As a transactional attorney, I typically spend time trying to cap or limit my client’s indemnification obligations when negotiating contracts. The word “indemnity” is a legal concept, the meaning of which may not be familiar to non-lawyers.
According to Wikipedia, indemnity is defined as: “a contractual obligation of one party (indemnitor) to compensate the loss occurred to the other party (indemnitee) due to the act of the indemnitor or any other party.”
Although it is not necessary to include an indemnity provision in order to create a legally binding agreement, commercial parties typically agree to stand behind their representations, warranties and covenants by including indemnification clauses in their contracts.
As a starting point, I prefer to limit my client’s indemnity obligations to losses caused directly by their negligent acts and willful misconduct. For example, unless the contract is carefully drafted to link causation to the loss, the mere fact that a tenant possesses a leasehold interest in real property could result in an indemnification obligation if the property is damaged. Further, it is preferable that any such loss would only be the responsibility of my client if they acted negligently or willfully. For example, if the indemnity is limited in this manner and the tenant has “battened down the hatches” in anticipation of a hurricane, it should not be liable for any resulting property damage. Getting these limitations incorporated into contracts often entails a hotly contested negotiation in my deals.
I typically represent service providers and consultants. Many of their contracts provide for a monthly retainer to be paid as compensation for the services to be provided. However, due to the high degree of risk associated with their services (i.e. infringement claims relating to the intellectual property rights of third parties), I also seek to cap the total amount of damages payable for indemnification claims to the amount payable under the contract, or even better, to the amount of compensation actually paid to my client during the first year of the term of the agreement.
When third parties push back on my efforts to limit the indemnification obligations of my client, I consider this legal issue to have crossed over into a business decision. Is the value of entering into the transaction worth the risk of an uncapped indemnity exposure?
I understand that litigators regularly face similar challenges, asking the question: Is it worthwhile to sue a breaching party for damages? Litigation is an expensive, time consuming and emotionally draining experience. Will the costs of litigating a contract breach outweigh the potential award of a win? Oftentimes, reasonable parties will conclude that it is more cost effective to simply accept the loss and move on.
A conscientious attorney will discuss these considerations, and ask her client to conduct a cost/benefit analysis before entering into contracts or pursuing litigation.