Key Takeaways
- Indemnification should be tied to specific contractual breaches, not drafted as blanket insurance coverage.
- Limit indemnification to third-party claims and always draft it in coordination with your limitation of liability clause to avoid unintended consequences.
- AI tools create unique indemnification challenges that require specific contractual attention rather than standard boilerplate language.
Indemnification clauses are among the most poorly understood provisions in commercial agreements. Many lawyers freely admit to cutting and pasting provisions from templates without much thought. Let’s try to change that mentality together, shall we? As general counsel, here are three issues I see all the time that I could easily go on a Lewis Black-style rant about.
Indemnification Is Not Insurance
Let’s start with first principles: Indemnification should be anchored to specific contractual breaches (or legal standards), not drafted as a blanket policy against every risk that might arise from the business relationship. The purpose of indemnification is to allocate liability or loss that accrues when a party fails to live up to a specific promise: such as a breach of a representation, warranty, covenant, or standard of care.
Tying indemnification obligations to a defined trigger (e.g., failure to provide services in a professional and workmanlike manner, infringement, failure to implement appropriate data security safeguards, gross negligence or willful misconduct) allows both parties to understand the risk, their exposure, and negotiate meaningfully.
However, some people expect indemnification clauses to read like catch-all insurance policies, turning the indemnifying party into a general insurer against business risk. My principle is this: if a party does everything as promised, they should not be contractually obligated to indemnify. Here’s why.
Even with perfect performance, external risks exist. That’s what insurance is for. Vladimir Putin can still wake up tomorrow and hack into your systems as easily as mine. The right question when it comes to indemnification isn’t whether a breach occurred, but whether it happened because a party left the barn door open. If fault isn’t going to be required, that commitment belongs in an insurance clause, not indemnification.
Contract drafting tip: Make sure that your indemnification clause is tied to breaches of specific contractual or legal standards, not just blanket business risks.
The Limitation of Liability vs. Indemnification Obligations Trap
The second issue involves misunderstanding how indemnification relates to a limitation of liability. In any contract, the parties have privity, meaning they can already sue each other directly for breach. Indemnification exists to cover third-party claims arising from the other party’s breach. If indemnification isn’t limited to third-party claims, bad and often unintentional results follow.
Say the indemnification clause is not limited to third party claims (e.g., it includes first party claims). But you successfully excluded extraordinary damages and capped direct damages to fees paid or payable in the 12 months preceding a claim. There are three common scenarios that can arise next.
Scenario 1: You carved out indemnification obligations from the cap. If the indemnification clause isn’t limited to third-party claims, then it also covers direct claims between the parties. And that means that a party can make an end run around your cap simply by suing you under the indemnification clause for “losses” rather than for breach of contract for “damages.” Oops.
Scenario 2: You did not carve out indemnification obligations from the cap. That may mean that even if you limited indemnification to third-party claims, the indemnification you thought you had is meaningless because the other side doesn’t have to defend those claims once the cap is reached.
Scenario 3: The limitation of liability clause and the indemnification clause aren’t clearly drafted with each other in mind. This can mean that a court will have to decide the proper interaction between the two; something in our business we call “litigation-friendly” (which, it turns out, isn’t actually friendly at all).
In each of these scenarios, the first-party indemnification obligations interfere with the limitation of liability clause, causing an unwanted result for one or both of the parties.
Contract drafting tip: Limit indemnification to third-party claims so it serves its intended purpose, and always draft it together with the limitation of liability clause so that it is clear whether indemnification sits inside or outside the cap.
AI is Disrupting Everything. Why Should Indemnification Clauses Be Different?
What would an article in 2026 be without a discussion of AI and its impact to contractual deals and risks? As you might imagine, when you’re dealing with a vendor that uses AI (or are one), there are some unique challenges that need to be addressed.
Remember, let’s recognize that there are risks inherent in these tools. For example, AI can produce unexpected outputs. Also, it may have been built using other people’s copyrighted content or proprietary data. These are inherent risks of using AI.
If you’re an AI vendor, you generally want the customer to contractually acknowledge and absolve you from these inherent risks. Also, you understand that AI outputs are partly shaped by how the customer uses the tool (the prompts, the data they feed in) and so you don’t want to take on open-ended liability for results you can’t fully predict.
If you are a customer, you realize that narrowing or eliminating coverage for exactly the scenarios most likely to generate claims is risky. You might point out that while these risks are inherent in the technology being offered, the party best positioned to mitigate or insure against them is the vendor, not the customer.
Contract drafting tip: Both parties need to understand the unique challenges of AI tools and specifically address them in the indemnification clause.
So, fellow Contract Nerds, don’t cut and paste indemnification provisions on autopilot. Tailor them to the deal’s actual risk profile and make sure they work with the rest of the agreement.
Follow-up assignment: Ask your favorite AI tool to tell you about the importance of including the word “defend” in an indemnification provision.
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