The assignment of responsibilities for liabilities is often a large part of agreements for commercial transactions. While the parties to a contract have broad discretion to transfer property, obligations and liability between themselves, they are limited in their ability to dictate that third parties – who have not joined into the contract – respect the terms of an agreement they had no say in. This conforms to the broader legal principle that “no one gives what they do not have.” For the same reason you cannot contract to sell something that belongs to another without their consent, you cannot contract to limit the rights of others to make claims they are otherwise entitled to make. Because the allocation of liability for certain causes of action is such an important part of many contractual matters, parties sometimes instead use indemnification provisions to essentially refund, or “indemnify,” the other party if they suffer damages resulting from certain types of issues.
To illustrate this principle, consider the following situation. A business owner rents a storefront from a landlord and agrees in the lease that they can only sue the landlord under certain circumstances. The business owner accepts certain risks or faults with the property they are renting. For this example, assume the landlord discloses the radiator is not up to code and could cause a burn, so the tenant will take on the responsibility to get it fixed and agrees not to sue the landlord if they get burned by it before it is fixed. On its face, this arrangement seems a valid contractual exchange – the landlord gives up the right to use the property for a set time in exchange for: (1) rent and (2) the tenant’s agreement to limit suit against them from injuries over certain disclosed problems and (3) the agreement by tenant to fix the radiator.
In contrast, the landlord cannot effectively include a provision saying that “none of your customers can sue me if they are injured on the property, because you are responsible for keeping it in good and safe condition.” Despite the landlord shifting responsibility to keep the property in good condition to the tenant, they cannot prohibit third parties from making claims against the landlord if they are injured on the property. If the business owner fails to have the radiator replaced and a customer burns themselves while shopping, the burned customer would be fully within their rights to sue the landlord, despite the landlord’s arrangement with the tenant to fix the issue.
To better protect themselves, the landlord should have included an indemnification provision. Since the parties cannot limit who third parties claim damages from, they instead say “If I am forced to pay a certain type of claim, you agree to pay me back.” Here, the lease could apply indemnification to liabilities arising from the tenant’s negligent maintenance or actions with respect to the rented space, perhaps with specific reference to damages from the radiator if they fail to replace it. If the injured customer sues the landlord, the landlord would pay the claim and then seek to enforce the indemnification provision to recover the costs from their tenant who had agreed to indemnify them under these circumstances.
Far from being the “standard provision” they are often dismissed for, indemnification provisions can vary widely in scope, application and duration. Depending on the bargaining power of the parties, all such points may be negotiated.
The scope of an indemnity governs what circumstances are covered under it. A common scope provision might provide damages fall under the indemnity if they are a result of a breach of the agreement, inaccuracy of any representations or warranties made by the indemnifying party. Before agreeing to indemnify another party, consider what type of actions would fall under the described scope, whether any ambiguities exist regarding the scope of coverage and whether you have any control over preventing or reducing the risk of those types of claims. Ideally, you should not be agreeing to indemnify a party for liability resulting from the actions, errors, or omissions of their own or of a third party you have no control over. Wisconsin law permits broad indemnification clauses, but Wisconsin courts tend to strictly construe them, meaning they will not generally stretch the interpretation of the clause to bring an ambiguous situation under the indemnity. Wisconsin also has special rules for the scope of indemnification in construction contracts.
The application of an indemnity relates to how an indemnity will mechanically be triggered, calculated, and resolved. This includes important provisions on the required notices and timelines associated with various aspects of the indemnification procedure. A party seeking to rely on the clause should carefully comply with these technical requirements as the party obligated to pay under it will likely be looking for ways to get out of it if it is triggered. The provision may also place limits on the amounts required to be paid under the clause, or require certain steps are taken to ensure damages are mitigated or funds are available to comply with the indemnification requirements. The parties may require each other to carry insurance policies designed to cover these costs during the term of the indemnity to ensure it is effective. This is important because an indemnification right against a party with no collectible assets does not offer much protection. In the example used earlier of the landlord and tenant, the landlord’s indemnity will not be useful if the tenant has no assets from which to recover or if all of the assets are separated from the limited liability entity which granted the indemnity and thus very difficult to reach.
The duration of the indemnity governs how long the agreement to provide indemnity lasts. Contracts for purchase and sale transactions often have the bulk of the agreement terms end following the transfer of goods and payment, but indemnification provisions are often among the terms separated out and assigned a longer period of “survival.” These terms usually are tied to the statute of limitations for the claims they are being applied against but may still vary.
If you have questions on how an indemnification clause in a contract you are considering will operate, you should speak to a business law attorney to help you review, understand and potentially negotiate alterations to the agreement.