Imagine for a moment that you rent a chainsaw from the local ABC rental company. Since your ability to use a chainsaw safely remains unproven to the ABC rental agent, he may ask you to sign a number of papers. One of those papers might read: "The renter of this equipment agrees to defend, indemnify and hold harmless ABC Rental Company and its staff for any third-party claims which may arise from the use of the equipment." This is considered indemnification, an agreement between two parties not to hold one of them responsible for future legal action or fines. Indemnification usually only works in one direction; you as the renter agree not to hold ABC Rental Company employees responsible if you have an accident with their chainsaw.

Indemnification may not seem like a major consideration in most circumstances -- the chances are pretty good that you won't be hit by a baseball at a game or suffer damages from faulty rental equipment. But indemnification can be a very important consideration if you're a director of a medical equipment company, for example. There's always a possibility of a patient suing one of your client hospitals for damages suffered in a fall from one of your wheelchairs. An indemnification agreement with your company means that the hospital agrees to take financial responsibility if a patient prevails in a lawsuit. Without indemnification, you could be held personally liable for damage payments.

Many times an indemnification clause is invoked in the case of third-party claims. If you rented your chainsaw from ABC Rental Company and signed an indemnification clause, then you essentially agreed to indemnify them, or hold them harmless. This means if you accidentally used the chainsaw to carve up a neighbor's car, the neighbor could not sue ABC for renting the chainsaw to an incompetent user in the first place. If the neighbor still tried, ABC would expect you to testify in court and aid in their legal defense.

Indemnification clauses usually trump any other legal arguments, so it is important for both parties to understand precisely what actions are covered under the agreement. Some indemnification clauses can be worded too vaguely to be enforced, while other can be very specific about geographical limitations or eligible third-party participants. This is why many companies consult legal counsel before drafting an indemnification agreement for new employees and board members. The legal language must be solid or a company's executives could face major financial ruin from liability claims and lawsuits.