The other day, I met a guy who told me about a situation he was in where he was a consultant for a company who got in a legal dispute with another firm. Then he got tangled up in the lawsuit and got sued by the other firm and was forced to defend himself with his own funds because there was no clear indemnification in any contracting agreement.
At the moment, this guy is shelling out between $25K to $50K per month out of his own pocket to pay for legal fees. There is a soon to come happy ending though. It turns out that this guy was employed through another temp firm while working for the company. While indemnification was not explicit, it just so happens that employees are automatically indemnified via the California Labor Code (see section 2802) and is the same for pretty much every other state’s Labor Code.
However, had this guy worked directly for the company without an official statement of indemnification as a consultant, he would have been really screwed. There would be no clear path for indemnification and thus reimbursement for legal fees.
Very scary. How would you like to pay out of pocket legal fees of $25K to $50K per month, and for months on end?
As soon as I heard this story, I called my lawyer and thanked him for being so adamant about indemnification.
In my journey to implement indemnification, here are my thoughts and discoveries:
1. Ignorance of the state’s Corporation Code, especially with respect to indemnification, is common among the lawyers I’ve worked with. So they err on the side of company favorable tactics, which is to never give anything away, including indemnifying advisors.
2. Not knowing or understanding indemnification is also shared by investors and other entrepreneurs.
3. It’s very much a worst-case scenario discussion. It’s difficult to discuss sometimes.
4. Experienced entrepreneurs have no issue with it. They just assume they’ll protect anybody that does work for them. It’s natural for them to thank people who help them in that way.
5. By the way, all the Corporation Codes stipulate that in the case of an external person causing harm willfully to a company, the Code states that indemnification is invalid, even if a contracting/consulting/advisory agreement calls for indemnification. By the way, there is the case of unknowingly causing harm which is a huge grey area and would probably have to be explored on a case by case basis.
If you’re interested, you can read about indemnification in the California Corporation Code or in the Delaware Corporation Code.
6. No matter what, I do not want to put my personal assets at risk for another company. It doesn’t make sense at all.
7. I will definitely walk away from any deal that will not indemnify me as an advisor. It is a deal breaker.