Entrepreneurs sign contracts ALL of the time and more often than not if you’re paying attention you’ll notice something called an indemnity clause. Here is a clause from an LOI related to an asset sale:
The Seller represents and warrants that the Purchaser will not incur any liability in connection with the consummation of the acquisition of the Business to any third party with whom the Seller or its agents have had discussions regarding the disposition of the Business, and the Seller agrees to indemnify, defend and hold harmless the Purchaser, its officers, directors, stockholders, lenders and affiliates from any claims by or liabilities to such third parties, including any legal or other expenses incurred in connection with the defense of such claims. The covenants of the Seller in this paragraph 13 will survive the termination of this letter of intent.
We see these sorts of clauses ALL of the time, so often in fact that you may assume they are ‘standard’ and ‘boilerplate’. I am here to tell you that you may be risking your ENTIRE business if you don’t take a moment to actually understand what you are agreeing to. Indemnity means YOU will pay for the other party’s lawyer, associated expenses AND any judgement. In many cases indemnity is warranted, but it must be taken in context with the scope and size of the contract.
For example, several years ago I licensed a piece of software to a billion dollar media company who used it in a mobile application. Subsequently a patent troll filed patent infringement lawsuits against more than 50 similarly sized corporations with mobile applications. I had agreed to a ‘standard’ / ‘boilerplate’ indemnity clause and my lawyer (who is no longer my lawyer) didn’t bother to negotiate it at all. According to the clause we would have to cover all of their legal bills (billion dollar media companies hire REALLY expensive lawyers) and pay any settlement/judgement against them. It was clear we would win the patent case, but the cost of defending against it would run into the hundreds of thousands of dollars – we only made $60K or so on the deal at the time. It was a stupid mistake that could have bankrupt the company.
There are two simple AND reasonable edits you should ALWAYS propose when you see an indemnity clause depending on the nature of your contract (BTW this is not legal advice, talk to your lawyer before signing anything):
Option One (I like this one best):
In no event shall the maximum liability hereunder exceed the sum of $10,000 (or whatever seems reasonable).
Option Two (good for larger contracts):
In no event shall the maximum liability hereunder exceed the amount actually paid to [your company] under this contract.
If the other party balks or has a problem with either one of these options you should really ask yourself “why”. Is there a high likelihood of litigation? damages? If there is maybe you shouldn’t do the deal in the first place. But never ever agree to blanket indemnification without a cap ever again. Okay?
Please remember to ALWAYS consult a startup lawyer like Kevin Vela before signing anything.