We come across indemnity provisions in invariably in all commercial contracts with a significant stake or subject matter value. An indemnity provision is primarily designed to mitigate risk of one party and affix the same risk as a liability upon other party.
Thus, indemnity provision seeks to provide comfort to a party by protecting it from economic hardships, risks and liabilities and impose the cost of such protection on the other party. How this respective allocation of comfort and liability would take place depends on negotiation and drafting.
Indemnity provision can be drafted as a mutual or unilateral provision. Under mutual provision, liability will be on either party (indemnifying party) to indemnify the other party (indemnified party) from certain actions of former party, third party claims and expenses, etc. In a unilateral provision liability will be only on the party which agrees to indemnify and protection will be provided to the other party which receives indemnity from the aforesaid defined actions, claims, expenses etc.
Sometimes, a party does not have a role beyond paying up for the goods or services availed under the contract, so there may be no / limited scope for the other party to seek any indemnity beyond seeking payment of its dues.
Unlike other provisions, liability of a party under an indemnity provision may be limited or otherwise, depending on the scope of indemnified parties.
If indemnifying party agrees to indemnify only other party then liability to indemnify is limited only with respect to such other party for any direct loss, expense, etc. However, due to legal, business and economic dynamics involved in the transaction, indemnifying party may have to agree to indemnify not only other party but also other party's officers, affiliates, employees, directors, contractors, etc., - the list is endless, it should be suitably drafted as per the requirements of the transaction and comfort of the parties.
Elements of risk, negotiation power, and deal size (economic and business) play a significant role in deciding the list of indemnified parties.
Assume that if a transaction involves a giant corporation (licensee) and startup (licensor), under which licensee would purchase bulk licenses worth of one million dollars which means a lot of money for licensor:
a) In this case, licensee may try to use its position as a leverage to influence negotiation process to make licensor agree to a unilateral provision (i.e indemnity obligation will be on licensor and licensee will go risk free and receive the protection from licensor) and insist on inclusion of different parties in the indemnified parties list.
b) Typically, licensor may not have much leverage to negotiate given the financial benefit involved to licensor – Licensors need to weigh on economic benefit it will get from such deal and accordingly need to accept any kind of indemnity obligation –
It is advisable to carefully negotiate the scope of indemnified parties to make sure liability of licensor never outweigh the economic benefit of licensor.
It is really crucial to evaluate element of risk and liability and economic benefit of the transaction to decide if the risk and liability involved under indemnity provision is worth undertaking.
There is no clear cut, defined criteria to decide the process to draft list of indemnified parties – Decision making and negotiation of scope of indemnified parties and related risk allocation or mitigation depends on the nature of transaction, business relationship between the parties (long term or short term), economic inflow or outflow from the transaction. Fine art of balancing varied interests and give and take approach come into play here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
