Most important points

• An indemnity clause obliges one contracting party (debtor) to indemnify the other party (creditor) against certain third-party claims, i.e. to pay damages or costs in the event of a claim.

• Such clauses are often used to cover risks arising from one party’s area of responsibility, for example when a supplier guarantees that its product does not infringe the rights of third parties and indemnifies the buyer in the event of patent or copyright claims by third parties.

• Typical areas: Infringement of intellectual property rights (IP-Indemnity), product liability, data protection violations, violations of laws by one party that could lead to claims against the other.

• In German law, the term “indemnification” is also known as hold harmless. Legally similar mechanisms can be found, for example, in Section 257 of the German Civil Code (BGB) (claim for release from an obligation).

• Indemnification clauses are double-edged for start-ups: as a service provider, they must be careful not to take on incalculable risks, but as a customer they can insist on indemnifications, e.g. to be covered when using a third-party product.

Purpose and mode of operation

The purpose of the indemnity clause is to ensure that one party (usually the party that controls the cause of a risk) can not only be held passively liable for damages in the event of a claim, but also actively indemnifies the other party against third-party claims. In concrete terms, this means that if the agreed event occurs (e.g. a third party sues due to an IP infringement), the debtor of the indemnification must

• defend against or satisfy the claims of third parties,

• and reimburse the injured party for all necessary costs (legal defense costs, damage payments, etc.).

This puts the beneficiary party in a position as if it had nothing to do with the dispute. Ideally, the indemnified party even takes over the entire defense in the lawsuit.

Application examples

• IP indemnification: Software or component supply contracts often contain the assurance that the delivered product does not infringe any third-party rights (patents, copyrights, trademarks). In the event that an infringement does occur, the supplier undertakes to indemnify the customer. In practice, the supplier must then pay for legal fees and court costs and, if necessary, provide for license fees or compensation so that the customer is not burdened. At the same time, the supplier can define typical exceptions (e.g. no indemnification if the customer modifies the software and the infringement arises as a result).

• Product liability: A manufacturer who delivers to a retailer indemnifies the retailer against claims from end customers if the product has defects that lead to damage. This means that in the event of damage, the manufacturer must bear the liability, which is appropriate as the manufacturer is responsible for the product.

• Violations of laws: For example, a service provider could promise that its solution is GDPR-compliant and include indemnification in the event that the customer is held liable by third parties (e.g. data subjects) for data protection violations.

Limits and design

Exemption clauses should be clearly formulated:

• Scope: What type of claim or infringement is indemnified against? (e.g. “Claims based on infringement of intellectual property by the contractual product”).

• Scope: Is 100% indemnification granted, including all costs? Can the indemnified party defend itself or must the obligated party assume the defense? It is often stipulated that the indemnifying party also takes over the conduct of the proceedings in order to retain control, while the other party has obligations to cooperate (e.g. information about the claim, no acknowledgements without consent).

• Exclusions: When does the exemption not apply? (For example, if the indemnified person is partly to blame or has breached contractual conditions).

• Procedure: Notification deadlines for third-party claims, duties to cooperate in defense.

In German law, an indemnification can also be structured as a contract in favor of third parties (the injured third party can demand fulfillment directly from the obligated party). In most cases, however, it remains an internal claim between the contracting parties.

An excessively broad indemnification can harbor risks: Whoever indemnifies should be able to assess the risk (e.g. how likely are such third-party claims, are they insurable?). It may also be advisable to apply a limitation of liability to the indemnification obligation (e.g. maximum X euros or exclusion in the event of gross negligence on the part of the other party).

Importance for start-ups

Startups encounter exemption clauses both as providers and as customers:

• As a provider (e.g. software startup), you want to give customers convincing guarantees, but you should make sure that you only promise manageable risks. If necessary, insurance (product liability, financial loss liability) should cover these risks so that a single liability case does not deprive the company of its financial basis.

• As a customer/licensee, it is legitimate to demand an indemnification so as not to be left out in the cold if the purchased product causes legal problems. Here, the startup should insist on clear wording so that its own position is protected in the event of an emergency.

In any case, indemnification clauses are potential deal-breakers in negotiations, as they can be risky. A balanced formulation that is fair to both sides is therefore important: the party granting the release accepts responsibility for its sphere of influence, while the beneficiary cooperates fairly and does not make excessive demands.