When Does Your Business Need an Indemnification Agreement?

Most standard contracts and contract templates for companies include something called an indemnification clause. Although many contracts between California business entities include this provision, they are often improperly written and deployed. As an entrepreneur, you might sometimes hear an indemnification clause referred to as a “hold harmless” clause; this verbiage gives us a clue to the ultimate purpose of this particular contract provision. 

What Is an Indemnification Agreement?

To “indemnify” a person or entity means you cover any losses specified by the applicable indemnification agreement. Essentially, you take the place of the party who is otherwise subject to a loss. 

Why would anyone agree to cover another party for losses? Depending on the circumstances, many parties in a business-to-business contract insist on some sort of indemnification clause if they are in a position to lose money should the other party breach the contract. If the other party breached the contract it had with your company and a third party came after you, having an effective indemnification provision would be useful. 

When Are Indemnification Provisions Used?

Broadly speaking, parties should implement an indemnification clause when either party’s breach of contract (or general malfeasance) would foreseeably result in losses for the non-breaching party. Companies should be sure to include such provisions in the following circumstances: 

  • An individual or business purchases goods or services from your company;
  • Another company or individual agrees to provide goods or services to your company; or
  • One company merges with or acquires another company.

To illustrate an indemnification clause, let’s say you are acquiring a competitor and all of its intellectual property. After the acquisition, you receive a cease-and-desist letter from another company alleging trademark infringement because one of the trademarks you purchased as part of the acquisition infringes on an existing mark. 

Upon advice of counsel, you decide to honor the company’s wishes and cease using the trademark. However, your business misses out on potential revenue because you are not able to use the trademark. As long as the acquired company guaranteed the authenticity of its intellectual property in the representations and warranties section of the M&A agreement, you have a good chance of obtaining coverage for any losses.

The exact structure of indemnification provisions used by your company depends on many factors. In some cases, you will want to negotiate greater protections under the provision. In other cases—such as when you are providing goods and services to another party—it is best to limit the coverage included in your indemnification provision. Indemnification provisions may be limited by a specific claim’s dollar amount, timeframe, or type. 

Conclusion

Indemnification provisions are an important of many commercial contracts, but they are complex and can require extensive negotiation. Relying on the generic language afforded by a contract template is probably not in your company’s best interests. The team at Integrated General Counsel is prepared to help draft and optimize every contract you need. Call us at (925) 399-1LAW to learn more.