Entering into contracts with other businesses or individuals may expose your organization to some risks and liabilities. An indemnity agreement can help protect you from liability caused by the contracting party’s negligence or breach of contract.
Indemnity agreements are complex business contracts, so you must approach them carefully to ensure you get the intended protection under the agreement.
What is an indemnity agreement?
An indemnity agreement is a contract that protects one party of a transaction from the risks or liabilities created by the other party of the transaction. Hold harmless agreement, no-fault agreement, release of liability, or waiver of liability are other terms for an indemnity agreement.
For instance, car rental companies usually require a renter to sign an indemnity agreement to hold the company harmless for any loss, damage, or legal action against it because of the renter’s use of the car. Meaning that, if an accident happens while the renter is using the car, the car rental company will not be liable for any damage.
An indemnity agreement will protect the party indemnified from lawsuits, damages, or claims from third parties. The party that provides the protection is the indemnitor, while the party protected is the indemnitee.
Indemnity agreements usually work in either or both of the following ways:
- To protect the indemnified party from any liability arising from third party claims
- To prevent the indemnitor from making any claim against the indemnified party
When do you need an indemnity agreement?
You need an indemnity agreement when you want to transfer liability from one party to another. You should use an indemnity agreement when a contracting party will be involved in acts that carry some risk.
Some transactions with inherent risk include:
- Hiring a party to provide a service for your business
- Allowing a party to use your property or equipment
- Providing high-risk services
- Permitting high-risk activities on your property
How to create an indemnity agreement
Your goal when creating an indemnity agreement depends on whether your company is the indemnitor or the indemnitee. As the indemnitor, you want an indemnity agreement that holds your company liable only for its negligent acts or breach of contract. But if you are the indemnitee, you want an indemnity agreement that protects your company as much as is legally enforceable.
Types of indemnity agreements
Indemnity agreements are classified based on the degree of protection they offer the indemnified party.
Broad form indemnity agreement
Under a broad form indemnity agreement, a party is indemnified from liability even when that party is the sole cause of the liability. This type of indemnity agreement is rare and unenforceable in many states—including California—especially in construction contracts.
Intermediate form indemnity agreement
An intermediate form indemnity agreement indemnifies a party for negligence unless the party is solely at fault, meaning the indemnitor will still protect a partly negligent indemnitee. This type of indemnity agreement usually includes the phrase “caused in part.”
Comparative form indemnity agreement
Under this type of indemnity agreement, each party is responsible for acts caused by its negligence. Each party agrees to hold the other harmless for actions caused by its negligence.To spot a comparative form indemnity agreement, look for the term “only to the extent.”
Limitations on indemnity agreements
No indemnity for illegal acts
Parties cannot use an indemnity agreement to shield themselves from liability for illegal acts. This will also include any amount a party is fined for the offense.
Use of an indemnity cap
It’s also common for parties to limit the indemnifiable amount to a certain dollar amount. For instance, an indemnity agreement can provide that the indemnitor is only liable for loss not exceeding $500,000. In that case, the indemnitor won’t be liable for more than $500,000, even if the loss suffered by the other party exceeds it.
Parts of an indemnity agreement
An indemnity agreement should contain the following key terms:
Governing law and jurisdiction
Indemnity laws vary state by state. While some states have anti-indemnity statutes, some don’t. You should consider this when specifying the state law that will govern the agreement.
Your indemnity agreement may also state that the courts will have jurisdiction to settle any dispute or claim that may arise from the agreement.
The indemnification clause is the crux of your indemnity agreement. This is where you state the acts that the indemnitee will be indemnified against. You should ensure the wording is unambiguous, especially if your business is the protected party under the agreement. This is because any ambiguity is normally resolved in favor of the indemnitor.
Standard drafting of this clause will include that the indemnitor agrees to “indemnify, defend, and hold harmless” the indemnitee. It’s crucial to include this phrase in every indemnity agreement.
Scope of coverage
Your indemnity agreement should state the extent of protection the indemnitee can claim under the transaction. Before you sign off on any indemnity agreement, you want to ensure that you are only taking on liabilities caused by your company’s actions.
This is where the agreement specifies any condition under which the indemnitee will not be protected by the indemnitor. The conditions will vary based on the nature of the agreement. It’s common to state that an indemnitee will not be indemnified where the indemnitee:
- Committed a criminal offense, unless there was sufficient reason not to know that the act was unlawful
- Acted in bad faith or unreasonably
- Benefited from the act
- Received or will receive compensation under a valid insurance policy, indemnity agreement, or bylaw, unless such compensation did not fully cover the loss
Notice and defense of a claim
An indemnity agreement should provide how the indemnitee will give the indemnitor notice of a claim or dispute covered under the indemnity agreement. It should also detail steps for how the indemnitor can defend the claim.
Settlement and consent clause
This clause provides how parties will get each other’s consent before engaging in settling an action or claim covered under the indemnity agreement.
The indemnity agreement should also provide how the indemnitee can enforce the agreement if the indemnitor refuses to fulfill its obligation.
An indemnity agreement should provide how long the rights and obligations between the parties will exist.
Managing indemnity agreements
Businesses face challenges with indemnity agreements in two major ways.
Negotiation: For several reasons, an indemnity clause is one of the most contentious terms to negotiate. It imposes liability once fault is determined, and sometimes even before fault is determined. Also, many people don’t understand the meaning of the technical terms used in an indemnity agreement.
Litigation: Indemnity agreements are often heavily litigated. It’s common for the indemnitee to be added as an insured party under the appropriate insurance policy. This means that, until there’s a defense and indemnification claim, you may think you’ve covered your bases. When the courts have to interpret the indemnity agreement and the insurance policy, it can easily become a lengthy process.
Why use digital contract management for an indemnity agreement
Most commercial, construction, and service contracts use an indemnity agreement. For a large organization, this can quickly amount to hundreds or even thousands of indemnity agreements you need to manage.
Indemnity agreements will either expose or protect your organization from liability. To successfully manage them requires a high level of collaboration between your Legal and Risk Management departments.
These departments need a tool to help them do their jobs. A digital contract management tool will help them in the following ways:
- Generate indemnity agreements faster
- Negotiate more collaboratively with stakeholders
- Store the agreements in a central location for easier management
Automate workflows for indemnity agreements
Indemnity agreements are high-risk contracts, and you need to be cautious when dealing with them—from creation to negotiation to approvals and execution.
Your organization probably already has a process for generating and negotiating indemnity agreements. How about automating it?
How contract management software can help simplify the process
Create indemnity agreements with ease
Indemnity agreements are contentious contracts that must be drafted with care. Workflows will help you create templates for different transactions. Using templates to generate indemnity agreements will not only save you time, but will also keep those agreements in compliance with your company’s standards.
Streamline your negotiation
We said earlier that an indemnity agreement is one of the most contentious contracts to negotiate. Usually, there will be lots of redlining. A contract management tool enhances communication and collaboration, resulting in a more streamlined and faster negotiation process.
Tighten your approval process
An indemnity agreement is usually a high-risk contract. Using a contract management tool, you can ensure no agreement leaves your organization without first passing through the designated channels. The individuals who need to approve the agreement will also receive a prompt when it’s time for them to weigh in. This way, no agreement will slip through without approval, and it can happen promptly.
Leverage Workflow Designer to automate indemnity agreements
- What is an indemnity agreement?
- When do you need an indemnity agreement?
- How to create an indemnity agreement
- Types of indemnity agreements
- Limitations on indemnity agreements
- Parts of an indemnity agreement
- Managing indemnity agreements
- Why use digital contract management for an indemnity agreement
- Automate workflows for indemnity agreements
- How contract management software can help simplify the process
- Leverage Workflow Designer to automate indemnity agreements
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Ironclad is not a law firm, and this post does not constitute or contain legal advice. To evaluate the accuracy, sufficiency, or reliability of the ideas and guidance reflected here, or the applicability of these materials to your business, you should consult with a licensed attorney. Use of and access to any of the resources contained within Ironclad’s site do not create an attorney-client relationship between the user and Ironclad.