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The Importance of Understanding an Indemnity Clause

An indemnity clause is often one of those “boilerplate” clauses that makes a business owner’s eyes glaze over. This is a contractual provision which protects one party from the negligence or bad acts of the other party, by shifting the compensation for a loss from one party to another.

A common example is if you hire someone to write original software code for your business. If you are sued by a third party because the code-writer infringes the third-party’s copyrights, you would want the code-writer to pay your damages. In legal terms, the code-writer would indemnify your business for software infringement.

A lot of money can be hidden in an indemnity clause, so it is important to understand how to evaluate them.

First off, if you are being asked to indemnify someone, look closely at what actions or events will trigger an indemnity. Determine how likely it is for that action or event to occur, or if there are best practices you can implement to minimize the risk.

Limit the amount of the indemnity to insurance proceeds, the amount of the contract or some other fixed or determinable amount.

Limit the time during which an indemnity claim can be brought (3 years from completion of work, for example).

Require the other party to promptly notify you of an indemnity claim and to take all reasonable actions to mitigate the claim.

If you need to be indemnified, also try to draft the indemnity clause as clearly as possible. It is often tied to damages from a breach of warranty or a breach of contract.

Make sure you are able to take control of the lawsuit or legal proceeding brought by a third party against your customer/client. You don’t want them to be able to settle it without you.

When in doubt, have a lawyer review your contracts.

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