“Indemnification” – Many contracts contain this mouthful of a word, but what does it mean? And how important is it for nonprofits? Most simply put, indemnification means “the action of making compensation to [a party] for incurred hurt, loss, or damage.”[1] An indemnification clause in a contract can provide significant risk mitigation, as a binding promise by one party to compensate another party for damages or other loss arising from activities within their contractual parameters. This article addresses how indemnification affects nonprofits’ contractual arrangements, which could apply in a variety of contexts, such as for consulting services, intellectual property licensing, third-party facility usage, real estate sale and purchase transactions, special events, speaking engagements, employment, grants, and donation agreements.
Man’s Best Friend – Why Include Indemnification?
Consider the following scenario. Man’s Best Friends (“Friends”) is a hypothetical nonprofit focused on canine health and well-being. Friends contracts with a creative consultant to develop Friends’ website content. The resulting website copy is excellent and traffic to the website increases, as do charitable contributions. All good so far. But then Friends’ Board Chair receives a demand letter from a law firm alleging infringement of copyrighted materials owned by the lawyer’s client, which are now posted on the firm’s website. That’s bad! The Board Chair’s quick online search reveals that Friends’ not so creative consultant apparently cut and pasted large sections of another writer’s copyrighted materials. The law firm is seeking damages in the amount of $10,000 – double the cost of the consultant’s fees. What legal remedies can Friends pursue?
If the consulting agreement contains a well drafted indemnification provision, Friends may have significant legal recourse available. For example, if Friends negotiated well, the contract would contain a provision requiring the consultant to indemnify Friends for any damages resulting from the consultant’s copyright infringement in connection with its provision of creative services. That is, if the consultant did something wrong (e.g., copyright infringement) and liability is sought against Friends because of such wrongful conduct, then the consultant must pay for any liability imposed on the organization. More concretely, if Friends were sued for copyright infringement and the consultant did in fact infringe another party’s copyright, then the consultant would be responsible for paying the $10,000 owed by Friends to the rightful copyright owner.
Indemnification Clauses
The above example illustrates the importance of written contracts. Additionally, it demonstrates the accompanying importance of contractual indemnification provisions to determine who is responsible if a third party brings an adverse claim involving the contract’s subject matter (e.g., development of creative content for public availability).
Indemnification provisions serve a basic risk management function. Properly drafted, they allocate risk between the parties by shifting liability from one party to the other under certain circumstances, based on their relative culpability for wrongful actions or related responsibilities. The party assuming risk by promising to indemnify the other is the indemnitor - the Indemnifying Party. The party benefiting from that promise to indemnify is the indemnitee - the Indemnified Party. Many agreements are reciprocal, that is, each party agrees to indemnify the other for actions within their own realm of responsibility that harm the other party.
Here's one example of a basic indemnification clause with related language, favoring one party:
“Party A agrees to indemnify, defend, and hold harmless Party B and its agents from and against any liability or loss arising from this agreement, unless such liability or loss is the result of Party B’s sole negligence or willful misconduct.”
In this indemnification clause, Party A is agreeing to assume the following risks:
1. Party A is agreeing to indemnify Party B, meaning Party A will reimburse the other party for its losses resulting from a third-party claim, subject to certain limitations involving Party B’s wrongdoing;
2. Party A is also agreeing to defend Party B – that is, to take responsibility for actively defending Party B against a third-party claim; and
3. Finally, Party A is agreeing to hold harmless Party B, which means both to assume responsibility for losses resulting from a third-party claim against Party B (overlapping (1) above), and to refrain from holding Party B responsible for those losses.
The above indemnification clause is surely overbroad, providing protection against any liability or loss arising from this agreement except for losses where Party B has been solely negligent or engaged in willful misconduct. Consequently, it may be helpful to modify the language as follows: (i) indemnification only for actions resulting from Party A’s negligence or willful misconduct (or those of Party A’s agents); and (ii) make it mutual, as between Party A and Party B, as noted above regarding reciprocity. Fair enough.
Nonprofit Indemnification Clause Best Practices
Provide for indemnity with the entire agreement in view.
When developing indemnification clauses, consider the entire agreement between the parties. The clause should be drafted in a way that is consistent with the overall purpose and intent of the agreement and should allocate risk in a way that is appropriate for the specific transaction.
Should Party A be responsible in such a lop-sided way? Perhaps, if Party A’s responsibilities and potential missteps are quite significant. Or perhaps not, if the parties’ respective responsibilities are quite balanced or broad.
Additionally, should the indemnification language be mutual? Drafting the provision in that way could promote good faith and trust between the parties. But take note that such language could also lead to some contentious debate later, in terms of who is liable for what resulting harm. In other words, whose liability led to adverse consequences for each party? The “Friends” example above is fairly straightforward. Other situations – not so much. Negotiating power differentials may influence the final language too (e.g., owner-occupant, buyer-seller, joint venturers).
Remember the nonprofit’s leaders and other workers.
When negotiating contract indemnification provisions, nonprofits should seek protection for not only the nonprofit organization but also its directors, officers, employees, volunteers, and other agents. Indeed, many nonprofit leaders serve on a voluntary basis. A well drafted indemnification provision should provide additional layers of protection from personal liability, through such specific identification, thereby adequately protecting individuals too.
Remember which party is best positioned to mitigate risk.
Generally, an indemnification clause should assign risk to the party best able to mitigate that risk. That is reasonable and fair, and therefore such approach should not pose any controversy in the negotiation process.
For example, if a nonprofit is contracting with a vendor to provide services, the vendor may be in a better position to mitigate certain risks associated with those services. In such cases, the nonprofit may seek to negotiate an indemnification provision that requires the vendor to assume responsibility for any losses or damages arising from the services. Additionally, if the nonprofit is the Indemnified Party (as in the Friends scenario) it should ensure that covered damages are defined broadly to include liabilities, losses, claims, and causes of action not yet brought as claims. On the other hand, if the nonprofit is the service provider, service recipients will likely desire the nonprofit to serve as the indemnitor of liability resulting from the services since it is in the best position to reduce risk related to the services.
In another example, a nonprofit contracts with an IT vendor providing cloud-based data services. A nonprofit might seek indemnification from third party claims arising from cyberattacks into the nonprofit’s system. In such instance, the covered events (cyberattacks) are reasonably related to the IT services provided (cloud services).
Consider the clause’s coverage implications.
Check the extent of the indemnification obligation too. The clause should clearly define the types of damages or losses that are covered, which may include liabilities, losses, and claims. Liabilities are generally legal obligations that have not yet been paid, while losses include legal obligations, expenses, and fees that have already been paid. Claims refer to potential legal obligations that have not yet been imposed and have not yet been paid.
Think through exceptions.
Indemnification clauses usually include an exception, for example due to an Indemnified Party’s fault. Such exceptions are framed with language like, “unless such liability or loss is the result of Party B’s sole negligence or willful misconduct”. This qualifying language should prevent the Indemnifying Party’s liability to Party B (the Indemnified Party) if a third party sues the Indemnified Party for causes that are actually the Indemnified Party’s fault. In the above IT vendor agreement, for example, the IT vendor will likely want a carve out from its general indemnity obligation if the nonprofit’s personnel willfully leak passwords and other secure information. Properly managed, such exceptions should not be problematic but instead help all parties involved to be careful in carrying out their contractual obligations.
Details matter.
Small language changes in terms can have significant impacts on application of an indemnification provision. For example, a provision requiring indemnification for losses “caused by” the Indemnifying Party’s activities pursuant to the agreement will likely not capture the same scope of losses “arising from” those activities. The language “arising from” is broader than “caused by,” so an Indemnifying Party likely should seek the latter verbiage (and an Indemnified Party may seek “arising from”).
Additionally, an Indemnifying Party should aim to ensure that a contractual indemnification obligation does not apply to claims resulting from its mere negligence. Form contracts often leave the Indemnifying Party responsible for such harm, which can be quite significant depending on what actually happens in the future. On a related note, an Indemnifying Party should pursue indemnification that excludes an Indemnified Party’s improper use or bad faith. Again, considering both fairness and appropriate risk management, it does not seem appropriate for a party to be indemnified for adverse consequences that it has caused.
Last and as noted above, mutual indemnification can be highly beneficial and contractually appropriate, imposing indemnification obligations in a balanced way. Properly developed and clear, mutual indemnification clauses allocate risk fairly, proportional to the degree each party should be responsible for and capable of mitigating risk. They thus may be perceived in negotiations as an expression of good faith.
Conclusion
Indemnification clauses provide important legal protections and related risk management measures for nonprofits engaged in transactions and relationships with other organizations, service providers, and related contractual activities. Such clauses thus warrant careful attention for specific terms, as part of negotiations to allocate risk, and to otherwise address how each organization will carry out its respective activities (e.g., sufficient insurance, appropriate due diligence, control over workers). So read the fine print, especially the indemnification language, and keep in mind that such all-too-often “boilerplate” language perhaps warrants risk management modification.
[1] Adapted from the Merriam-WebsterDictionary.
