Business contracts have two main purposes – 1) spell out the business terms the parties have agreed to and 2) manage risk. But, in order to manage your risk, you need to understand one of the most common risk-shifting terms: indemnification. Not sure what indemnification is? Read on.
Indemnification is the act of indemnifying. Helpful, right? Let’s break it down a little more. Indemnity is an obligation of Party A to pay for the losses of Party B. Indemnifying is what Party A does for Party B. Party A is the indemnitor. Party B is the indemnitee. Clear as mud. An example will help.
The term “indemnification” is most commonly heard in the context of insurance. For example, your car insurance company is your indemnitor, and you are the indemnitee. If you are in a car accident, your insurance company will indemnify you for (read: pay for) your losses. This means your insurance company will pay for the cost of damage done to your vehicle and any medical expenses you may have, with any exceptions to this rule laid out in your insurance policy.
If you caused the crash, your insurance policy, at least in Virginia, will also pay for the damage to other people or property caused by your actions. This is because, although the damage to another person’s vehicle isn’t a direct loss to you, the other vehicle’s owner has the ability to sue you for his losses. Your insurance company protects you, often with some limitation, from the costs associated with the other driver’s potential lawsuit.
Now that you hopefully have a handle on the terms, let’s talk about the legal nature of indemnification. Indemnification is a contract between two parties. In the case of your car insurance, you have contracted with your insurance provider to indemnify you in the case of an accident in exchange for paying your monthly premiums.
Many types of contracts outside the insurance world also contain indemnity provisions. Consider another example. If you own an event space and someone asks to rent out your space for a holiday party, you likely have them fill out a rental agreement. Your rental agreement may contain an indemnity provision that says the renter will agree to pay for all costs associated with a lawsuit brought by anyone attending the event. If an attendee is injured and files a lawsuit against you, the renter may be required to pay for any money damages awarded by a court or agreed to in settlement negotiations. Additionally, an indemnity provision could require the renter to pay for the cost of your legal defense, or even assume your legal defense (in other words, hire a lawyer to defend you).
You can see from this last example how beneficial or dangerous indemnity agreements can be for businesses. If you are the indemnitor, you may be on the hook for a huge payout if something goes wrong. On the other hand, if you are the indemnitee, an indemnity provision can give you the security you need to enter into a contract. Note, typically indemnity provisions contain limitations. For example, an indemnitor may only be responsible for losses up to a certain amount, or may only be responsible for losses caused by his or her own actions. Beware, however, of mutual indemnification clauses that either cancel each other out or expose both parties to undue risk.
Linden Legal Strategies PLLC regularly helps businesses navigate their contract issues, including indemnification clauses. Contact us if you have questions about how to use indemnification agreements to protect yourself, or are concerned that an indemnification provision has put you at risk.
This article is for informational purposes only and does not constitute legal advice nor does it create an attorney-client relationship. Always consult appropriate legal counsel for specific questions related to your business. Some states may consider this attorney advertising.