Defining the scope of indemnification

The language set out in a contract's risk allocation provisions frequently dictates the outcome of contract litigation. And one of the most important risk allocation provisions is the indemnification provision, which includes an undertaking by one party to compensate the other party for certain costs and expenses.

Proper drafting and skillful negotiation require the attorney to understand the scope of the indemnification provision. Here’s what to look out for:

1.  Whether the indemnification provision should be unilateral or apply to both parties.
2. Whether the indemnity also covers people or entities who are not parties to the contract, for example, managers, affiliates, or even customers of the indemnified contract party.
3. Whether the provision also covers the obligation to defend, which includes the obligation to reimburse (or advance funds) for covered litigation costs and expenses and which may apply even if indemnification ultimately is not triggered (for example, because the underlying claim has no merit).
4. What types of damages or expenses incurred by the indemnified party are recoverable, for example, whether the indemnity extends to attorneys' fees and extracontractual tort damages.
5. The specified events that give rise to the indemnity, for example, whether the indemnity extends to direct claims of the indemnified party in addition to third-party claims.
6. The degree to which the event giving rise to the indemnity and the indemnified party’s damages need to be related for the event to qualify for recovery.
7. Whether indemnification is the exclusive remedy for the specified events that give rise to the indemnity.
8. Any exceptions, for example, excluding indemnification for the indemnified party's negligent or grossly negligent acts or omissions.
9. Any deductibles, baskets, or thresholds that apply to shift the risk back to the indemnified party until the specified level of damages have accrued.
10. The relationship between the indemnification clause and other provisions in the contract, for example, any:

                • Limitation of liability provision that might limit the types or amount of damages recoverable                    under the indemnification clause
                • Third-party beneficiary provision, which might limit the right of non-parties to pursue their                    indemnification rights
                • Cumulative remedies provision, which if not drafted to carve out exclusive contractual                    remedies, might allow the indemnified party to pursue otherwise exclusive indemnification                       on a non-exclusive basis
                • Survival clause, which might impact the duration of the indemnity
                • Other contractual remedy provisions, for example, product warranty provisions and                                     dedicated intellectual property indemnification provisions, which must be drafted to clearly                     set out the rights and obligations of the parties to avoid ambiguity
                • Any other provision such as representations or covenants that may contain materiality or                           other qualifiers that may affect the scope of the indemnity, especially if the indemnity is                             also qualified

 11.    Any statutory, common law, or public policy barriers to indemnification, such as any restrictions against indemnification for all claims, regardless of who is at fault.

Indemnification provisions are critical risk allocation devices that serve as key negotiation points in most commercial contracts. The Standard Document Indemnification: Avoiding Common Pitfalls, available with a free trial to Practical Law, can help your organization understand these provisions and additional issues to consider when drafting or reviewing an agreement.