Business contracts can be complex, and there are several ways that a business owner can be tripped up when drafting one.
A critical component of any commercial contract is an indemnification clause that can eliminate much of the risk to your business in a transaction. In fact, it can be one of the most contentious parts of an agreement, which is why you should understand what it is and its importance.
What is an Indemnification Clause?
Indemnification is the notion that a party will compensate another for loss, damages, or liability, typically because of a third-party claim. An indemnification clause can also cover direct claims—where one party initiates an indemnity clause dispute against the other. It protects a party against the financial fallout from certain actions or events. In other words, this clause manages a party’s legal risk. An indemnification clause also identifies the way in which a party will provide indemnification, detailing the obligations of the indemnifying party to cover the indemnified party for certain losses or damages. Further, this clause will indicate the types of claims covered, the process for claiming compensation, and any limits to liability.
Why Are Indemnification Clauses Important?
Indemnification provisions are critical in commercial agreements because they permit a contracting party to customize the level of risk it’s willing to undertake in each transaction and with every party. This clause also insulates your company from damages and business contract litigation that the other party might assume more efficiently.
Drafting and negotiating an effective indemnification clause can be a benefit to both parties and may let the indemnified party recoup certain types of losses that aren’t usually recoverable under a common law cause of action (like attorney's fees); it also can lower a business’s liability by adding a liability limit and other safeguards.
A company’s commercial contract should have an indemnity clause, and in some circumstances, a number of specific types of indemnity clauses are required. The terms and conditions of indemnification can be tailored to detail the level of risk acceptable to each party. An indemnification clause is an important part of every commercial contract that helps to mitigate the risks and consequences in the event of a breach. It also ensures that the parties are fairly compensated for their losses and helps keep a stable and predictable business relationship.
What Terms Should Be Included in an Indemnification Clause?
Make sure that your indemnification clauses contain the following:
- The scope of indemnification. The extent of the indemnifier's responsibility, specifying the types of losses, damages, and liabilities that are covered.
- Timeframe. The time in which indemnification is applicable, and may be limited to the contract’s duration or beyond the contract’s conclusion.
- Triggering events. A list of the specific events or situations that trigger indemnification.
- Limitations and exclusions. Any limitations on the amount of indemnification or exclusions for certain kinds of damages.
- Insurance. The indemnifying party can be required to have insurance to cover potential indemnification claims and state the type and amount of coverage required to make certain that the indemnifying party has the resources needed to fulfill their obligations.
- Subrogation. Whether the indemnifying party may pursue third parties for reimbursement.
- Claims resolution. The process for initiating an indemnification claim, and includes notice and deadlines.
- Jurisdiction and governing law. The jurisdiction on which any disputes stemming from the indemnification clause will be resolved, along with the governing law that will apply.
Bottom Line
Well-crafted indemnification clauses make certain that each party is protected in the event of a dispute or loss. It also can provide peace of mind to the parties and lets them devote their energies to other aspects of their business relationship by reducing stress and anxiety.
To avoid mistakes in the drafting of a crucial indemnity clause and the prospect of business contract litigation, contact Eanet, PC to review your commercial agreements. Our firm knows California indemnity law and can help you draft contracts that protect your business to the fullest extent.