What is indemnification?

Towards the end of a commercial agreement, maybe somewhere above the general terms and conditions, and close by to limitations of liability and warranties, may often be found a term regarding indemnification.

Typically, we see language like, party agrees to indemnify and defend, or indemnify and hold harmless the other party from third-party claims arising out of the performance of agreement. But what does it mean to indemnify the other?

An indemnification obligation can be compared to an insurance policy. One party is agreeing that under certain circumstances, one party to the contract may be required to provide a legal defense for or make a judgment or settlement payment incurred by the counter-party.

Indemnification claims most typically come into play when a third-party has a claim against one or more of the parties to a commercial agreement.

Let’s use an agreement between a service provider and its client. The service provider, we’ll call ABC Consulting, provides consulting personnel who develop software in conjunction with client personnel. ABC Consulting and Client into a master service agreement and several statements of work that identify the consultants that will be staffed at the Client’s business and the work to be performed.

ABC Consulting and Client have several documents that constitute an agreement. The agreement describes the services that ABC Consulting will perform, acceptance standards applicable to any deliverables and payment terms. So, if there is a dispute that arises where ABC has not been paid, the contract provides a remedy or a dispute resolution process to resolve the payment issue with Client. Likewise, if ABC has not provided the personnel it had agreed to provide, then Client has a remedy available through the contract.

But what if a third party has a claim against ABC or Client? To explore the example further, ABC has been tasked with developing custom software for Client. In the course of developing the software, ABC personnel copies hundreds of lines of code from Software Corp.’s copyright-protected software, without Client’s knowledge. In this example, Client would likely demand that ABC (a) obtain for Client the right to use the infringing software, (b) pay or reimburse Client for its legal fees in defending against a lawsuit, and/or (c) pay any settlement amount or judgment entered against Client.

When reviewing indemnification provisions, there are a number of items to consider, such as:

1. Who has to indemnify? Is it mutual or one party?
2. What could the burden of indemnification be? For example, will the indemnifying party be sending personnel to my facility or will they work remotely? Is the contractor providing just personnel or are they developing products or software, where IP infringement is a concern?
3. Does the counter-party have the financial resources to indemnify my business? Can a contractor pay the hundreds of thousands of dollars in legal fees that my firm will incur in defending against an intellectual property dispute?
4. What steps are required to obtain indemnification from my counterparty? Do I have to timely notify the indemnitor of a claim? Do I have to wait until a judgment has entered before I am entitled to indemnification? Do I have the right to select the attorneys who will defend my company?

If your business has questions about an indemnification provision, please feel free to reach out and schedule an appointment.