Not My Problem: Indemnification

Is an indemnification clause right for your client?

Damages are a common-law remedy for misrepresentation or for breach. Indemnity, by contrast, is a remedy created by contract when a party seeks a remedy that’s broader or narrower than the common-law damages (in other words, something other than just “being made whole”).

If common-law damages are too limited or extensive to meet your client’s needs, an indemnification clause may be your answer.

Include an indemnification clause to serve any of these purposes:

Purpose One

To expand on common-law damages by providing a remedy not generally available at common law, such as the following:

  • Attorneys’ fees and expenses associated with a contractual breach—costs that are generally not recoverable in the United States and in other jurisdictions without a UK-style “loser pays” rule.
  • Liability arising from a disclosed fact (for example, an environmental contamination or a pending or threatened claim).
  • Losses caused by a third party (for example, a vendor’s claim against a business for goods delivered before the business changes hands).
  • Losses associated with external events or circumstances outside a party’s control (for example, a regulatory agency’s denial of an approval that is a condition to closing).

Purpose Two

To limit the indemnity party’s financial responsibility:

  • Capping a party’s potential liability.
  • Providing for a deductible or threshold amount of damages that must be incurred before the breaching party is liable.
  • Limiting or eliminating a party’s potential liability for certain types of damages (for example, consequential damages).
  • Shortening the time available for a party to bring a claim under the applicable statute of limitations.

Purpose Three

To put an affiliate of a party on the hook (for example, to shift liability to a party’s deep-pocketed sponsor formed solely for the purposes of a certain transaction). Of course, the affiliate must have signed either the agreement itself or a separate indemnity agreement.

Purpose Four

To attempt to create an exclusive remedy for claims, whether those claims are based in breach of contract (or warranty) or in tort (such as misrepresentation, fraud, or gross negligence). When using an indemnification clause for this purpose, keep in mind:

  • When, and to what degree, a court will honor an exclusive-remedy provision to disallow extra-contractual (tort) remedies varies greatly among jurisdictions. When the alleged misstatement rises to the level of fraud, at least some courts will override the exclusive-remedy provision no matter how tightly drafted it is. See, e.g., ABRY Partners V. L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006).
  • An effective exclusive-remedy provision requires customized drafting of not just the indemnity term but also the governing-law and entire-agreement terms, as well as both disclaimers of reliance on representations and warranties outside the contract and disclaimers of recourse against the individuals who allegedly make them.

This article was written with the help of Gary Karl, my co-author for the forthcoming Deal Struck: The World’s Best Drafting Tips.