Common Clause

What is Indemnification?

May 16, 2023

Indemnification is one of those words that sounds terrifying, and explanations of what it means often makes people even more confused. Taking the point of view of freelancers and small businesses presented with an indemnification clause to sign, we’re going to explain what it means, the different forms it takes, and how to negotiate them.

What is Indemnification?

The American Bar Association defines Indemnification as “the practice of guaranteeing a third party claim against your counterparty”. In simple terms, indemnification is the act of risk transfer whenever you’re contracted as an external party. When something goes wrong, to what extent will you be responsible for damages?

Let’s try to break out of the legal jargon with a real-life scenario about one of our favorite desserts:

If you’ve signed a contract with Mango Markets that includes an indemnification clause which requires you to ‘indemnify’ them for potential damages from poor shipments, you may be responsible for covering the costs of Thai Paradise’s claim.

Types of Indemnification

As you may expect, assignment of liability in a contract is one of its most consequential components. Depending on the industry, indemnification takes different forms:

  • Construction: the primary contractor wants subcontractors to indemnify them for errors made in construction.

  • Freelance Design: the client wants contracted designers to indemnify them for breaches in intellectual property (e.g. using trademarked imagery).

  • Shipping Logistics: the buyers wants sellers to indemnify them for delays in arrival due to improperly filed customs paperwork.

How to negotiate Indemnification

Liability: The core of indemnification is assignment of liability. There are three levels of Indemnification: Broad, Intermediate, and Limited. They range from assigning all liability to the Indemnitor (Broad) to only what’s expressly the fault of the Indemnitor (Limited). You may be surprised that a blanket assignment like Broad Indemnification exists at all, which is why 21 states prohibit Broad and Moderate indemnification, but your first goal should be to negotiate a Limited Indemnification.

Covered Events: Next, you should review the covered events where Indemnification is triggered and judge if it suits your situation. For example, if you’re a remote freelancer, you shouldn’t be liable for workplace injuries as it’s not applicable.

Recoverable Damages: Finally, there should be a sensible limit to the damages you are liable for. Depending on your negotiating leverage, setting the cap to damages at the value of the contract itself is much easier to manage than covering ‘all potential losses’ which may include legal fees and loss-of-future-revenue calculations. In cases where you cannot cap damages, ensure they’re specifically tied to outcomes of covered events.

Returning to our mango farm, we can see how the liability for a bad shipment requires further clarification. What if our healthy mangoes are shipped first to Mangoland, and the rot was caused by a delay in their subsequent shipment? Even if the delay was on our end, should we refund the cost of the mangos, or the revenue loss from the sticky rice? Make sure you understand the scope and scale of your indemnification clause and how they impact the rest of your contract. After all, it is a transfer of risk to you.

For advocacy and beyond!
The Ask Ginkgo Team

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