In the world of commercial contracts, indemnification provisions play a crucial role. Indemnification provisions can provide your business with protection by allocating risks in a commercial relationship. Additionally, they help to clearly outline the responsibilities between contracting parties. Without an indemnification provision in your business contract, you could expose your business to avoidable risk. This article explains the commercial advantages and practical implications of indemnification clauses.
What is an Indemnification Provision?
An indemnification provision is a risk management tool. These provisions allocate risks given one party (the indemnifier) commits to compensate the other party (the indemnified party) for losses, damages, or expenses they suffer if a trigger event arises.
Businesses typically include indemnification clauses in their commercial contracts since they provide some level of assurance. In other words, party A is certain that party B will cover their potential losses or expenses where party A experiences setbacks due to reasons outlined in the agreement.
What Are the Implications of Indemnity Provisions?
Each contract will specify what event triggers the indemnity. Triggers can include:
- breach of contract provisions;
- negligence; and
- a failure to comply with the law.
By specifying the trigger event, the contract ensures the indemnifying party understands what circumstances compensation would be triggered.
You should customise the trigger events and tailor them to align with:
- your business needs;
- the usual course of business operations; and
- the nature of your commercial relationship.
What Does a Good Indemnification Provision Contain?
Although there are many different forms an indemnity provision could take, a comprehensive indemnification clause will usually specify the following:
1. Identify the Parties
The indemnity provision should specify who the parties are to:
- avoid ambiguity;
- ensure that the intended parties are assigned the correct responsibilities; and
- hold parties accountable for their respective obligations.
2. Scope of Indemnification
The indemnity provision should also specify:
- what events the indemnity will cover;
- the types of losses, liabilities, and expenses that the indemnifying party will be responsible for covering; and
- any limits to the indemnified party’s liability.
Liability should be capped to specify the certain types of damages which will be excluded from indemnification.
This example illustrates how indemnification provisions help allocate risks between the parties involved in a business transaction in case of certain specified breaches or liabilities.
3. Trigger Events and Time Limits
The contract should clearly outline the circumstances in which indemnification arises, especially if it includes specific situations relevant to the specific business area. This is fundamental to avoid disputes and promotes smoother resolution processes.
Things to consider when drafting this clause include the following:
| Consideration | Explanation |
| Immediacy | You should specify whether the indemnification is immediate or if there is a time period for seeking recourse or for it to be repaired/addressed. Determine whether there will be any thresholds or deductibles before indemnification obligations are triggered. |
| Time Limits | Establish a time limitation for indemnification claims. This helps prevent indefinite exposure to potential claims and ensures that claims are brought within a reasonable timeframe. |
| Notice | Include notice requirements specifying how and when indemnification claims should be communicated. |
| Survival Clause | Include a survival clause indicating how long the indemnification obligations will last after the termination or expiration of the agreement. |
4. Mitigation
Mitigation requirements compel the indemnified party to take reasonable steps to minimise losses. This can help prevent the indemnifying party from being responsible for losses that could have been minimised. Additionally, these elements contribute to the efficiency and fairness of the indemnification process.
5. Governing Law and Dispute Resolution
You should specify the governing law that will apply to the indemnification provision. Additionally, define the dispute resolution mechanism in case disagreements arise regarding indemnification obligations.
This guide provides key information on how to manage a business dispute as quickly and cost-effectively as possible.
Avoid Unfair Indemnification Provisions
It is important to note that the updated Unfair Contract Terms regime came into effect on 10 November 2023. The regime makes unfair terms in standard-form contracts unlawful.
As a result, it is important for the party drafting indemnities into their contracts to ensure that they are fair and proportionate. Indemnities that make customers responsible for losses outside their control or for the indemnified party’s negligence are likely unfair and can be subject to significant financial penalties.
However, there are several strategies to reduce the potential unfairness of an indemnity clause, including making it mutual, including carve-outs, or including a duty to mitigate.
Key Takeaways
An indemnification provision is a powerful legal tool that goes beyond risk allocation. These provisions function as an essential element of many business contracts by offering clarity, predictability, and legal commitments essential for nurturing secure business relationships. Parties to a contract with an indemnification provision should seek legal advice as required to ensure that they are complying with legal standards in a comprehensive manner.
If you need help in drafting, reviewing or negotiating indemnity clauses, our experienced contract lawyers can assist you as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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