unfortunately, indemnity clauses are often very boring and arcane, and can be overlooked by business leaders when reviewing a contract. It pays to read the indemnity clause in any contract, and in particular, to make sure the indemnity clause is:

• Fair
• Balanced
• Mutual
• Within your control
• Limited

If an indemnity clause in a contract doesn’t meet those five factors above, you should not sign the contract and instead seek to revise the language until it meets all five factors.

An Indemnity Clause Must be Fair

All too often, I see contracts that are thrust upon small business leaders that are anything but fair. This includes the language of the indemnity clause, that will oftentimes be one-sided or shift all the risk upon the party with less negotiating power. The bigger companies are especially guilty of this, such as the billion-dollar vendor with a non-negotiable form contract, who demands very broad indemnity clauses.

It is fair when parties agree to indemnify the other party for damage, harms or liability associated with:

• Their breach of the contract
• Their negligence
• Their tortious conduct (i.e. crimes or intentional acts that cause harm to the other party)

… within the scope of the contract.

It is not fair when one contracting party demands to be indemnified for:

• Lost profits
• Conduct within their control
• Damages, harms or liability not related to the contract
• Damages, harms or liability they could have mitigated (i.e. minimized) or they have, through their action or inaction, helped to cause
• Third-party infringement actions, when they are in control of the intellectual property (For example, read: Don’t Permit a Patent in Your Indemnity Clause)

There is no specific indemnity clause language I can give you, that would be fair in all circumstances. This is where you must read the indemnity clause carefully, and make sure it is fair given the circumstances and subject matter of the contract.

In the situation depicted in the picture above, I would think one could expect that the vendor you hired is providing adequate training and equipment to their contractors, as well as insurance, and therefore one would expect that the vendor would indemnify your company in this instance.

The Risk Managed in an Indemnity Clause Must be Mutual and Balanced

An indemnity clause is mutual and balanced in one of two ways. The first way, is where the indemnity clause mentions a specific party to be indemnified, then repeats itself in a reciprocal paragraph, switching the roles of the parties so that both parties have the same indemnity language applied in the overall contract.

The second way, is if the indemnity clause doesn’t mention a specific party and instead can apply to either party. Such an indemnity clause will use words like “indemnified” and “indemnifying” party, for example.

The indemnity clause is not mutual and balanced, however, when the indemnity does not apply to both parties equally. Often, this will look like the “first way” above, but without the corresponding reciprocal paragraph for the other party. Removing any indemnity for a party is a common way for the party with the stronger negotiating position to shift risk to the weaker party.

To make things really confusing, note that there are legitimate reasons why an indemnity clause may not be mutual and balanced, such as one party is specifically contracting to reduce risk or a party is agreeing to obtain appropriate insurance. It is critical you factor in the overall circumstances and subject matter of the contract, to make sure the indemnity clause is appropriately applied.

The Circumstances Giving Rise to an Indemnity Must be Within Your Control

You must make sure the indemnity you are agreeing to give the other party applies to circumstances within your control. Otherwise, you will create substantial risk for your business. The damages, harms or liability that befall the other party due to your breach of the contract should be in your control, assuming of course, that you haven’t agreed to terms of a contract that you’re not in overall control of.

Beware of language that isn’t specifically limited to within the confines of the contract. For example, beware of an indemnity clause that simply says you “must indemnify and hold (the other party) harmless for any third-party claims or causes of action“, without more. Specifically, this clause would need additional language making sure it only applies in instances where you’re legitimately at fault (i.e. you’ve breached the contract or committed some form of negligence).

Manage Your Risk by Limiting Your Liability

Finally, no matter what sort of indemnity you agree to in an indemnity clause, make sure it’s limited in scope either in the indemnity paragraph itself, or in another clause, such as a “limited liability” clause.

This is important, so that you avoid potential “infinite liability.” What you want to do, is limit your overall liability to the other contracting party to something manageable or appropriate, given the circumstances. Common approaches include a general “limited liability” clause that says something to the effect of, “notwithstanding anything to the contrary in this Agreement, the Company (i.e. YOU) shall not be liable to the other party for any amount greater than what has been paid to Company by the other party.” Such language limits your overall liability to whatever you have been paid. It’s also common to put a time limit on such language (i.e. “paid to Company by the other party in the previous four (4) months”) or to put a specific dollar amount on total liability (i.e. “… shall not be liable to the other party for any amount greater than $10,000 …”).

Aside from limiting “total liability,” be sure to limit liability for circumstances outside your control. For example, you should make sure you have limited liability language that voids indemnity language in instances where the other party was either in control of the circumstances, or where a third-party is involved.

Let me give you an example. Let’s pretend you own a commercial vehicle repair shop, and that a customer brings in a commercial truck for repair. You promise (i.e. contract) to repair the vehicle within two days. Hopefully, you are a prudent business owner that has a form repair order for all repair requests, and hopefully you didn’t just download something off the Internet without carefully reviewing it. Hopefully, your form repair order doesn’t have a poorly worded indemnity clause for your breaches of the contract, because if your parts’ supplier took longer to deliver a key part than they promised you, you would then be late in repairing the commercial truck you said would take just two days. You’d technically be in breach of that contract.

What you need, in this particular example, would be a limitation from liability associated with the performance of third-parties, such as parts suppliers.

In summary, that boring and arcane language representing the indemnity clause in your contract can have a profound impact on the health of your business should indemnity become an issue. Be sure the language is in your favor, and cannot cripple your business with an expensive lawsuit or legal judgement. If you want the opinion of an attorney, L4SB does have a low-cost, flat-rate contract review service for $20/page (minimum 5 pages).

Don’t let a poorly written contract force you to be liable for the circumstances depicted in the picture above.

Law 4 Small Business. A little law now can save a lot later. A Slingshot company.