The term indemnification actually has two working definitions (and to add to the confusion, they’re somewhat related). Indemnification can mean either:
1. Compensation for loss, harm, or undue hardship; or
2. A security that protects an individual from legal liability by shifting the liability to another party
To understand indemnification provisions, the definition that we’re interested in is the latter: a security that protects an individual from legal liability by shifting the liability to another party. Some of the confusion surrounding indemnification is a result of these dual definitions. However, much of the misunderstanding is simply because indemnification can be a rather complicated concept.
Indemnification allows the shift of liability from one party to another, but what exactly does that mean? Obviously, not just anybody can impose their legal issues onto another party to avoid liability. So, when can indemnification provisions come into play?
A Quick Example
As stated earlier, the central idea of indemnification is the transfer of liability from one at-fault party to another. However, this liability cannot be shifted (or even shared for that matter) unless it’s explicitly specified in a contractual agreement before the disputed incident occurs. A simple example might involve a personal injury claim.
Let’s say you own a small business. To ensure your office building is wheelchair-accessible, you hire a construction company to install an exterior ramp leading to the front entrance. This seems straight-forward enough; you sign a contract with the construction company, they come to survey the area and begin construction. Once the ramp is finished, you pay the company and the construction crew leaves the site. In reality, you are trusting that the company created a structurally sound ramp that won’t fracture or collapse under the weight of a wheelchair.
However, what if a handicapped patron is injured because of a faulty ramp? Say the ramp cracked while a patron was entering the store, and the wheelchair-bound individual fell and suffered serious injury. Who is responsible?
In this situation, it seems as though the construction company is the responsible party for creating a faulty structure. However, when the injured individual takes legal action, it will undoubtedly be against your business. How can you legally shift this liability to the contractor? The answer is to include indemnification provisions into the initial contractual agreement between you and the construction company. Without clearly-stated indemnification provisions written into your contract, you are the at-fault party. The addition of these clauses—so long as they are clear and well-written—will transfer any liability from you to the construction crew that built the faulty structure.
Indemnification is a Two-Way Street
It’s important to note that the process of indemnification can go both ways. In our example above, the business owner should have written indemnification provisions into the contract to hold the construction crew responsible for any injuries resulting from their faulty ramp.
However, the construction company also could have written indemnification clauses to ensure that any injuries resulting from the ramp are the responsibility of the business owner, not the construction company. These types of indemnification provisions—those that protect the third party—are far more common in real-world situations.
Depending on its severity, a successful personal injury claim can cost tens- to hundreds-of-thousands of dollars in retribution and legal fees. Thus, both parties may attempt to include subtle language into the agreement that clears their name from liability in the event of an accident. Because each party is essentially trying to pass responsibility to the other party, indemnification provisions can get very complicated very quickly.
Business Owners Beware
Indemnification provisions can indeed go both ways—that is, business owners can write provisions that shift liability onto the 3rd party, and likewise the 3rd party can write provisions that shift responsibility onto the business owner. In reality, the latter situation is more common of an occurrence. As a result, business owners are more-often the ones absorbing large amounts liability—many-times unknowingly. As a business owner, it’s paramount to know the language and consequences of indemnification provisions. A legal professional experienced in business law can be invaluable in these types of situations.
Indemnification clauses are interesting, in that only a few phrases or key words are needed to transfer mass amounts of liability. Phrases like “to defend” or “to hold harmless” have enormous power and prowess, and should be a resounding red-flag for signees. Remember, other parties will always try to minimize their legal risk by shifting liability onto you. Don’t be vulnerable; contact a legal representative to review any contract before signing away your protections.