Key Risks in Indemnification Clauses in Contracts

Indemnification clauses appear frequently in commercial contracts and are often treated as boilerplate. However, they can carry significant financial and legal exposure, especially for startups and small development firms dealing with larger enterprise clients.

This article outlines what indemnification means, why it matters, and what language to look out for when reviewing or negotiating contracts with international partners.

What is Indemnification?

In simple terms, indemnification is a contractual obligation by one party to compensate another for certain damages or losses that arise from specified events. It functions as a risk-shifting tool. For example, if Party A agrees to indemnify Party B, Party A promises to cover losses Party B suffers due to certain claims — usually third-party claims.

Example: If a developer agrees to indemnify a client, and a third party sues that client for IP infringement related to the software, the developer may have to cover legal costs, settlements, and damages—even if the claim arises from how the client used the product.

Why Startups and Dev Shops Should Pay Close Attention

Indemnification clauses in contracts drafted by large companies are often one-sided. Startups — particularly software developers, SaaS vendors, and digital agencies — are frequently asked to:

• Indemnify the client for all third-party IP claims (e.g., alleging that your software infringes another's copyright or patent)

• Cover all costs, including attorneys’ fees, even before a court determines liability

• Accept broad indemnity language like "any claim arising out of or relating to the use of the software"

These obligations can:

• Expose the vendor to disproportionate financial risk compared to the contract’s value

• Lead to risks that may not be covered by standard liability insurance

• Create liability for how the software is used — even when usage is outside the vendor’s control

Key Language to Watch Out For (Red Flag Phrases)

Below are commonly used indemnification phrases that may require negotiation or clarification:

1. "...will indemnify, defend, and hold harmless..."
   Including "defend" may obligate you to pay legal fees immediately, even before any fault is determined.

2. "...any and all claims arising from use of the product..."
   Overly broad. Try to limit to direct IP infringement or negligence resulting from your deliverables.

3. "...without limitation to amount..."
   Suggests uncapped liability. Propose a reasonable cap (e.g., 1–2x contract value).

4. "...including but not limited to attorneys’ fees, settlements, and judgments..."
   Ensure you retain control over legal defense and approval of any settlements.

Indemnification clauses often look standard but can expose your company to substantial liability. If you don’t have strong negotiating power or are unsure about the implications, always seek legal advice before signing.

LexSoy Partners helps founders and early-stage companies identify, assess, and negotiate around contract risks like these. For assistance with reviewing or negotiating English-language contracts, contact us at sc@lexsoy.com

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