Understanding Contractual Indemnity
Indemnity clauses appear in all kinds of contracts. The word indemnity is commonly used in law, and in business—yet many businesses that enter into contracts have no idea what it means, or what the ramifications may be when the term is used.
The best way to understand what an indemnity agreement is is by illustration. Let’s pretend there are 2 contracting parties:
- Company 1, which wants a contractor to develop software for it, and
- Company 2, a software development company.
Company 1 hires Company 2 to develop software for it.
But Company 2 has some concerns. It knows that Company 1 is in a high-risk industry, where lawsuits are common. It also knows that the software being developed could lead to lawsuits. Company 2 doesn’t want to be responsible for lawsuits brought against Company 1. Company 2 is, after all, just a contractor performing a single service for Company 1, with no say in how Company 1 runs its business.
So, Company 1 tells Company 2 “If anybody sued you for anything we (Company 1) do, we will pay any damages that you have to pay to that person.”
That is the nature of indemnity: A promise to protect another person or company, from any suits or damages that may be brought against them.
Indemnity Options in Contracts
Indemnity is not as easy as that, because there are different kinds of indemnification scenarios.
Using our example, Company 1 would have some options. It could
- Promise to pay any damages from any lawsuits brought only against Company 2, no matter why the lawsuit was brought, or
- Promise to pay any damages from any lawsuits brought against Company 2 for anything that Company 1 may have done wrong – Company 2 is still “on the hook” for any damages that may arise from Company 2’s own actions.
What is Being Indemnified?
On top of these options, an indemnification agreement must also address exactly what is being indemnified—that is, what is being paid, and when the indemnity obligation takes effect. For example, a party can agree to pay any judgment entered against another party, but could also agree to also pay any settlement even in the absence of a judgment.
Of course, governmental fines, regulatory penalties, or administrative law claims can also be indemnified, as can the costs of defending a lawsuit, such as attorneys fees and costs.
Control is an issue as well—if Company 1 is indemnifying Company 2, does Company 1 select, hire, and pay its own lawyers? Does Company 1 select Company 2’s lawyers, or can Company 2 select its own lawyers, and send the bill to Company 1? Who has the final authority to settle a claim or case?
There is no right or wrong way to do things when it comes to indemnification options. The key is to be clear what is being indemnified, and when the obligation to indemnify arises in your business law contracts.
Call the West Palm Beach business litigation lawyers at Pike & Lustig for help drafting and reviewing your business agreements.