“Let’s leave that to the lawyers.” It’s a familiar refrain that I hear often as contract negotiations drag on between parties. After the primary deal points in a contract have been agreed upon, many clients believe that the remaining terms can be easily resolved without their involvement. Unfortunately, this is rarely the case, as what some clients perceive to be boilerplate or “standard” could become critically important if a dispute arises relating to the transaction.
One such provision is indemnity. Indemnity is defined by statute in California as “a contract by which one engages to save another from a legal consequence of the conduct of one of the parties, or of some other person.”[1] In other words, one party (known as the indemnitor) agrees to be responsible for certain liabilities of another party (known as the indemnitee). It’s similar to a guaranty, but instead of guaranteeing a specific obligation such as a loan, an indemnity is a broader agreement to pay for damages incurred by the indemnitee if certain circumstances occur.
Perhaps unsurprisingly, defining the scope of those circumstances is paramount. The language of these provisions typically starts the same: “Party A agrees to indemnify, defend and hold harmless…” From there, the parties will have to decide how and when that indemnity will apply:
- Who is indemnified? Is the indemnity limited only to the party to the contract, or also to its owners, employees, agents or affiliates? Obviously, the more parties that are indemnified, the greater the risk that a claim will occur.
- What claims will give rise to a right of indemnity? Typically, these provisions include situations such as a party’s breach of the contract and/or a party’s negligence (or gross negligence) or intentional misconduct. This list can be expanded depending on the transaction, such as a broad “all acts or omissions occurring on the Premises” during the term of a lease.
- What procedural requirements will serve as conditions precedent to an indemnity? For example, the indemnitor may not be liable under its indemnity unless the indemnitee gives notice of the claim within a specific time. In addition, the indemnitor’s liability may not apply unless the total damages incurred exceed a minimum threshold and/or are less than a maximum liability threshold.
One common misperception regarding indemnities is whether the provision should be limited to third party claims. The contracting parties will be liable for a breach of contract regardless of whether an indemnity provision is included. An indemnity’s importance applies in the context of third-party claims, since these claims will be asserted by a non-contracting party and the scope of liability under California law may not be clear. For example, if a seller defaults under a purchase contract, the escrow company may assert a claim for cancellation costs against the parties, including the non-defaulting buyer. With an indemnity, a buyer can seek indemnification against the seller for those costs.
Finally, all indemnities should exclude the acts of the indemnitee. These exceptions will typically provide that the indemnity does not apply to the extent caused by the negligence (or gross negligence) or intentional misconduct of the indemnitee.
Now, I’m not suggesting that my clients should take over the negotiations of contractual indemnities, which require a thorough comprehension of multiple legal principles. Rather, the purpose of this article is to provide a basic explanation of the concept and some key terms to consider. A client that understands the importance of an indemnity and thinks through how it should apply to a transaction will save considerable time (and therefore legal expense) in contractual negotiations.
[1] Cal. Civ. Code § 2772.
