Law School for Entrepreneurs: Indemnification Clauses

January 7, 2013

11:00 am

Reading contracts – it’s not as cool as growth hacking, and it’s not as sexy as raising a Series A round.  But it is necessary for every entrepreneur to have a basic understanding of common contract provisions, which can help save both time and money.  The topic of this post: indemnification provisions.

Here is a basic one:

Smith shall indemnify and hold Jones harmless against any and all claims, demands, damages, liabilities and costs incurred by Jones which directly or indirectly result from, or arise in connection with, any negligent act or omission of Smith, its agents, or employees, pertaining to its activities and obligations under this Agreement.

Think of an indemnification like an informal insurance policy.  Basically, the party with whom you are entering into an agreement is agreeing to pay for any damages you incur which it causes.  For example, in the quoted provision, Smith agrees that if his negligence causes Jones to get sued, Smith will pay Jones’ costs.

Consider this example: BentoToGo delivers bento lunch boxes to busy office workers.  In order to meet demand, BentoToGo hires a delivery service that agrees to provide 100 delivery drivers to deliver the boxes.  BentoToGo should ask the delivery service to agree to indemnify Bento (and pay for damages) in case the delivery drivers get into a car accident or spill a hot bento box over a customer’s lap.

In both cases, the delivery service would be liable for any damages.  But, it’s likely that BentoToGo would also be sued since the delivery service was acting on Bento’s behalf.  When Bento is sued, it is in a much better position if it has a contractual indemnity from the delivery service.  Bento can require the delivery service to pay its attorney fees from day one.

Here are a few keys to negotiating indemnification provisions:

  1. Make them mutual.  If the other party in your contract wants you to give them an indemnification, make them give you one as well.
  2. Make them narrow.  If you indemnify the other party in your contract, tailor the provision narrowly and only for your grossly negligent, reckless or intentional behavior (not just simple negligence).
  3. Create a procedure.  A good indemnification will set out a procedure for one party to inform the other of a lawsuit or claim and set out clearly how the other party will respond.

Most importantly, try to stick to a policy on indemnification.  Either always give them or never give them.  If you give them, always make them mutual and narrow.

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Clint Costa is an attorney and CPA with the Chicago law firm of Harrison & Held, LLP, working with startups, entrepreneurs, and privately held companies on all manner of official-sounding legal and tax matters. Reach Clint at ccosta@harrisonheld.com or (312) 803-7104.

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