Contract negotiations can be complicated, especially when they involve legal issues. One of the most frequently negotiated contract provisions is indemnification, which is found in most business-to-business contracts.
Indemnification is about risk allocation -- shifting liability from one party to the other. In effect, it makes one party the insurance company for the other.
Indemnification provisions commonly include three interrelated requirements: to indemnify, to hold harmless, and to defend. To indemnify means to compensate a party for its liabilities or losses (or settlement). To hold harmless means one party will not assert a claim against the other party. To defend means to pay the fees of the attorneys who defend the claim. Each of these three obligations may be limited through negotiation.
For example, the burdens of indemnification, hold harmless, and defense can be lightened by:
- limiting the types of claims indemnified (e.g., indemnify for fraud but not for breach of contract);
- limiting the source of the claims (e.g., indemnify for third party claims but not for claims made by the other contracting party);
- capping the aggregate amount of the indemnification and defense obligation (e.g., the aggregate liability might be limited to twice the annual fees paid under the contract);
- requiring a minimum threshold amount of losses before the indemnification obligation can be triggered;
- shortening the period of time within which indemnification claims may be brought;
- requiring the indemnifying party to be at fault (e.g., fraud, negligence) before any indemnification obligation is triggered;
- excluding indemnification and defense obligations to the extent the indemnified party is at fault for the claim; or
- carrying insurance that will cover some of the indemnification and defense risks owed to the other party.
A careful analysis of risks and rewards is important when it comes to indemnification, hold harmless, and defense provisions.