Arguments for Including Indemnities in a Contract: Risk allocation: Indemnities play a critical role in allocating risks between parties in a contract. By clearly defining the responsibilities of each party and outlining the consequences for breaches, indemnities provide a framework for managing potential liabilities and mitigating the impact of unexpected events. Financial protection: Indemnities offer financial protection to the indemnified party by shifting the burden of potential losses to the indemnifying party. This can be particularly important in high-stakes transactions or when dealing with potentially costly claims, such as intellectual property infringement or product liability issues. Clarity and predictability: Including indemnities in a contract helps establish clear expectations for both parties, outlining the procedures for addressing claims and disputes. This clarity can promote a more predictable and stable business relationship, reducing the likelihood of misunderstandings or conflicts. Incentive for compliance: Indemnities create an incentive for parties to comply with their contractual obligations, as they face potential financial consequences for breaching the agreement. This can promote more responsible and diligent behavior, ultimately benefiting both parties.

Arguments against including Indemnities in a Contract: Overreaching indemnities: Overly broad indemnities can unfairly burden one party with risks that they may not be able to control or manage effectively. This may create an imbalance of power within the contractual relationship, which can lead to disputes or the indemnifying party being unable to fulfill their obligations. Inhibited negotiation: The inclusion of indemnities can sometimes lead to protracted negotiations as parties try to allocate risks and responsibilities. This can delay the execution of the contract and potentially harm the business relationship between the parties. Limited enforcement: Depending on the jurisdiction, some indemnities may be difficult to enforce or may be subject to specific limitations. This can create uncertainty and may undermine the intended purpose of the indemnity, ultimately weakening the indemnified party's protection. Potential for misuse: In some cases, indemnities may be used as a bargaining chip or as leverage in negotiations, which can lead to disputes and potentially harm the parties' relationship. This can create an environment of mistrust, hindering cooperation and collaboration between the parties.

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Indemnity blocks

Q: Indemnity obligation

Indemnified Party- Firstly, who is being indemnified? Also, will the Indemnified Party's Affiliates, employees, contractors etc. also be indemnified? Scope of indemnity- Next, decide on if the indemnity obligation relates to only indemnifying the Indemnified Party or must an obligation created to indemnify, defend and hold harmless the Indemnified Party?

This guide explains the different parts that makeup indemnity blocks.

Intro

Indemnity

An indemnity block aims to protect the Indemnified Party against certain liability or losses that the Indemnified Party is not willing to take when entering into the transaction.

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For example, suppose you are the Customer using the Provider’s Software. In that case, you do not want to be exposed to claims from third parties for the infringement of intellectual property rights related to the use of the Software. Therefore, the indemnity creates an obligation on the Provider to cover you for the indemnified losses arising from the intellectual property infringement claim.

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The general belief is that an indemnity provides an easier way to recover losses and isn’t easily resisted in legal proceedings (this belief is because an indemnity creates a primary obligation and functions as a debt and is not a claim for breach of contract).

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If the Indemnified Party suffers the indemnified loss, a claim can be instituted under the indemnity. The usual hurdles relating to causation and mitigation are side-stepped (in a way), and an Indemnified Party may be able to recover more losses (compared to losses recoverable under a breach of contract).

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The above, however, only holds if the indemnity is worded properly and used correctly.

Different types of indemnities

There is no exhaustive list of indemnity types, as they can vary depending on the specific circumstances of a contractual agreement. However, indemnities can be categorized into two groups: third-party indemnities, which cover claims made by external parties, and inter-party indemnities, which address losses suffered by the indemnified party due to the other party’s breach of the agreement.

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The appropriate indemnities to incorporate into a contract depend on the nature of the transaction, the associated risks, and, to some extent, the industry involved.

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Common indemnities in tech-related contracts include:

Indemnities against third-party intellectual property infringement claims: When purchasing or reselling software, avoiding exposure to intellectual property infringement claims related to the product is crucial. Typically, the provider assumes this risk, which can be transferred to them through an indemnity clause against third party intellectual property claims in the agreement.
Indemnities against third-party claims: Depending on the risks faced by the indemnified party, an indemnity may be included to cover any potential third-party claims. Commonly, third-party indemnities protect the indemnified party against claims involving personal injury, property damage, legal breaches, and employee or contractor compensation.
Indemnities related to breach of contract: These indemnities are generally specific to certain types of breaches. For example, let’s say a breach of the data security obligations will be detrimental to the Customer; in such a case, the Customer may want to include a specific indemnity relating to the breach of the data security obligations.

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Ultimately, it is essential to carefully assess a given transaction’s unique risks and considerations to determine the most appropriate indemnities for inclusion in a contractual agreement.

FREE Quick reference guide

Parts

Indemnity obligation

Indemnified Party-

Firstly, who is being indemnified? Also, will the Indemnified Party’s Affiliates, employees, contractors etc. also be indemnified?

Scope of indemnity-

Next, decide on if the indemnity obligation relates to only indemnifying the Indemnified Party or must an obligation created to indemnify, defend and hold harmless the Indemnified Party?

Indemnified losses

Indemnified Losses refer to the losses the Indemnified Party can claim under the indemnity.

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Here are a couple of examples of common losses that can be claimed under an indemnity-

paying for judgment finally awarded
paying for settlements
legal fees and costs (reasonably incurred)
legal fees and cost
fines
penalties
expenses

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It is important to be as specific as possible here and make sure you are clear on the Indemnified Losses.

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When acting for the party being indemnified, you want to include as many possible losses and damages which can be claimed under the indemnity to ensure maximum protection on the happening of an Indemnified Event. Furthermore, you also want to be clear that the indemnified losses will not be limited to the extent that such losses were foreseeable or not.

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When acting for the party providing the indemnity, you need to aim for the opposite and make the Indemnified Losses as specific and narrow as possible.

Indemnified event

The Indemnified Event is the trigger required to claim under an indemnity.

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For example, an Indemnified Event may be a situation where a third-party institutes (or even only threatens), for example, an IP infringement claim against the Indemnified Party due to their use of Software supplied by the Indemnifying Party.

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If you are the Indemnified Party, you want the Indemnified Event to be comprehensive and to occur as soon as the possibility of a claim arises.

Claims procedure

The claims procedure refers to the process the Indemnified Party needs to follow to claim under a third-party indemnity.

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Generally, if you are indemnifying someone else, you want them to jump through a couple of hoops before they can claim under the third-party indemnity.

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Typical claims procedures relate to when notification must be provided to the Indemnifying Party, the right to control the legal proceedings and the obligation to provide reasonable assistance.

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Some indemnities provide that if the claims procedures are not adhered to, the Indemnifying Party will be absolved from their obligations under the indemnity. This provision benefits the Indemnifying Party and may be necessary for certain circumstances.

Exclusions

The exclusions refer to the claims that will not be covered under the indemnity and are often the most negotiated part of indemnity provisions.

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The effect of an exclusion is that if an Indemnified Event occurs, the Indemnified Party cannot claim under the indemnity.

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Examples of typical exclusions are if the Customer modifies the supplied product somehow or the Client uses the product beyond specification/documentation.

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These Exclusions must be worded carefully and must usually provide that the exclusion only applies to the extent that the exclusion relates to the claim.

Remedies

Must the indemnity be regarded as the exclusive remedy on the happening of an Indemnified Event? In other words, must the Indemnified Party only be able to claim under the indemnity and will not be allowed to claim damages under breach of contract?

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Stipulating that the indemnity is the exclusive remedy can benefit the Indemnifying Party. Suppose the Indemnified Losses part of the indemnity provisions is drafted in your favour. In that case, the losses that can be claimed will be limited and very specific, enabling you to take out appropriate insurance.

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However, if you are the Indemnified Party, you what to have all options open and pursue the remedy that will be most beneficial to you. Generally, you don’t want to agree that the indemnity will be the exclusive remedy.

Limitation of liability

A limitation of liability clause may limit the extent to which you can recover losses under an indemnity (i.e. there is a liability cap). If you are acting for the Indemnified Party, you would want to avoid a situation where there is a cap placed on an indemnity claim.

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Some commentators argue an indemnity is a debt and not a liability and therefore does not fall under the limitation of liability. But rather be safe than sorry. If you do not want the indemnity to be limited by the limitation of liability, make sure to expressly stipulate this (i.e. carve it out from the scope of the limitation of liability provisions).

Minimum claim amount

Defending claims under indemnities can cost a lot of money. You do not want to get involved in legal proceedings where the legal costs will exceed the actual claim amount.

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For the above reason, you want to include a minimum claim amount. In other words, the Indemnifying Party will not be liable for any claim where the claim is below a certain amount.

Mitigation

Different legal jurisdictions handle mitigation obligations differently when it comes to indemnities. For this reason, it is suggested that you expressly provide whether or not there is an obligation to mitigate losses on the happening of an Indemnified Event.

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If you are acting for the Party providing the indemnity, you want the Indemnified Party to do everything possible to keep the Indemnified Loss to a minimum.

Reserved rights

If you are acting for the Indemnifying Party, it is usually a good idea to reserve some rights for the Indemnifying Party if the paw-paw hits the fan.

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For example, the Indemnifying Party would typically want to have the right to replace any product subject to an IP infringement claim the moment such a claim is threatened.

Important considerations

Arguments for

Arguments for Including Indemnities in a Contract:

Risk allocation: Indemnities play a critical role in allocating risks between parties in a contract. By clearly defining the responsibilities of each party and outlining the consequences for breaches, indemnities provide a framework for managing potential liabilities and mitigating the impact of unexpected events.
Financial protection: Indemnities offer financial protection to the indemnified party by shifting the burden of potential losses to the indemnifying party. This can be particularly important in high-stakes transactions or when dealing with potentially costly claims, such as intellectual property infringement or product liability issues.
Clarity and predictability: Including indemnities in a contract helps establish clear expectations for both parties, outlining the procedures for addressing claims and disputes. This clarity can promote a more predictable and stable business relationship, reducing the likelihood of misunderstandings or conflicts.
Incentive for compliance: Indemnities create an incentive for parties to comply with their contractual obligations, as they face potential financial consequences for breaching the agreement. This can promote more responsible and diligent behavior, ultimately benefiting both parties.

Arguments against

Arguments against including Indemnities in a Contract:

Overreaching indemnities: Overly broad indemnities can unfairly burden one party with risks that they may not be able to control or manage effectively. This may create an imbalance of power within the contractual relationship, which can lead to disputes or the indemnifying party being unable to fulfill their obligations.
Inhibited negotiation: The inclusion of indemnities can sometimes lead to protracted negotiations as parties try to allocate risks and responsibilities. This can delay the execution of the contract and potentially harm the business relationship between the parties.
Limited enforcement: Depending on the jurisdiction, some indemnities may be difficult to enforce or may be subject to specific limitations. This can create uncertainty and may undermine the intended purpose of the indemnity, ultimately weakening the indemnified party’s protection.
Potential for misuse: In some cases, indemnities may be used as a bargaining chip or as leverage in negotiations, which can lead to disputes and potentially harm the parties’ relationship. This can create an environment of mistrust, hindering cooperation and collaboration between the parties.

World Commerce Principles

World Commerce and Contracting has provided the following principles:

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Indemnification of Third Party Claims (Excluding Intellectual Property Claims)

Indemnifications generally do not encompass claims directly between the parties to the contract.
Although parties to a contract generally recognize that their acts or omissions under the agreement may affect third parties, the Indemnitor should only be expected to step into the shoes of the Indemnitee in taking on damages directly caused by the Indemnitor’s acts or omissions under the contract.
Third parties should not be viewed as beneficiaries of an agreement between customers and suppliers unless expressly made so in the agreement.
Indemnitees should be expected to undertake commercially reasonable efforts to shield themselves from liability (e.g., by including appropriate flow down terms in their own agreements or by reasonably mitigating any damages incurred by the third-party.)
The agreement is not the sole vehicle by which a party can hold the other party accountable for third-party claims. A party can also join the other party as a third-party defendant in litigation initiated by a third party plaintiff.
Indemnification obligations should extend only to the degree that the indemnifying party was responsible for the damages incurred. Proportionate liability should result from situations where multiple parties contributed to an event.
A party’s indemnification obligations should be tied to its own acts or omissions under the agreement as well as that of its subcontractors and agents.
The indemnitor should have full control over the defense and settlement of the claim; however, the indemnitee should be permitted to approve any settlement that requires non-monetary performance by the indemnitee or requires that the indemnitee admit liability or take a public position that may adversely impact its reputation or market stature.
Unnecessary delays in notification to the indemnitor of a third-party claim that negatively impact the defense or settlement should be borne by the indemnitee.

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Indemnification for Third Party IP Claims

Where goods or services are provided by a supplier, the focus of the contract with the customer should be on their characteristics and functionality and how the customer can use them, and the customer should be able to rely on the belief that it will not be subject to any third-party IP infringement claims as long as it complies with instructions provided by the supplier and generally accepted practices.
The supplier should stand behind all intellectual property incorporated into the products, software and/or services conveyed under the contract and indemnify the customer against third-party claims that relate to them, subject to appropriate limitations.

Example clause

1. INDEMNITIES

1.1 Developer indemnity obligations:

(a) For purposes of Section ‎1.1:

(i) Action means any claim, action, cause of action, demand, lawsuit, arbitration, inquiry, audit, notice of violation, proceeding, litigation, citation, summons, subpoena, or investigation of any nature, civil, criminal, administrative, regulatory, or other, whether at law, in equity or otherwise.

(ii) Indemnified Event means any infringement by the Product of a third party Intellectual Property Right.

(iii) Indemnifying Party means the Developer.

(iv) Indemnified Party means the Client.

(v) Indemnified Losses means paying for judgment finally awarded, paying for settlements, legal fees and cost, fines, penalties and expenses

(vi) Intellectual Property Rights means any and all registered and unregistered rights granted, applied for or otherwise now or hereafter in existence under or related to any patent, copyright, trademark, trade secret, database protection or other intellectual property rights laws, and all similar or equivalent rights or forms of protection, in any part of the world.

(vii) Product means the Software and the Documentation provided under this Agreement.

(b) Subject to Sub-Section ‎1.1(c), the Indemnifying Party must indemnify, defend and hold harmless the Indemnified Party from and against Indemnified Losses as a result of an Action relating to, or arising out of Indemnified Event.

(c) The Indemnifying Party is not liable to the Indemnified Party in terms of Sub-Section ‎1.1(b) to the extent that:

(i) combined with any other product, service, or technology;

(ii) modified in any way;

(iii) used in breach of this Agreement or applicable law;

(iv) used without adherence to requirements;

(v) used beyond specification; or

(vi) distributed outside the Territory.

(d) The Indemnified Party must:

(i) promptly notify the Indemnifying Party of the claim;

(ii) give the Indemnifying Party the sole right to control the legal proceedings; and

(iii) provide reasonable assistance and cooperation to the Indemnifying Party during the defence of the claim.

(iv) If the Indemnified Party does not notify the Indemnifying Party as per the obligation under Sub-Section ‎1.1(d), it will not affect the obligation to indemnify as per Sub-Section ‎1.1(b) unless it materially prejudices the ability to defend the Action contemplated in Sub-Section ‎(b).

(e) Indemnified Losses caused by a contributory act or omission of the Indemnified Party, their employees, contractors or agents must be apportioned to the Indemnified Party, and the Indemnifying Party is only liable for losses to the extent that it is its fault.

(f) If a claim under Sub-Section ‎1.1(b) is made against the Indemnified Party, or is likely to be made in the Indemnifying Party s opinion, then the Indemnifying Party may modify or replace the Product that is the subject of the claim, in defense or settlement of the claim.

(g) The Indemnified Party must use reasonable efforts to mitigate their liability if there is a claim instituted against them as contemplated in Sub-Section ‎1.1(b).

(h) Despite anything else stipulated in this Agreement, the indemnity in Sub-Section ‎1.1(b) is the sole remedy available to the Indemnified Party if a claim, as contemplated under Sub-Section ‎1.1(b), is instituted against the Indemnified Party.

(i) Despite anything stipulated in this Agreement, the indemnity in Sub-Section ‎1.1(b) will not be limited by any limitation of liability provisions in this Agreement.

(j) No amounts awarded or agreed to be paid under this indemnity will count towards any liability cap stipulated in this Agreement.

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Primary Blocks

Indemnity blocks