What is an Indemnification Clause and When Should It be Included in a Contract?
Imagine this: a state chooses to use a phone app during the primaries to allow voters the ease of voting from their own homes. This is believed to be a more efficient and fairer voting process. This app has not yet been used but has been tested many times for accuracy, security, performance, and the like.
Now imagine this: on voting day, something goes terribly wrong and the app doesn’t work properly, causing confusion and chaos. What’s more, voter information is stolen. Who is responsible for the damages? Is it the software company that created and tested the app? Or, is it the state agency that contracted with the software company?
The answer may lie in the contract, especially if there is an indemnification clause. What these clauses are and when they are included in contracts is discussed below.
What are Indemnification Clauses?
Indemnification clauses are clauses in contracts that set out to protect one party from liability if a third-party or third entity is harmed in any way. It’s a clause that contractually obligates one party to compensate another party for losses or damages that have occurred or could occur in the future.
California Civil Code § 2772 defines indemnity 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.
According to California law, if the indemnified party is found liable for damages, then the indemnifying party must pay the costs of the damages and typically the costs of the attorney fees. For example, in the above scenario, if the state agency was sued by its residents and the court favored the residents, the software company would have to pay the costs if it indemnified the state.
Language to look for that would indicate indemnity include:
- hold harmless
When an indemnification clause uses the word “defend,” you want to look at it particularly carefully. “Indemnify” and “hold harmless” both mean pretty much the same thing: to make the injured party whole again. Language using “defend,” on the other hand, may suggest responsibility for defending against lawsuits. Some indemnified parties may prefer to defend against their own lawsuits, so depending on the circumstances and the parties, this language should be carefully considered. In California, you have the option to choose – if you are the indemnifying party – to choose to defend yourself. In fact, California Civil Code § 2778 states:
The person indemnifying is bound, on request of the person indemnified, to defend actions or proceedings brought against the latter in respect to the matters embraced by the indemnity, but the person indemnified has the right to conduct such defenses, if he chooses to do so.
Again, using the above example, the state agency may want to defend itself and has the right to do so, but in these circumstances it may have to pay the attorney fees itself. Likewise, you can choose to defend yourself, too, but may want to ascertain the same in the contract.
When are Indemnification Clauses Used in California Contracts?
Indemnification clauses are used on a regular basis between businesses. Whether or not your company is small and large, tech or professional, indemnification clauses can be useful. These clauses are typically used when either:
- a business wants to guarantee it’s service or product; or
- a business wants to protect itself from liability, especially in cases of sub-contractors.
Implicit in the above is this: these clauses are very often one-sided. Because one party may have to shoulder the burden of all the costs, you always want to consult with an attorney. If you are a startup company and are also the indemnifying party, one lawsuit could be the end of your business.
Keep in mind, these clauses can be negotiated or worded to address specific events that would invoke them, and an experienced business attorney is best able to advise you.