Indemnity Clause: A Dangerous Contract Clause

Contracts often contain a provision called an Indemnity Clause. This clause states that one of the parties ("Indemnifying Party") promises to defend and pay costs and expenses for the other party ("Indemnified Party") under certain circumstances. One rationale for including such a clause is the belief by the Indemnified Party that the contract subjects him to some risk of loss or expense by a claim which might be made by some third party. Often the type of claim and identity of the third party claimant are not yet identified. He wants the other party to be responsible should that risk become an actual claim. Like all aspects of a contract, the specific wording is very important.

The circumstances described in the Indemnity Clause are sometimes limited to the intentional acts or negligence of the Indemnifying Party. With this type of language, the Indemnifying Party can reasonably ascertain what types of conduct on his part would obligate him to pay expenses for the Indemnified Party. Sometimes, however, the circumstances stated in the Indemnity Clause are very broad and outside the control of the Indemnifying Party. This level of risk is almost impossible for the Indemnifying Party to evaluate. People can be sued by others for many reasons and often the claims have no merit but can be costly to defend. With a broad Indemnity Clause, if the Indemnified Party gets sued, or even threatened with suit, for any type of claim, the Indemnifying Party will be obligated to pay to defend against the claim.

If a claim is filed, the amount the Indemnifying Party will be obligated to pay depends on the language of the Indemnity Clause and the circumstances giving rise to the claim. The broader the Indemnity language, the greater the liability for the Indemnifying Party. Most Indemnity Clauses will include language similar to "A agrees to indemnify and hold harmless, B from and against any and all suits, claims, demands, costs and expenses, including attorneys' fees, to defend against any claim which may arise from B’s performance of this contract." This kind of broad language requires the Indemnifying Party (A) to pay costs to defend the Indemnified Party (B) even if the Indemnified Party was negligent in his actions and some third party believes he was injured by that negligence. The possibilities are numerous.

The requirement to pay the attorneys' fees incurred by the Indemnified Party is a very significant and costly risk for the Indemnifying Party. Keep in mind, even an unfounded claim can be made by a third party against the Indemnified Party requiring an attorney's involvement. It is not unusual for attorneys' fees to reach thousands and even tens of thousands of dollars, in a disputed claim. On top of that, there can be other costs the Indemnified Party is forced to incur just to defend. If the claim is successful or a settlement reached, the Indemnifying Party is on the hook for those expenses too.

If a party to a contract is asked to indemnify the other party, he should check with his liability insurance carrier to find out if he is covered before signing a contract with an Indemnity Clause. Many policies do not cover this. If there is no coverage, the Indemnity Clause should be eliminated if possible and if not, should be negotiated to the most favorable terms possible.

So, how common are Indemnity Clauses? Quite common. They are standard provisions in larger commercial contracts for goods or services and in commercial real estate agreements and leases. They can even be found in smaller contracts for security alarm services, shredding services and in social media user agreements and many others. Imagine, your service providers asking you to indemnify them for their actions.

Read the entire contract. If you do not understand it, or if you see the words "indemnity" or “hold harmless” you should consult with one of our experienced contract attorneys. You can reach us at 610 323-7464.