Benefits of Including Indemnification Provisions in Commercial Contracts

You must include an indemnification provision in your business contracts to protect your commercial interests. If problems in a commercial agreement cause your business to suffer loss, you can rely on this provision. An indemnification clause establishes what the other party is liable for if their breach causes loss to your company. However, it may be unenforceable if the clause is unclear or uncertain. Alternatively, your business may be unable to claim the total compensation you deserve. This article will explore indemnification clauses and how they can benefit your business.    

What is an Indemnification Clause?

Two common types of indemnification clauses include: 

• third-party indemnity clauses that protect your business from any loss or damage from parties outside the contract; and
• inter-party indemnity clauses that protect your business from loss or damage from the other party breaching the contract itself.

Inter-party indemnity clauses are the most common type. Therefore, this article will focus on this indemnity clause.

Example

Suppose you establish a law firm in early 2020, at the beginning of the COVID-19 pandemic. Accordingly, you set it up as a ‘virtual only’ law firm. All meetings and conferences are by telephone or video call, and all lawyers work from home (not from an office). Consequently, you enter an expensive contract with a software provider to run and maintain a wholly online, cloud-based file management system.

In June 2021, the entire file management system goes down and is inaccessible. This is because the service provider suffers issues with the server that hosts your website and file management system. As a result, your business suffers three continuous weeks of your website being down (thereby losing new customers). Furthermore, your lawyers cannot log into their email or access documents, and your clients become increasingly angry due to a lack of response.

The impact is understandably huge, and your business loses money directly, through client loss, and indirectly through reputational damage and employee resignations. Your agreement with the service provider states that they are to provide and maintain services on an ongoing basis. Therefore, the system failure represents a breach of contract. 

Importance of Wording

Therefore, the wording of these contracts is crucial. Using the above example, you could foreseeably end up in any of the following situations:

• the clause is poorly drafted and unenforceable so your business receives no financial compensation upon suing the other party;
• the clause only permits direct and provable economic damage so you can only claim for loss of fees from departing clients who explicitly state the  system outage in their termination letter; or
• the clause is strong and wide enough to cover both direct and indirect loss so your business can also claim for the recruitment costs of replacing employees who left within six months of the lengthy system outage and, also, for predicted loss of new business during the outage.

Thus, the various possible outcomes reflect the importance of the wording in an indemnity provision.

When You Cannot Use An Indemnification Clause

You cannot use an indemnification clause when it is legally ‘unfair’ in specific contexts. So, for example, a business selling goods cannot have customers sign an indemnification clause that they will be liable for lost profits if they complain about the product quality on social media. 

Key Takeaways

On the whole, indemnification clauses are some of the most highly negotiated clauses within commercial agreements. A poorly worded clause may restrict your business from claiming reasonable sums upon breach of contract by the other party. Conversely, a strongly worded clause could effectively compensate your company for any financial losses you incur.

If you need help with indemnification clauses, our experienced contract lawyers can assist 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 0808 196 8584 or visit our membership page.

Frequently Asked Questions