Indemnification is a legal term for compensating someone for a loss or damage they have suffered. In the context of contracts and legal agreements, indemnification clauses are used to allocate risk between parties. These clauses require one party to compensate the other in case of certain types of losses or damages. For example, a contract between a client and a service provider might include an indemnification clause that requires the service provider to compensate the client if the service provider’s negligence causes the client to suffer a loss.
Indemnification can also refer to securing someone against legal liability for their actions. For example, an employer might indemnify an employee for actions taken on behalf of the employer, provided those actions were within the scope of the employee’s duties. Indemnification can also be a form of insurance where an insurance company indemnifies the policyholder against certain types of losses.
Business contracts have two main purposes – 1) spell out the business terms the parties have agreed to and 2) manage risk. But, to manage your risk, you must 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 damage done to your vehicle and any medical expenses you may have, with any exceptions to this rule 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 can 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. An 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. Suppose an attendee is injured and files a lawsuit against you. In that case, 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 massive 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 that, 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 of mutual indemnification clauses that either cancel each other out or expose both parties to undue risk.