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San Diego Business Law: What is Contractual Indemnification?
Typically, a business sales/purchase contract will contain provisions imposing indemnification obligations. These are often called “hold-harmless” provisions. In general, one party to a contract indemnifies the other party by agreeing to “hold them harmless” by paying for the legal fees, litigation expenses, judgments or fines, or any other loss/damage with respect to some worrisome aspect of the deal or some foreseeable problem. Sometimes, there is a separate stand-alone indemnification agreement. Generally, it is the seller who is asked to provide indemnification. Here is some basic information on contractual indemnification clauses. In a companion article, we will discuss how a good San Diego corporate lawyer can limit and constrain indemnification obligations.
San Diego Business Law: What is an Indemnification Clause?
At its most basic, an indemnity clause is a method of allocating — as between the seller and buyer — certain risks that are associated with the transaction. Say, for example, the seller is a business using a certain logo, but there is a worry that the logo might be infringing on the logo of a nationally known company. There is a risk that the seller will be sued and a risk that the buyer will be sued if the buyer used the logo. Litigation is expensive. Any potential buyer will want the costs of any future litigation about the logo to be paid for by the seller. Many specific types of risks are subject to indemnification clauses such as costs related to environmental contamination, failure to comply with permitting and licensing laws, trade secret misappropriation, breach of a director’s fiduciary duties, and more.
San Diego Business Law: Sample General Indemnification Clause
Indemnification clauses can be very general like this example:
“Indemnification: SELLER hereby agrees to indemnify and hold harmless the BUYER, its officers, directors and employees from any liability, loss or damage it or they may suffer as a result of claims, demands, costs or judgments against the BUYER arising out of a breach by SELLER of any obligations, representations and/or warranties set forth in this AGREEMENT.”
As can be seen, this is a very broad and general indemnification provision. This is a very “pro-buyer” indemnification provision and a seller should avoid agreeing to a provision of this kind.
Note a couple of non-obvious implications of this clause. First, implicit here is the seller’s agreement to pay the buyer’s attorneys’ fee if there is a lawsuit about the agreement. The “arising out of” language coupled with the “breach by SELLER” language gives rise to an obligation of seller to pay for the buyer’s attorneys’ fees. Moreover, the language is broad enough that the Seller arguably must pay even if the buyer does not prevail in the litigation.
In addition, as discussed here, this indemnification provision creates two duties – the duty to defend and the duty to pay any judgment. These two duties are imposed by the “any liability, loss or damage” language. Thus, in our logo example, if the buyer is sued for trademark infringement, a demand will be made for the seller to pay the buyer’s costs to defend the infringement suit. Likewise, if there is a judgment, the seller will be asked to pay the judgment. As noted above, indemnification clauses should be the subject of vigorous negotiation.
San Diego Business Law: Making Sure the Seller can Pay
As with any contractual payment obligation, the obligation is only as good as and as deep as the obligor’s ability to pay. Thus, if the seller will cease doing business after the sale is consummated, any indemnification provision is essentially useless to the buyer. To avoid this, buyers often insist upon a hold-back of some of the sales proceeds into an escrow, an indemnification from a third-party or insurance. These issues, too, should be the subjects of vigorous negotiation.
Contact San Diego Corporate Law Today
If you would like more information about indemnification, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has been named a “Rising Star” for three years running by SuperLawyers.com. Every business needs a good business attorney like Mr. Leonard to review, draft and assist in executing business contracts and with other business-related matters. Mr. Leonard can be reached at (858) 483-9200 or via email.
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