Indemnification
A contractual obligation where one party agrees to compensate another for certain losses or damages. It shifts financial responsibility from one party to another, often appearing as "hold harmless" clauses.
Explanation
Indemnification clauses are risk allocation tools found in virtually every commercial contract. They determine who bears the financial burden when things go wrong, particularly regarding third-party claims.
These provisions often accompany representations and warranties. If a representation proves false or a warranty is breached, the indemnification provision specifies the remedy. The scope can vary dramatically—some indemnities cover only third-party claims, while others extend to all losses including direct damages between the parties.
Key negotiating points include: which losses are covered, any caps or baskets (minimum thresholds), survival periods after closing, procedures for notice and defense of claims, and whether the indemnitor controls litigation. Understanding and negotiating these terms is essential in any significant transaction.
Real-World Examples
Vendor Contract Indemnification
A software company licenses its product to a business. The license includes an indemnification clause for intellectual property infringement.
If a third party sues the business claiming the software infringes their patent, the software company must defend the lawsuit and pay any damages, protecting the customer from IP liability.
Commercial Lease Indemnification
A tenant's customer slips and falls in the leased space due to a wet floor the tenant failed to clean. The lease contains tenant indemnification for injuries in the premises.
When the injured customer sues both landlord and tenant, the tenant must indemnify (compensate) the landlord for any costs or judgments, as the injury occurred due to tenant's negligence.
M&A Indemnification
Company A buys Company B. After closing, Company A discovers Company B had undisclosed tax liabilities of $2 million. The purchase agreement includes seller indemnification for undisclosed liabilities.
Company A can seek indemnification from the sellers for the $2 million tax liability, shifting this unexpected cost back to those who represented there were no such liabilities.