DO YOU BELIEVE IN INDEMNITY CLAUSE Obligations of indemnity and

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DO YOU BELIEVE IN INDEMNITY CLAUSE Obligations of indemnity and Powered By Docstoc
					                      DO YOU BELIEVE IN INDEMNITY CLAUSE?
                       Obligations of indemnity and their impact
                                                   on insurance

Insurance does not effect the obligation to indemnify

It is not uncommon for a major commercial enterprise (A) to contract functions of its
enterprise (the “Works”) to contractor (B). In doing so, as part of their contractual
relationship, A will often insist that B:

    (a) agree to indemnify A against any loss caused to A by reason of the performance
        of the Works (the “Indemnity Clause”); and

    (b) procures insurance (ie with C) in the name of A in respect of damage which A
        may sustain arising out of or connection with the Works.

If, when performing the Works, B causes an injury to a third party (ie “D”) and D
successfully brings an action against A for its loss and damage (the “Claim”), then A
would seek to recover its liability for the Claim from B under the terms of its indemnity
clause and from C under the terms of insurance that has been procured by B.

This scenario was considered by the Court of Appeal of the Supreme Court of Western
Australia in Speno Rail v Hammersley Iron (2000) 23 WAR 291. In that case an
employee (D) of Speno (B), a contractor of Hammersley Iron (A), successfully sued for
damage that was sustained during the performance of the Works (the “Claim”) but
which was caused by A’s negligence. In turn, A brought an action seeking indemnity

    (a) B, based on an indemnity clause in its contract with A; and

    (b) Zurich (C) under cover that had been procured by B pursuant to the terms of its
        contract with A.

The Court held that B and C were jointly and severally liable to A for the Claim.

In attempting to meet A’s claim for contribution, both B and C raised a number of issues
based on the nature of the contract of insurance that had been procured by B, the
terms of the indemnity clause provided by B and the legal effect of their
interrelationship with each other.

B argued that because it had procured insurance cover with C that was in the name of
A and which responded to the claim that A was not entitled to rely on the indemnity
clause against B as A’s liability for the claim had been completely satisfied by the
policy. That is, because of the cover provided by the insurance policy, A suffered no
loss to which the indemnity clause responded.

While the parties and the Court accepted that the insurance cover procured by B was in
the nature of a contract of indemnity, the Court rejected B’s contention on the basis that
the obligations of an insurer are secondary when compared with the obligations of a
party under an indemnity clause. Central to the Court’s analysis was the concept that
contracts of insurance are res inter alios acta. That is, a contract that is not intended by
the parties to it, to have the effect of prejudicing any rights that a party to it has against
a third party. In the circumstances, therefore, the contract of insurance which dealt with
the obligations of C to indemnify A in respect of the Claim, was not intended by either A
or C to affect any rights A would have otherwise had against B.

Under the terms of its indemnity clause, B was under a primary obligation to indemnify
A for any loss caused to D arising out of the performance of the Works. A contract of
insurance, even if it was procured by B for the benefit of A, was, given the terms of the
contract between A and B, secondary in its nature when compared to obligations
imposed by the indemnity clause. It was intended to provide additional comfort to A in
the event that B defaulted in its obligations under the indemnity clause and was not
intended to be a substitution for B’s liability to A. That is, both the insurance cover and
the indemnity clause were provided by B to protect A from the liability of D. The Court
noted that the insurance cover would operate, for example, in circumstances in which B
was insolvent and therefore A’s right of indemnity would be practically ineffective.

The importance of Speno’s case is that clients in the position of A will be able to rely
on an appropriately worded indemnity clause in a contract with their contractor (B)
notwithstanding the fact that the contract also requires B to procure insurance to protect
it against the same loss. However, a client should be mindful to ensure that such an
indemnity clause is clearly drafted so as to make certain that foreseeable risks are

expressly covered by the terms of the indemnity clause given the recent High Court
decision in Andar Transport Pty Ltd v Brambles Limited [2004] HCA 28 (unreported,
15 June 2004). In that case, the High Court confirmed that such clauses, particularly
when included in standard form contracts drafted by A, are likely to be read strictly so
as to limit the scope of any indemnity provided there under.

The existence of an indemnity clause will defeat an insurer’s claim for

In contrast, clients in the position of an insurer like that of C should note that the Court’s
finding in Speno that the nature of the obligation of the indemnity clause was primary
when compared with the insurance cover, operated to defeat C’s claim for contribution
from B as the Court held that the two liabilities were not coordinate.

The primary reason noted by the Court for finding the liabilities were not coordinate was
based on the proposition that because the contract between A and B allocated the risk
the subject of the Claim to B, the parties had indicated an intention that B’s
responsibility for the liability would be primary and that ultimately liability for any claim
should rest with B. This meant that the nature of the obligations created under the
indemnity clause were not equivalent to the obligations created by the insurance policy.
In those circumstances the necessary requirement that would have enabled the insurer
to seek contribution from B was absent. However the Court was not prepared to find
that such a conclusion would invariably be the case as it would necessarily depend on
the wording of the indemnity clause.

The impact of an indemnity clause on double insurance

The facts of the Speno case might also give some guidance to the situation in which A
too had its own insurance policy which responded to the risk and C sought to argue that
it was entitled to seek contribution from A’s insurer with regard to its liability in respect
of the Claim. In cases of double insurance, that is, where an insured has the benefit of
two insurance policies both of which respond to the same risk, one insurer is normally
entitled to seek contribution from the other insurer in respect of the liability the subject
of the insurance policy such that they rateably bear the burden of the loss.

However, in circumstances in which double insurance arises by virtue of a contract like
that described between A and B which contains an indemnity clause, A’s insurer might

argue that C is not entitled to seek contribution from it on the basis that the terms of the
Indemnity Clause between A and B, coupled with the obligation on B to procure cover
for A indicates an intention that the loss should rest with the mechanism for allocating
the risk that existed under the contract. Speno indicates that liability should rest with B
and not on A. The fact that A had an insurance policy in its own name should not be
permitted to disturb the allocation of risk agreed to by the parties which included the
effecting of an insurance policy by B which was also in the name of A.

In support of this contention one might rely on the decision in Hacai Pty Ltd v Rigil
Kent Pty Ltd and Ors (unreported decision of the Full Court of Western Australia, 16
August 1996). In that case the tenant by the terms of its lease was required to effect
public liability insurance both in its own name and in the name of the landlord. Despite
this requirement, the tenant only effected a policy in its own name. A claim was made
against both the landlord and the tenant in relation to a person injured on the premises
and the Court found that both the landlord and the tenant were liable to the plaintiff. In
bringing its contribution claim against the tenant, the landlord argued that it had
suffered loss by reason of the failure of the tenant to have procured insurance in the
landlord’s name. The tenant sought to argue that because the landlord had its own
insurance policy it had suffered no loss by reason of the tenant’s failure to procure a
second insurance policy covering the liability on the part of the landlord.

The Full Court rejected the tenant’s submission finding the fact that the landlord had its
own insurance cover irrelevant to the question of whether the landlord had suffered a
loss by reason of the breach of the term in the lease to procure cover. In this case too,
the parties to the lease had agreed to allocate a responsibility to the tenant and if that
responsibility had been carried out there would have been two insurance policies
effectively in the name of the landlord both of which would have responded to the risk.
However, the judgment supports the conclusion that the allocation of the responsibility
to the tenant to have procured the second policy would be a basis upon which the court
might find that the respective liabilities of the insurers were not coordinate and therefore
one insurer could not make out the necessary requirement to claim contribution from
the other based on the principle of double insurance.


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