Indemnity or “hold harmless” clauses are another way of allocating financial risk to a particular party in a transaction. Indemnity clauses require one party to bear the cost of certain risks defined in the contract, which can range from particular losses, lawsuits, or even non-conformance with prescribed warranties. Most commercial agreements should have some form of indemnity clause, in which one party agrees to defend (i.e., hire a lawyer) and indemnify (reimburse) the other party for the risks described.
We find that indemnity clauses are often one-sided, and sometimes taken from unrelated contracts, so that the risks which ought to be negotiated and indemnified are overlooked, while the indemnity clause as written produces results which the parties never contemplated. For example, Party A would not expect to find a clause that lays the costs of Party B’s fault back upon Party A. Yet that kind of result can happen when indemnity clauses are not carefully negotiated and drafted.
Indemnity clauses can be quite complex, including provisions regarding the selection and control of the attorneys who will defend the claim. A well-drafted indemnity clause will include a provision that the benefited party will be entitled to their reasonable expenses incurred to pay the indemnified loss, and any settlement, judgment and defense costs.
Losses are not always caused by one person or one discrete act or omission. Events like construction site accidents and other industrial accidents are often the result of a combination of factors. Environmental contamination can have multiple causes spread over decades. In such cases, the wording of an indemnity clause can make a big difference.
The legal effect of an indemnity clause is usually a question of state law. Different states have varying rules for interpreting and enforcing indemnity clauses. Therefore, the state law selected in the agreement can have a major effect on the results produced by the indemnity clause. Some states require particular wording in an indemnity clause before a court will shift the risk of a loss from one party to another. If the contracting parties intend to shift the risk of one party’s “active” negligence to the other, such an intent will often need to be specifically spelled out or the indemnity clause will not be given that effect.
Most or all states have limitations on the kinds of liabilities that may be indemnified, and some even have special statutes that change the rules in particular settings, such as construction contracts, for example. Indeed, California courts have at times distinguished between “Type I,” “Type II” and Type III” indemnity clauses. (I will spare you those details.)
Ultimately, the effect of an indemnity clause will turn on the state law chosen in the contract, the subject matter of the contract, the words used in the indemnification provision, the circumstances of the loss to be indemnified, and the different parties’ roles in producing the loss.
Read more in the 4-part Making Contracts Work for You, where we discuss various ways that you can strengthen your commercial contracts, so that in the case of a dispute, your contract works on your behalf. Part 1- Boilerplate, Part 2 – Warranties, Part 4 -Insurance Provisions