The indemnity clause in commercial contracts

Purpose

If one party breaches a contractual duty, the other party can claim damages under certain conditions.

An “indemnity” clause goes further. It expands the liability of the indemnifying party, typically the supplier. German law has no equivalent legal concept. In substance, the indemnity gives rise to a contractual claim to be indemnified (Freistellungsanspruch). Its conditions and consequences are a matter of negotiation in each case. A classic application is the indemnity for IP infringement. In the article “IP clauses in commercial contracts”, I briefly explain how it relates to the warranties in an IP clause.

Scope

The indemnity is a primary obligation. It does not require proof of a breach of contract. That gives it several advantages over a damages claim for breach of contract:

• Compensation is typically triggered by the occurrence of a loss, without the need to prove fault. This can also bypass the rules on causation and mitigation, which would otherwise make recovery harder.

• Where the indemnity is broadly drafted, it can allow broader recovery of losses such as legal costs and other related expenses than a damages claim for breach of contract would.

• Indemnity claims are seen as harder to fend off, and the indemnifying party is more likely to pay under an indemnity without litigation.

What the indemnifying party should do

Review every indemnity clause critically for that reason. As the indemnifying party, narrow it as far as possible (see the example below). Depending on the wording, further restrictions are needed (see the list of additional protections below).

Case law

Under recent US case law, an indemnity clause as a rule only covers claims by third parties, not claims by the other contracting party itself.¹ Keep that in mind when drafting the clause. This matters because contracting parties increasingly try to make the typical indemnity much broader.

Even deliberately broad wording has its limits. For a Delaware court, the words “whether or not involving a Third Party Claim” were not enough to award the indemnified party its attorneys’ fees. It had incurred those fees suing the indemnifying party to enforce the indemnity.² A party that wants those costs covered needs an express fee-shifting provision. Without one, the American Rule applies, under which each party bears its own attorneys’ fees.

The limitation of liability matters here too. I cover it under German law in the article “Why your limitation of liability in B2B contracts fails”. The indemnified party often tries to draft the limitation so that it does not cover the indemnity. Liability under the indemnity would then be unlimited. For the indemnifying party, the limitation of liability should therefore expressly cover the indemnity.

The German perspective

So far this has been mainly about the common law. For German suppliers, though, the most important point comes only now. If the indemnity is in the customer’s purchase conditions and German law applies, it often fails content review under German standard-terms law. That alone makes it open to attack.

The Federal Court of Justice held several clauses on liability in a DIY chain’s purchase conditions invalid under Section 307 of the German Civil Code (Bürgerliches Gesetzbuch, BGB). They included the supplier’s liability for defects in title without fault and its obligation to compensate the buyer for all damages arising from an infringement of industrial property rights.³ An unrestricted IP indemnity as a rule creates the same liability without fault.⁴ A supplier negotiating a form indemnity may therefore be negotiating over a clause that would not apply in a dispute anyway. Liability clauses fail regularly under German standard-terms law. I show why in the article “Why your limitation of liability in B2B contracts fails”.

Conversely, striking the word “defend” helps the supplier less than it thinks. According to the Federal Court of Justice, a supplier that assumes an indemnity must satisfy justified third-party claims. In principle, it must also defend the customer against unjustified ones.⁵ The duty to defend is therefore no Anglo-American peculiarity. Under German law it is regularly part of the indemnity itself. If the indemnity is not to cover the duty to defend, the contract has to say so expressly.⁵

So check first which law governs. Under German law, a form indemnity is primarily a validity problem for the customer and also a negotiating problem for the supplier. If the parties negotiate the clause individually, however, it is not a standard term and escapes content review (Section 305(1) sentence 3 BGB). In the article “Standard terms or individually negotiated?”, I show what that takes. Under common law, by contrast, every word of the clause counts, as the following examples show.

Example of a standard indemnity clause

Example of a revised standard indemnity clause from the indemnifying party’s perspective

The Supplier shall indemnify, defend, and hold harmless⁶ the Customer, its affiliates, officers, directors, employees, agents, and subcontractors (“Indemnitees”)⁷ against all claims, demands, suits, liabilities, costs, expenses (including reasonably incurred⁸ legal fees), damages, and losses, if these were reasonably foreseeable when the parties entered into this agreement,⁹ suffered or incurred by the Indemnitees Customer arising out of or in connection with a third-party claim against the Customer caused directly by¹⁰:

a) Supplier’s breach or negligent performance or non-performance of this Agreement the Supplier’s culpable breach of its confidentiality obligations according to section [insert reference] of this agreement¹¹; or

b) Any any actual or alleged infringement of a third party’s intellectual property rights from by the Customer’s use of the delivered products and performed services.¹²

The Supplier is not required to defend the Customer against third-party claims.

This indemnity does not apply to the extent that a claim under it results from the Customer’s negligence or willful misconduct; using the delivered products and performed services in accordance with this agreement is not negligence for this purpose.¹³

This indemnity does not apply if the Customer fails to take reasonable steps to mitigate its losses.¹⁴

Indemnification is the Customer’s sole remedy for matters covered by the indemnity.

Model clause from the indemnifying party’s perspective

Additional protection for the indemnifying party

The indemnifying party can reduce its risk further. It can, for example, include the following terms in the contract:

• the indemnified party has to notify the indemnifying party of any claim without undue delay;

• the indemnified party must not acknowledge the claim or settle with the third party without the indemnifying party’s prior consent;

• the indemnifying party has sole control over how the claim is handled if it takes over the defense;

• the indemnified party has to support the indemnifying party in the defense at the indemnified party’s own cost;

• a minimum amount has to be reached before the indemnification obligation is triggered (“basket”);

• no indemnification if and to the extent that:

  • the contract product (or service) has been modified;

  • the contract product (or service) has been used together with other products (or services) not approved by the indemnifying party;

  • the contract product (or service) has been used contrary to the indemnifying party’s instructions;

• the indemnity is limited in subject matter (for example only to patents rather than to intellectual property in general), geography (for example the EU), and time (for example one year after delivery).

Recommendation

From the indemnified party’s perspective, an indemnity makes sense. The indemnifying party, by contrast, has to limit it to a reasonable level. Otherwise it faces unlimited and unforeseeable liability.

Frequently asked questions

What is an indemnity clause?

A clause creating a primary contractual obligation. The indemnifying party assumes specific risks regardless of fault and without the other party having to prove a breach of contract. It extends liability beyond damages for breach of contract, which is why the indemnifying party should keep its scope as narrow as possible.

What does “indemnify, defend, and hold harmless” mean?

Three terms: “indemnify” means compensating the other party for losses, “defend” means defending it against third-party claims (at the latest once the indemnified party asks the indemnifying party to take over the defense, and so before any finding of liability), and “hold harmless” is sometimes read as a waiver of claims against the indemnified party; its exact scope is disputed.

Does an indemnity cover claims between the contracting parties?

Under US case law, an indemnity is presumed to cover third-party claims only. Parties that want to include direct (first-party) claims need clear and unequivocal language; even broad wording does not always suffice.

Does the limitation of liability apply to the indemnity?

Reliably only if the contract says so expressly. Indemnities are often carved out of the limitation of liability, leaving the indemnifying party with uncapped exposure. From the indemnifying party’s perspective, the limitation of liability should expressly include the indemnity.

What is an IP indemnity?

An indemnity against third-party claims that the use of the delivered products or services infringes intellectual property rights, the classic use case. Typical carve-outs apply where the product was modified, combined with non-approved products, or used contrary to the supplier’s specifications.

What is the difference between an indemnity and a damages claim?

A damages claim requires a breach of contract and, depending on the governing law, fault; an indemnity is triggered by the occurrence of a defined loss. It can bypass causation and mitigation rules and typically covers losses, costs, and legal fees more comprehensively than a claim for breach of contract.

Notes

1. Cf. Sarn Energy LLC v. Tatra Defence Vehicle A.S., C.A. No. N17C-06-355 EMD CCLD, 2019 WL 6525256 (Del. Super. October 31, 2019); Winshall v. Viacom International, Inc., C.A. No. N15C-06-137 EMD CCLD, 2019 WL 5787989 (Del. Super. November 6, 2019); Collab9, LLC v. En Pointe Technologies Sales, LLC, C.A. No. N16C-12-032 MMJ CCLD, C.A. No. N19C-02-141 MMJ CCLD, 2019 WL 4454412 (Del. Super. September 17, 2019). ↩

2. Ashland LLC v. The Samuel J. Heyman 1981 Continuing Trust for Lazarus S. Heyman, 2020 WL 6582958 (Del. Super. November 10, 2020): indemnification provisions are “presumed not to require reimbursement for attorneys’ fees incurred as a result of substantive litigation between the parties to the agreement absent a clear and unequivocal articulation of that intent.” ↩

3. BGH, judgment of 5 October 2005 – VIII ZR 16/05. ↩

4. BGH, judgment of 15 December 2010 – VIII ZR 86/09, para. 12. ↩

5. BGH, judgment of 15 December 2010 – VIII ZR 86/09, concerning a supplier that had indemnified its buyer after a warning letter alleging infringement of an industrial property right. ↩^{1 2}

6. Narrows the indemnifying party’s obligations. The term “defend” includes the indemnifying party’s duty to defend its contracting party in litigation with a third party. The duty to defend arises before any finding of liability (Crawford v. Weather Shield Manufacturing, Inc., 44 Cal. 4th 541, 554–559 (2008)). In California it is even implied unless expressly negated – merely deleting “defend” is not enough there. The term “hold harmless” is sometimes understood to prevent the indemnifying party from asserting claims against its contracting party (debated); on “hold harmless” as a distinct, “defensive” right, see Queen Villas Homeowners Ass’n v. TCB Property Management, 149 Cal. App. 4th 1 (2007). ↩

7. Narrows the very broad personal scope of the indemnity clause. ↩

8. Under US procedural law, even the prevailing party is not entitled to recover its attorneys’ fees unless a statute or contract provides otherwise (the so-called “American Rule”). For that reason, attorneys’ fees are listed as recoverable losses in indemnity clauses. They should at least be limited to fees reasonably incurred. On “reasonable” attorneys’ fees under English law, see also Euro-Asian Oil SA v. Credit Suisse AG [2017] EWHC B7 (Comm) (23 January 2017). ↩

9. Limits liability to reasonably foreseeable losses. Without this condition, the “test of remoteness” (also called “test of reasonableness”), first stated in Hadley & Anor v Baxendale & Ors [1854] EWHC Exch J70 (23 February 1854), probably does not apply to an indemnity clause triggered by events other than a breach of contract. Where the clause is triggered by a breach of contract, it is debated whether the test applies. See Glenn D. West and Sara G. Duran, Reassessing the “Consequences” of Consequential Damage Waivers in Acquisition Agreements, 63 Bus. Law. 777, 786–788 (2008), ssrn.com/abstract=2660962. ↩

10. Limits the indemnity to third-party claims that the event under (a) or (b) directly caused. The common phrase “directly or indirectly” should be avoided. The same goes for the unqualified use of “arising out of or in connection with”, because “in connection with” extends the indemnity beyond losses that arise out of the claim. ↩

11. An indemnity covering any breach should be avoided. Alongside the usual scope of an indemnity (infringement of IP rights), it should, if at all, only cover breaches of confidentiality obligations. Fault should also be included as an additional element (the common-law systems that dominate many English-speaking jurisdictions do not require fault). ↩

12. Narrows the indemnity twice. Without “alleged”, it covers only actual infringements. If the Customer successfully defends an unfounded claim, the indemnity therefore does not cover the costs of that defense. Under German law and in California, this also requires the sentence excluding the duty to defend. With “by” instead of “from”, the Customer’s use itself must infringe the right. ↩

13. Carve-out for contributory fault (cf. Section 254(1) BGB if German law applies). Under US case law, an indemnity covers the indemnified party’s own negligence only where the contract says so expressly (the majority of US states; California requires this for the indemnified party’s own “active” negligence, Crawford v. Weather Shield Manufacturing, Inc., 44 Cal. 4th 541, 562 (2008)). ↩

14. Further carve-out for contributory fault. It goes further than Section 254(2) sentence 1 alternative 2 BGB, which under German law measures recovery mainly by each party’s share in causing the loss instead of excluding it for every failure. ↩

Reference: Poleacov, P. (2026). The indemnity clause in commercial contracts. INN.LAW. https://inn.law/en/perspectives/indemnity/

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