One of the most mysterious – and important – clauses found in many standard contracts is the indemnification clause.  What is indemnification?  And how can you tell whether the clause is favorable to your business or to the other side?

Indemnification is like private insurance.  It’s usually an agreement by one party to indemnify, or compensate, the other party if they’re sued by someone else because of their actions under the contract.  If not well drafted, an indemnification clause can act to shift responsibility for poor performance from one party of the contract to another – often in a way one of the parties didn’t anticipate.

Consider this simple scenario to demonstrate how indemnification can work.  Let’s say your business owns rental property and contracted with a vendor to handle the leasing and management of that property.  When a leaky roof resulted in water damage to a tenant’s belongings, imagine that the tenant sued the vendor for failing to promptly repair the roof.  In this situation, an indemnification clause in the vendor’s contract might require your business as the property owner to indemnify the vendor.  If so, that would mean the property owner would have to pay all of the vendor’s legal costs of defending against that lawsuit plus pay the damages, even if the vendor was at fault.

If you are the business owner who hired the vendor, you don’t want your contract to require you to pay the legal expenses and damages of the vendor if they acted negligently when failing to make prompt repairs.  Therefore, when reviewing an indemnification clause in a contract, be sure it clearly states that the vendor has no right to indemnification if the vendor acts negligently or is in breach of the contract. 

But what happens if your business is the vendor in this scenario?  In that case, you want to be sure that the indemnification clause protects your business from liability for damages when it did nothing wrong but only carried out the instructions of the property owner.  Let’s say you attempted to make repairs, but the property owner didn’t authorize you to spend the money necessary to fix the roof. 

As a vendor providing services, you don’t want your contract to require you to pay legal expenses and damages if the property owner was responsible for the problem.  Therefore, when reviewing an indemnification clause, make sure that the clause is mutual.  In other words, if you have to indemnify the other side, make sure they will do the same for you.  Also, be sure that the clause is not so broad that you are essentially guaranteeing perfection.  You only want your business to be held responsible to indemnify the other party if you did something wrong.

Look for more tips in future Contracts Competence columns.  If you have questions about indemnification, or want help drafting or reviewing a contract, please contact our Business Law Group partner, David A. Closson at [email protected].

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