What is an indemnification clause and how does it fit into a seller’s potential liability?

An indemnification clause is a contractual remedy in an agreement whereby the parties allocate risk for certain events. Under an indemnification provision, the indemnifying party agrees to compensate the other party for agreed costs and expenses related to the triggering event(s). Additionally, certain indemnification provisions include the obligation to defend the indemnified party.

Because a typical contract would include provisions allocating the costs and expenses between the parties regarding a claim between them, i.e. a first party contract claim, an indemnification clause is, at best, duplicative of other provisions in the contract. At worst, it is inconsistent with the remaining provisions of the contract, and thereby creates confusion. Thus, indemnification clauses should generally be limited to allocating the risk and expenses regarding third party claims related to the goods.

In addition to limiting the scope of the indemnification clause to third party claims, the provision also should limit the types of claims subject to indemnity. As discussed above, the seller can appropriately limit liability for contract claims, i.e. breach of contract or breach of warranty, by including contract provisions limiting the type and amount of damages available as well as the available remedies. The buyer can do the same when it resells the goods or incorporates them into a product it sells to a third party. As a result, third party contract liability can and should be limited. However, neither seller nor buyer can contractually limit liability for tort claims for personal injury or property damage related to the goods.

The appropriate scope of an indemnification clause running from the seller, as indemnifying party, to the buyer, as indemnified party, should be limited to third party claims for personal injury or property damage related to the goods. All other claims can, and should, be addressed via contractual provisions limiting liability, not with an indemnification clause. Thus, with the scope of indemnification appropriately limited, the seller can then obtain insurance coverage for third party claims for personal injury or property damage. In doing so, the seller can mitigate its exposure for such claims.