Indemnify is defined in Black’s Law Dictionary as follows:  “To make good; to compensate; to make reimbursement to one of a loss….”

In an indemnity clause, one party (the “indemnitor”) agrees to defend, pay all costs of the lawsuit and pay any judgment resulting from the lawsuit if the other (the “indemnitee”) is sued by a third party.

A key feature of an indemnity clause is that it creates an obligation that may not otherwise be imposed on a party by law.

For example, your contractor carelessly leaves some equipment lying around your facility.  A visitor trips over the equipment and injures herself. She sues you because the injury occurred on your property, even though it was the contractor’s act, not yours, which led to the injury. If there was an indemnity clause in the contract between you and your contractor, you could seek to have the contractor reimburse you for the costs of defending that lawsuit due to the contractor’s acts and for monies you might have to pay to the injured party.

Without an indemnity clause in your contract, you would be solely responsible to pay the costs to defend the lawsuit and the monies payable to the injured party.

In its purest form, indemnity is a means of shifting the ultimate responsibility for payment to the party who caused the injury.

Why are indemnity clauses the source of so much contention?

I believe the main reason is that an ever increasing number of customer proposed indemnity clauses go well beyond requiring the Seller to be responsible for its (the Seller’s) negligence and wrongdoing. They require that the Seller be responsible for not only the Seller’s acts and negligence but for its Customer’s and any third party’s negligence and wrongdoing as well.

The following is a typical example of such a clause:

Seller shall defend, indemnify and hold harmless Customer, its officers, directors, agents and representatives from and against any and all claims, suits, losses, penalties, damages and associated costs and expenses (including attorney’s fees, expert’s fees, and costs of investigation) that are caused in whole or in part by: (a) any breach by Seller of this Agreement or (b) any negligent, or intentional act, or omission by Seller, its employees, officers, or agents in the performance of this Agreement.

(NOTE:  Underlined and bolded language are provided for emphasis).

The Seller’s major objection to this clause is found in the words “caused in whole or in part by” on line 4. This language means that the Seller will be financially responsible notonly for claims resulting from the seller’s breach or negligence; the provision is so broadly written that the Seller will also be responsible for claims attributable to the breach or negligence of the Customer and anyone else.

In other words, a frequent source of contention is an over-reaching clause that makes the Seller responsible not only for it’s negligence and wrongdoing but everyone else’s as well.

A “fair” indemnity clause does not seek to avoid a party’s responsibility for its negligence or actions. Instead, it seeks to limit the extent of liability to that which may be attributable to its negligence or wrongdoing.

A Seller will want to limit its indemnity obligations to behavior over which it has control. Failing that, a Seller will want to limit it obligations to behavior about which it can conduct adequate due diligence.

A narrower version of above clause might say:

Seller shall defend, indemnify and hold harmless Customer, its officers, directors, agents and representatives from and against any and all claims, suits, losses, penalties, damages and associated costs and expenses (including attorney’s fees, expert’s fees, and costs of investigation), but only to the extent caused by :  (a) any breach by Seller of this Agreement or (b) any negligent, or intentional act, or omission by Seller, its employees, officers, or agents in the performance of this Agreement.

Note the addition on line 4 of the language but only to the extent caused by. These words change the meaning of the clause to apportion the Seller’s responsibility in relation to its negligence or wrongdoing.

Interestingly, the words “to the extent caused by” will frequently resolve the problem of overly broad indemnity clauses.

Many states have statutes or case law prohibiting agreements that indemnify someone for his own negligence when the negligence is in connection with construction contracts or contracts that affect the public. Other states have laws that prohibit these agreements in connection with residential leases.

In contracts where a party can be indemnified for its own negligence, the indemnity clause must state so in clear and unequivocal language. For example, a clause stating that the Seller will be responsible for all damages arising directly or indirectly out of the performance of the contract may likely not be considered clear enough to cover the negligence of the Buyer.

There is yet another problem a Seller will have with the above clause even after adding the qualifying language “but only to the extent caused by.”

The clause goes well beyond making the Seller responsible for third party claims against the Customer. It gives the Customer the right to recover from the Seller any consequential damages the Customer incurs, such as loss of business, profits, reputation, and the like.

In other words, we’re back to the issue of how to fairly allocate liabilities.

The Seller will want a limitation of its liabilities such as the following:

In no event will Seller be liable for any lost profits, loss of business, or other consequential damages arising out of any breach of its obligations under this Agreement. Seller’s maximum liability hereunder shall not exceed the amount paid to Seller.

The Customer will object to the limitation of liabilities in the second sentence, particularly as it applies to damages for personal injury, death or property loss/ destruction caused by Seller’s negligence or wrongdoing.

One approach to resolving this issue would be to narrow the Seller’s responsibility to claims relating to personal injury, death and property loss/ damage due to the Seller’s negligence or wrongdoing and doing so without a maximum cap on the dollar amount. A revised clause using this approach would read as follows (see bolded, underlined language):

Seller shall defend, indemnify and hold harmless Customer, its officers, directors, agents and representatives from and against any and all claims, suits, losses, penalties, damages and associated costs and expenses (including attorney’s fees, expert’s fees, and costs of investigation) for personal injury, death or property damages but only to the extent caused by :  (a) any breach by Seller of this Agreement or (b) any negligent, or intentional act, or omission by Seller, its employees, officers, or agents in the performance of this Agreement.