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San Diego Business Contracts: The Difference Between an Indemnity and Damages Cap

Without the assistance of an experienced San Diego corporate attorney, it can be difficult to distinguish different parts of a business contract. For example, many confuse the legal meaning and purpose of an “indemnification” clause, particularly if the clause has a limitation on damages. A typical indemnification clause with a cap might require that one party “indemnify and hold harmless” the other party “against any and all losses arising from any breach of any representation or warranty in this Agreement up to $100,000.” Sometimes indemnification clauses cause confusion where it is mistakenly believed that all claims and lawsuits will be capped at $100,000, but that is not the case.

An indemnification clause — sometimes called a “hold harmless clause” — is designed to protect a party from lawsuits or other proceedings and from judgments brought by third parties. That is the legal definition of indemnification. An indemnification clause has no application to a lawsuit, arbitration, or other proceeding between the parties to the agreement itself.

Let us take an example involving imaginary plastic novelty and gag gifts. The buyer agrees to purchase 50,000 units from the seller at, say, $10 each. However, the buyer wants to protect itself against risk that the plastic might be harmful to the consumers. Thus, the buyer asks for a representation and warranty from the seller that the plastic used is safe and that, generally, the novelty and gag gifts are safe. The representation is something like this: “Seller warrants and represents that the Product is safe for its intended purpose, is non-toxic to humans and complies with all California laws with respect to toxic substances.” As further protection, the buyer asks for an indemnification provision like the one listed above. The seller, however, wants a cap. The seller is agreeable to making the safety representation and warranty, but does not want unlimited liability. Thus, the parties agree to cap the indemnification to $100,000.

Now, let us assume a customer sues the buyer, claiming that the plastic caused some sort of injury. In that case, the buyer would demand that the seller defend the lawsuit and pay any judgment. The seller would be obligated to defend and pay any judgment, but only up to $100,000. Beyond that amount, the buyer would be liable.

By contrast, let us assume the seller breaches the agreement by failing to deliver the product or, maybe, by delivering the wrong plastic novelty items. The buyer sues and claims lost profits and other damages and seeks $1 million dollars in damages. The cap in the indemnity provision will not prevent the buyer from seeking more than $100,000 in damages. The indemnity provision applies to third party claims; not to claims between the buyer and seller.

If the seller wants to limit the damages that can be sought by the buyer, then the seller needs a damages cap or liability limitation clause. A damages cap provision might read like this:

Limitation On Damages: In the event of breach of this Agreement, if either party shall be held liable to the other, the parties agree that the amount of damages recoverable shall not exceed $100,000.”

Contact San Diego Corporate Law

For more information, contact Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard focuses his practice on business law, transactional, and corporate matters, and he proudly provides legal services to business owners in San Diego and the surrounding communities. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.

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