Indemnification is an undertaking by one party to compensate the other
party for certain costs and expenses. The obligation to indemnify is imposed
either by law or contract. Parties to a contract can use an indemnification
clause to customize risk allocation. Indemnification clauses can widely
vary – in a typical indemnification clause, the indemnifying party
promises to reimburse the indemnified party from and against
any and all losses, liabilities, claims and causes of action incurred by the indemnified party that
cause, arise from, or are related to, the
specified events giving rise to the covered event.
In many cases, a party negotiating an indemnity clause will also want to
negotiate a defense clause. A defense clause is one in which the indemnifying
party promises to defend the indemnified party against third-party claims.
The obligation to indemnify and the obligation to defend against third-party
claims are separate and distinct. Direct claims are claims that the indemnified
party has against the indemnifying party. Third-party claims are claims
that a third-party has against the indemnified party.
Depending on the language employed in the indemnity clause, the indemnifying
party may agree to compensate the indemnified party for direct claims,
third-party claims or both. Indemnification requires the indemnifying
party to: reimburse for paid covered losses, advance payment for unpaid
covered liabilities as they are incurred but only if the language in the
indemnity clause covers liabilities, claims, or causes of action.
The obligation to defend is usually broader than the obligation to indemnify
because it may apply whether or not the third-party claim has merit. The
obligation to defend includes both, an obligation – to reimburse
for covered paid losses and advance payment for covered unpaid liabilities,
and a right – to assume and control the defense, subject to the
specific terms of the parties’ defense clause. The obligation to
defend is generally held to exist only in the context of third-party claims
and if the defense clause covers the allegations (not the ultimate merits
of the action) in the complaint.
Parties entering into a commercial contract should be particularly cognizant
of whether the contract contains a properly drafted indemnification clause;
the failure to include a properly drafted indemnification clause may result
in the: non-breaching party being unable to obtain certain types of reimbursement
(i.e., attorney’s fees) and the breaching party being unable to
adequately cap its liability. When drafted improperly, an indemnification
clause can subject a party to continuing liability for circumstances beyond
its control. When drafted properly, an indemnification clause can be a
powerful tool to shield a party from lawsuits and damages.