I spoke with host Tony Martignetti on his Nonprofit Radio podcast about indemnification as Part I of our two-part discussion on nonprofit risk management. This follows a recent post we published on indemnification provisions in Bylaws. But on this program, we were able to discuss indemnification in the contexts of both governance and contracts. Here are some highlights and resources related to our discussion:
What is indemnification?
Generally, it means one person or organization will provide protection to another person or organization. The party providing the protection is the indemnifying party; the party receiving the protection is the indemnified party.
What type of protection?
Indemnification is often thought to protect one party in the event it gets sued. The protection would then be in the form of payment of the costs of defending the lawsuit and paying damages if the party loses in court or the amount of the settlement if the case settles.
Why would one party indemnify another?
A nonprofit corporation may indemnify its board members partly as an inducement to serve and partly because it seems equitable to protect its board members who get sued for simply doing their job in a lawful and responsible manner. Imagine the scenario of a plaintiff claiming to be harmed by the nonprofit and suing not just the corporation but also all of the board members in their individual capacity because, in such role, they are ultimately responsible for the management of the corporation. Even if the lawsuit was frivolous or unjustified, the board members could incur substantial costs in defending themselves.
This is a case in which indemnification may make complete sense. A nonprofit corporation may also indemnify its officers, employees, and other agents for similar reasons. Note that state laws may limit indemnification protections for directors, officers, employees, and other agents, though Directors & Officers’ insurance may provide important protections for such individuals even when indemnification is not permitted.
A nonprofit corporation may also indemnify a contractual partner under the terms of a contract. The scope of coverage may vary widely depending on the type of contract and the relative leverage (and legal knowledge) of the parties. The limits of coverage may also vary.
For example, a service provider may be required to indemnify the receiver of services for the service provider’s negligence or willful misconduct that results in the receiver of services being sued. This could happen where a nonprofit hires a service provider to deliver services on behalf of the nonprofit. Perhaps a caterer, a teacher, a counselor, a consultant, or a temporary worker hired from a staffing agency. The nonprofit could also be the service provider that is required to indemnify the party that contracted the nonprofit to deliver services.
It seems reasonable that a service provider paid to deliver lawful services in a competent manner should protect the payor for services for harm caused by the service provider’s negligence or willful misconduct. However, what if both parties’ negligence resulted in the harm? The language of a contractual indemnification provision may contemplate various types of scenarios and how that might change the scope and amount of indemnification required.
Why may indemnification be an important provision in contracts?
Indemnification clauses ideally allow each party to a contract to:
- Determine the level of risk it is willing to accept in such transaction(s); and
- Protect itself from specified risks and harms that would be more equitably and efficiently borne by the other party.
Considerations in negotiating indemnification provisions in contracts
Indemnification clauses are often the most contentious provisions in contracts, yet they are commonly not sufficiently understood by one or more parties entering into the contracts. They may also allow for unreasonable allocations of risk where one party has greater leverage or understanding of applicable laws, particularly when it’s the party that drafted the contract. The following are some important considerations for nonprofit leaders in entering into contracts:
- Do we have a strong understanding of indemnification and whether it should be part of the contract at issue?
- Do we need the advice of an attorney?
- If there is an indemnification provision in the contract –
- Who is it protecting? Only one party? Both parties?
- What is the scope of the indemnification protection? Are the indemnification provisions the same for each party (reciprocal)? Should they be?
- Are there any caps to the maximum liability of the indemnifying party?
- Does the indemnifying party have insurance to cover its responsibility to indemnify the other party?
- Does the indemnifying party otherwise have sufficient resources to cover its responsibility to indemnify the other party?
- Does the indemnifying party have to pay any and all attorneys’ fees of the indemnified party no matter the cost and how the case is managed and/or settled?
Indemnification can be confusing, but it’s best to develop some institutional expertise in knowing how to manage the inclusion of indemnification clauses in bylaws and contracts. These provisions can greatly impact a nonprofit’s ability to recruit individuals for key leadership positions, protect itself from unfair and unreasonable contractual obligations, and appropriately manage various types of risk in a manner that is in the best interests of the nonprofit.
Indemnification clauses in commercial contracts (Thomson Reuters)
Negotiating Indemnity (American Bar Association)