Many types of contracts include indemnification provisions. In a typical indemnification provision, one party (the indemnifying party) agrees to reimburse another party (the indemnified party) for specified recoverable damages that arise from certain covered events.
Such provisions usually state (a) the obligation of the indemnifying party to defend, indemnify and hold harmless, (b) the identity of the indemnified parties, (c) the types of recoverable damages, (d) the covered events for which indemnification will be provided, and (e) the required nexus between the covered events and the recoverable damages, i.e., the nexus phrase.[1]
This article frequently references the sample indemnification provision below as an example:
Seller shall defend, indemnify and hold harmless Buyer, its affiliates, the successors and assigns of Buyer and its affiliates, and the stockholders, directors, officers, employees, agents and representatives of the foregoing parties from and against all losses, liabilities, claims, and causes of action, including attorneys’ fees and related defense costs (“Losses”), regardless of whether any such Losses are incurred directly by an indemnified party or in connection with a third-party claim, arising pursuant to or in connection with (a) the failure of the equipment to conform to its specifications or any express or implied warranties; (b) defects in the design, material or workmanship of the equipment; (c) any infringement by the equipment of third party intellectual property rights; (d) any breach of laws by Seller, its employees or contractors; or (e) the negligent acts and omissions of the Seller, its employees or contractors.
1. Indemnify, Defend and Hold Harmless
The obligations to “defend, indemnify and hold harmless” have separate and distinct legal meanings. The obligation to defend is distinct from the obligation to indemnify because, subject to any control of defense provisions providing otherwise, it requires the indemnifying party to defend in court the indemnified party from third party claims. Some states also have given the hold harmless obligation a distinct meaning from the indemnification obligation, holding that a hold harmless clause releases the indemnified party from any related claim or cause of action of the indemnifying party.
2. Identity of Indemnified Parties
Certain related parties of the indemnifying party may suffer damages or be sued in connection with a matter for which the indemnifying party is required to indemnify the indemnified party. The indemnified party thus should include under the indemnification provision any related parties that may suffer damages or be subject to third party claims in connection with any matter for which the indemnifying party is providing indemnification. The description of the indemnified parties under the sample indemnification provision above addresses this concern by including Buyer, its affiliates, the successors and assigns of Buyer and its affiliates, and the stockholders, directors, officers, employees, agents and representatives of the foregoing parties.
3. Types of Recoverable Damages
An indemnification provision should identify (a) what types of damages are covered, (b) whether direct claims are included as well as third party claims, and (c) whether attorneys’ fees are covered.
Although seemingly redundant, different types of recoverable damages specified in an indemnification provision have different meanings. Consider, for example, the phrase “losses, liabilities, claims, and causes of action” in the sample indemnification provision above. Losses include covered final judgments, settlement amounts, fees, costs and expenses. Liabilities include debts and other legal obligations. Claims refer to damages from a third-party lawsuit. Causes of action include damages resulting from a right to seek relief.
An indemnified party’s obligation to provide indemnification may apply to direct claims (i.e., claims that the indemnified party has against the indemnifying party) and third-party claims brought against an indemnified party. An indemnification provision should state which of these types of claims are covered. The sample indemnification provision, for example, covers both types of claims by including the phrase “regardless of whether any such Losses are incurred directly by an indemnified party or in connection with a third-party claim.” Some contracts limit indemnification obligations to third party claims because the indemnified party has other remedies at common law, including breach of contract and tort claims.
The obligation to defend implicitly includes the obligation to pay attorneys’ fees and related legal costs and expenses but, under state law, the indemnification obligation typically does not include these amounts. Every indemnification provision therefore should state whether attorneys’ fees and related legal costs and expenses are included in the recoverable damages, and the sample indemnification provision expressly includes these.
4. Covered Events
Any indemnification provision must state the covered events, like subclauses (a)-(e) in the sample indemnification provision. The indemnified party typically bargains for more covered events and tries to make these as broad in scope as possible, and the indemnifying party usually bargains for as few narrowly-tailored covered events as possible. For example, the list of covered events in subclauses (a)-(e) is inclusive and favorable to the indemnified party. An indemnification provision drafted by an indemnified party, on the other hand, could limit the covered events to (a) any failure of the equipment to conform to its specifications and (b) any reckless acts or omissions, or deliberate misconduct of, the seller, its employees and contractors.
5. Nexus Phrase
The nexus phrase links the list of recoverable damages to the covered events, determining the extent to which a covered event and the recoverable damages must be related for the event to qualify for indemnification. In the sample indemnification provision above, the nexus phrase is “pursuant to or in connection with.” This is a broad nexus phrase, effectively providing that as many of the recoverable damages as possible related to the covered event are subject to indemnification. The indemnified party, on the other hand, typically prefers a narrow nexus phrase in order to limit the indemnification obligation as much as possible. Narrow nexus phrases include “caused by,” “resulting from,” and “solely to the extent that they arise out of.”
[1] A subsequent article will describe the various limitation of liability approaches by which parties may limit or alter the scope of an indemnification provision, including caps, thresholds, materiality and knowledge qualifiers, disclaimers of consequential damages, and defense provisions.
