Q&A #104 – Does indemnification language in a contract apply only to third party claims?

Question: My nonprofit is currently negotiating an agreement with a service provider and we have had discussions about language requiring each party to “indemnify” the other party for certain claims, liabilities, losses, and other expenses (including attorneys’ fees). Does standard indemnification language typically apply only to claims by third parties, or can it apply to claims between the parties to the contract?

Answer: Indemnification language in a contract is traditionally understood to apply only to third party claims and not to “direct” claims between the parties themselves. Many courts will presume this interpretation unless the parties clearly express an intent for indemnification to apply to direct claims. However, courts differ on this issue, so it is important to clearly state that indemnification only applies to third party claims if that is the interpretation your organization wants.

Indemnification is typically intended to protect one party from the costs of claims and lawsuits brought by third parties as a result of the conduct of the other party. In Q&A #77 we explained the concept of indemnification as follows:

“Indemnification is a way for two parties to allocate risk in a contract. A party that is required to ‘indemnify’ another party typically must cover the costs of a lawsuit, claim, or similar expenses (including judgments, settlements, and attorneys’ fees) that arise in connection with the indemnifying party’s conduct under the agreement. The language is often (but not always) aimed at claims and lawsuits brought by third parties. For example, if your organization subleases its facility to another organization to hold an event, you might require the sublessee to indemnify your organization in the event a person gets injured at the event and sues your organization.”

The premise in this example is that your organization has little or no control over the actions and safety precautions (or lack thereof) taken by the sublessee organization, and therefore should not be responsible for lawsuits brought by third parties related to the subject matter of the contract (i.e., events held at the space).

Courts will often presume the intent follows this traditional example. However, many indemnification clauses are drafted so broadly that it is not clear whether they are limited to third party claims. For example, some contracts require indemnification for “any and all claims, liabilities, losses, and expenses (including reasonable attorneys’ fees) arising out of, based upon, or attributable to any act or omission of the indemnifying party….”

With this type of very open-ended language, it is possible for a court to apply the broadest possible interpretation of the indemnification obligation, which could potentially have extremely significant unintended consequences, such as interfering with a party’s right to sue to enforce the agreement and/or requiring one side to pay the attorneys’ fees for any disputes between the parties. For this reason, it is crucial to expressly state whether the indemnification obligation is intended to apply only to third party claims, and be precise in describing the types of claims that are meant to be covered.

Planning Tip – With boilerplate contract language as well as any substantive term of an agreement, even minor changes in wording can have a substantial impact on the interpretation. For this reason, when negotiating a contract and exchanging drafts with modifications, you should always create your own “redline” document against the previous draft rather than rely on the redline provided to you by the other party. If you don’t, you could miss changes that the other party accidentally (or perhaps intentionally) failed to reflect in the redline document that they sent to you.

There are situations where a party might want indemnification to cover direct claims between the parties (such as where one party fails to adhere to certain “representations and warranties” made in the contract). But in all cases it is important to draft indemnification language very carefully to express the intended result.

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