Are you using the phrase “hold harmless” incorrectly? Does “indemnify” only apply to third-party claims?
Many legal commentators have considered the meaning of “indemnify and hold harmless” and advised to drop the “hold harmless” part of this couplet. Some commentators have also suggested that “indemnify” applies only to third-party claims and not direct claims between parties. Their conclusions have largely mirrored each other—draft your indemnification provision more clearly to say exactly what you mean. This post will provide specific drafting techniques to accomplish that goal, at least in the M&A context.
At the risk of repeating these other legal commentators, the first drafting tip is to drop the words “hold harmless” from your indemnification provision. When interpreting the phrase “indemnify and hold harmless” as a couplet, many courts have concluded that “indemnify” and “hold harmless” are synonyms. So, if you intend them to be synonyms, then drop “hold harmless” to avoid any court trying to find meaning with those words different from indemnify. If you intend those phrases to have different meanings, then use a phrase other than “hold harmless” to avoid any court saying they are synonyms and citing a string of cases for that proposition.
Actually, the discussion in these articles misses a more fundamental issue—while the phrases may have been judicially determined to be synonymous when used together, “hold harmless” by itself likely doesn’t mean indemnify. A hold harmless clause is more appropriately used when one person agrees not to hold another person liable for injury or damages suffered by the first person when engaging in certain activities. A classic example is a participant in high-risk activities like skydiving or rock climbing agreeing not to sue the purveyor of that service if the participant is injured while engaged in the activity.
One possible effect, although admittedly farfetched, with the typical misuse of “indemnify and hold harmless” could be to nullify the indemnity given by the other party. If a seller and a buyer in a purchase agreement both agree to “indemnify and hold harmless” the other party, does the hold harmless language given by one party (i.e., I won’t seek to hold you liable for damages I suffer) nullify the indemnity given by the other party?
One huge caveat to the foregoing discussion is that there are situations where “indemnify and hold harmless” is appropriately used. For example, in a real estate purchase agreement that gives the buyer the right to inspect the premises, the buyer may agree to indemnify and hold harmless the seller from damages resulting from the buyer’s inspection activities. That is, the buyer will indemnify the seller for any damage it causes to the seller’s property, and will hold the seller harmless from any injury caused to buyer or its agents, in each case as a result of buyer’s inspection activities.
In short, unless you have a situation like the foregoing where the couplet is properly used, stop using “hold harmless” in your indemnification provisions.
Some case law arguably implies that “indemnify” only applies to third-party claims. See, e.g., Queen Villas Homeowner’s Association v. TCB, 56 Cal. Rptr. 3d 528 (Ca. App. 4 Dist. 2007), which cites several other California cases. In the M&A context, this means if the buyer of a business is sued by a third party and that claim arises because the seller misrepresented some fact about the business or failed to perform some agreed-upon covenant, the buyer may recover any damages from the seller. The corollary to that interpretation would seem to be that “indemnify” doesn’t cover direct claims, i.e., damages suffered directly by the buyer because the seller lied or breached a covenant.
I wouldn’t be particularly concerned with these cases. First, these courts seem to be interpreting the language of the contract at hand as opposed to making a blanket statement that “indemnify” always only applies to third-party claims. Second, a dictionary definition of the word “indemnify” has no such qualifying language. A typical definition of the word “indemnify” says something like “compensate for harm or loss.” That definition clearly picks up losses both to third parties as well as between the parties.
Finally, it would be an odd interpretation indeed to say “indemnify” only covers third-party claims considering the context of the indemnification section in its entirety. Without an indemnification section, the parties to a contract could sue each other for warranty and covenant breaches, i.e., a direct claim. But, add an indemnification section with an exclusive remedy clause and somehow the parties have agreed not to seek compensation from each other for those breaches? That interpretation seems strained.
In any event, a drafter of an indemnification provision can clearly draft the provision to address direct claims. Here’s one suggestion. (The drafter will need to amplify the following as appropriate, e.g., adding joint and several if multiple sellers, defining the indemnified parties, etc. Also, a comprehensive discussion of drafting the entire indemnification section is beyond the scope of this post.)
In the general indemnification section, say something like, “The seller will indemnify the buyer for any loss suffered by the buyer, whether or not such loss relates to a third party claim, arising out of or relating to,” then pick up the litany of triggers, e.g., warranty and covenant breaches, retained liabilities or line item indemnities.
Then, under a separate section entitled, “Third Party Claims,” set forth the procedures for a party to seek compensation from the other party resulting from third-party claims. Finally, under a separate section entitled, “Direct Indemnification Claims,” set forth the procedures for a party to seek compensation from the other party resulting from non-third-party claims.
Assuming no other drafting issues, with this approach, a court should have no trouble understanding that “indemnify” doesn’t mean just third-party claims.