Some phrases turn up regularly in contracts, e.g., a party that “represents, warrants and covenants” something; the grant of a “right and license”; a set of “terms and conditions”; and a party owning all “right, title and interest” to something. When drafting, reading and/or interpreting a contract, you may view each of these phrases as a single concept. However, the component terms in these phrases often have different meanings. I have previously written about the differences between representations, warranties and covenants, and why those differences can be extremely important.
A core element of every contract is risk allocation. Most agreements contain risk allocation clauses such as limitation of liability, disclaimer of consequential damages, insurance obligations, and indemnification obligations. A contractual indemnification provision often begins with a statement that a party shall “indemnify, defend and hold harmless” one or more other parties from and against losses, damages, etc. arising from or relating to certain acts, omissions or occurrences. There are three separate and distinct concepts in this phrase – an obligation to indemnify, a duty to defend, and an obligation to hold harmless. Should these always be used together? Or are there circumstances when only one or two should be used, or used separately? Understanding what each of these concepts mean and how to use them strategically (as a whole or in parts) is critical to ensuring an agreement contains the right risk allocation.
Here’s a handy summary chart to differentiate these three concepts:
The obligation to indemnify
An “indemnity” is a core risk shifting provision of a legal contract, obligating one party (the “indemnitor” or the “indemnifying party”) to compensate and reimburse (or “indemnify”) the other party (the “indemnitee” or the “indemnified party”) for certain losses such as monetary costs and expenses (the “indemnified losses”) which arise from, result from or relate to certain acts, omissions or occurrences defined in the contract (the “scope of the indemnity.”) Properly defining the scope of the indemnity and any exclusions to scope, the indemnified parties, and the indemnified losses are especially critical. For example, the scope of an indemnity may include, among other things, the material breach of a representation or warranty; a violation of a law, rule or regulation; a party’s negligent, grossly negligent, and/or willful acts or omissions; a breach of confidentiality or security obligations; and a claim that a product infringes the intellectual property of a third party. Common indemnified losses include attorneys’ fees and costs (whether or not the contract includes a duty to defend), losses, expenses, costs, damages, fines, and penalties.
Indemnification obligations can be either “third party” (protection against damages and losses claimed by a third party and not the other contractual party) or “first party” (protection against damages and losses claimed by the other contractual party). Most parties do not use a first-party agreement in contractual indemnification clauses, preferring that any damages and/or losses claimed by the other contractual party be governed by general breach of contract principles. Some courts have interpreted an indemnity as a third-party indemnity absence express language as to the parties’ intention to cover first party claims.
If you are thinking this sounds a lot like insurance, you’re right – an insurance policy is a form of an indemnity pursuant to which the insurer (the indemnitor) agrees to compensate and reimburse a policy holder (the indemnitee) for losses and damages relating to losses, expenses, or other damages suffered by the policy holder in connection with an indemnified claim. Another important point is that indemnification is not automatic – it requires the indemnitor to accept its obligation to indemnify for a particular claim, or alternatively a finding by a court, arbitrator, or similar that the claim giving rise to the loss or damage was within the scope of the indemnity. For example, if Party A is required to indemnify Party B for third party damages and losses (including attorneys’ fees) arising from Party A’s negligence, and a third party (Party C) sues Party B for damages arising from Party A’s negligence, if the court finds that Party A was negligent, then Party A’s indemnification obligations are triggered. An indemnitor may sometimes contest their obligation to indemnify, which can lead to additional litigation over the obligation to indemnify itself.
The duty to defend
Like indemnity, the duty to defend has its roots in insurance. If you tender a claim to your insurance carrier and the carrier accepts your claim, your carrier will “step into your shoes” to defend you, by either having their in-house attorney handle the matter, or more commonly, by hiring an attorney to defend you against the claim. Similarly, if in a contract you accept a duty to defend the other party in the event that other party receives a claim, is sued, or some has other cause of action or proceeding commenced against it arising from certain specified occurrences, you are agreeing to step into their shoes and be responsible for their defense, whether or not you are also sued. This includes hiring attorneys, retaining experts, retaining e-discovery providers, and taking on other obligations associated with the defense of the claim. A duty to defend includes an obligation to bear the costs of providing the defense such as attorneys’ fees, expert witness fees, electronic discovery fees, court fees, and the like. Keep in mind that the defended party will still need to be involved the defense of the claim. While a party imposing a duty to defend on the other party gives up their ability to defend the claim as they see fit, the cost-shifting generally outweighs the loss of control.
If a party feels it must maintain direct control, e.g., where the reputational risk from a claim is so significant that they want to call the shots or where a party has outside counsel that they feel is essential for a particular type of claim), that party may want to negotiate out a duty to defend and rely solely on the duty to indemnify for reimbursement of incurred defense costs. However, this is often not palatable to indemnitees who insist on a right to defend; the most common argument is that if a party has the obligation to indemnify against costs of a judgment or settlement, that party must have control over the defense of the claim so they control the outcome. Some parties shifting the duty to defend will preserve the right to retain their own counsel at their expense in the procedures section, so they retain some say in the defense strategy. Remember that the damage from a legal proceeding may be non-monetary, e.g., reputational damage, so having a say in the other party’s defense may be important.
When offering a duty to defend and an obligation to indemnify, consider separate but sequential obligations to defend and to indemnify to narrow the scope of both obligations. In this approach, a party would provide a duty to defend the other party against third party claims arising from certain acts, omissions, and occurrences, and with respect to such claims, would indemnify the other party from and against defense costs (attorneys’ fees and other litigation expenses), indemnitor-agreed settlements, and court-awarded damages resulting from such claims. This approach avoids applying the broad categories of “damages, losses, expenses, costs,” etc. to either the duty to defend or the obligation to indemnify, which language often results in a broader risk shifting to the indemnitor than was intended.
The obligation to hold harmless
A hold harmless is an agreement by a party to assume responsibility for, and to not hold the other party liable for, damages resulting from the occurrence of certain acts, circumstances or events. In practice, a hold harmless and an indemnity are functionally equivalent in that both require a party to assume responsibility for losses incurred by another party in connection with certain acts and circumstances. Some argue that while an indemnity shifts losses, a hold harmless shifts both losses and liability. However, shifting liability is often not realistic or achievable. There is no way to assume responsibility for negative and equitable intangible liabilities such as damage to reputation, bad press, a public court record, an injunction or specific performance requirement, etc.; a party can only compensate the other monetarily for such intangible liabilities.
There is one important difference between a hold harmless and an indemnity – a party granting a hold harmless not only shifts risk to itself by taking responsibility for another’s losses associated with that risk, but also assumes the risk directly and agrees not to shift it to the other party even if the other party is ultimately responsible. This may prevent a party granting a hold harmless from shifting liability to the other party if the other party turns out to be the one that caused that liability to occur. Consider whether to ensure contractually that a contractual indemnity and hold harmless excludes liability and damages caused by the other party’s own acts and omissions.
To limit the scope of risk you or your client will accept, consider providing a duty to defend and obligation to indemnify only, and negotiating or leaving out an obligation to hold harmless. If the paramount concern is shifting as much risk as possible, ask for a hold harmless as well. A hold harmless provision can be unilateral (one party retains risk) or mutual (each party retains its own risk associated with certain acts, events or occurrences). Be very careful with mutual indemnity and hold harmless provisions. If you receive an indemnity, granting a hold harmless back for the same acts or circumstances as the two provisions may result in two conflicting provisions that may cancel each other out and leave you without indemnification protections.
Using the obligation to indemnify, the duty to defend, and the obligation to hold harmless properly in contracts helps ensure a party is taking on the right amount of risk under the relationship. Use of common legal phrases without thinking through whether that use is correct for a particular circumstance may cause your company or your client to take on more risk than they realized, or to give up rights you thought you had. The obligation to indemnify, duty to defend, and obligation to hold harmless also relate directly to, and may be impacted by, the language in other contractual provisions, including indemnification procedures and exclusions; disclaimer of consequential damages; limitation of liability; and insurance provisions. Working with your in-house attorney, or retaining a subject matter expert, is often a worthwhile an investment of time and resources up front to help you navigate the risk allocation terms in your agreement — such as the obligation to indemnify, duty to defend, and obligation to hold harmless — to ensure the risks you take are properly balanced against the expected rewards.
Eric Lambert is counsel for the Transportation division of Trimble Inc., an geospatial solutions provider focused on transforming how work is done across multiple professions throughout the world’s largest industries. He supports the Trimble Transportation Mobility and Trimble Transportation Enterprise business units, leading providers of software and SaaS fleet mobility, communications, and data management solutions for transportation and logistics companies. He is a corporate generalist and proactive problem-solver who specializes in transactional agreements, technology/software/cloud, privacy, marketing and practical risk management. Eric is also a life-long techie, Internet junkie and avid reader of science fiction, and dabbles in a little voice-over work. Any opinions in this post are his own. This post does not constitute, nor should it be construed as, legal advice.