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Information contained in this newsletter is current as at January 2005 Volume 1 Number 10
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to be frank ...
by Frank Adoranti CORPORATE LEGAL EDUCATION & DEVELOPMENT
Unlocking the mysteries of indemnity clauses
An indemnity is a contractual wording of the indemnity clause. This is
commitment by a party to make good a often why indemnity clauses can become
specified loss suffered by the other party. such long winded arrangements.
In other words, it is an acknowledgment The consequences can be far
and promise by one party to cover the reaching and serious for any business not
potential liability of another. exercising due care in the indemnities it
A key feature of an indemnity is that provides. Quite literally, ill considered
the obligation created by it can often indemnities could lead to financial ruin.
extend beyond that which would
otherwise be imposed on a party under Difference between warranties
the general law; that is the liability under and indemnities
an indemnity is not necessarily limited by A warranty is an assurance or
the dollar value of the contract under promise in a contract. It usually relates
which it was given. to assurances about past or present
The very concept of an indemnity facts in the transaction which is the
involves making the injured party whole subject of the contract.
again, as if the loss had not occurred, The purpose of a warranty is to give
even if the person who agrees to its recipient the right to sue for damages
indemnify would not otherwise have had if such assurance later proves untrue or
any obligation to do so. inaccurate.
In contracts the typical reasons for The breach of a warranty gives rise to
indemnities are: a claim for damages. Such damages, if
• transferring or reversing liability from awarded, are subject to the common
one party to a contract to another; and law rules relating to the assessment of
• confirming and reinforcing existing damages. For example, damages will be
liability. subject to the test of remoteness, the
duty to mitigate the loss and so on.
Purpose of an indemnity The ultimate effect of such common
The purpose of an indemnity clause in law rules is that the recipient of the
a contract is to protect a party from the warranty may recover substantially less
effects of an action, non-performance, than all losses connected with the
negligence or wrongdoing of another. breach.
Essentially, it amounts to a promise to A properly worded and well worded
keep another party to the contract free indemnity, instead, can make the entire
from harm to the extent specified by the loss recoverable.
contract
management IN PRACTICE
Other issues to consider are not foreseeable and not within the
Indemnities are an important and ordinary knowledge of the party being
complex area of contracts. The extent required to provide such protection.
of the problems created by indemnities Indeed, in some circumstances the risks
tends to be magnified when grappling can even extend to include the losses of
with the issue of consequential loss and persons who are not parties to the
damage. agreement!
Indemnities are not always simply Many organisations will have a firm
black or white issues. The issue is not policy against the acceptance of
always confined to ‘Do I provide an consequential loss clauses in
indemnity or not?’. commercial contracts. This is a wise
Indemnities can be qualified by move to prevent the unintentional or
certain exceptions and exclusions. With inadvertent acceptance of such
careful evaluation, subtle changes can clauses.
often create significant effects in
reducing or minimising liability. You Conclusion
should exercise great caution here, as When used correctly and prudently,
the converse can also apply. indemnities can be an extremely
In considering any indemnity powerful risk transfer tool.
provision, it is important to pay close On the other hand, they can have far
attention to the substance of the party reaching and devastating effects when
with whom you are contracting. misunderstood or blindly accepted. Their
Having a clause to ‘protect’ you is not impact is not necessarily limited to the
sufficient if the other party has no dollar value of the contract, or even to
means to satisfy any potential future the length of the contract term, so the
claim. potential liability can be ongoing and
Remember that it is not the clause perhaps unlimited in scope (in the
itself that protects you, but the standing absence of careful qualifications and
and substance behind the entity exceptions).
providing it — so the best worded The general ‘plain English’ principle
indemnity clause in the world may be to be applied in indemnities is:
useless when the time comes to enforce it • if we mess up, we are responsible for
against an organisation with no means the direct consequences;
or substance behind it. • if you mess up, you are responsible
for the direct consequences;
Consequential loss • if someone under our control is to
Consequential loss provisions extend blame, we are responsible;
the (already potentially problematic) • if we share the blame, then we share
liability created by indemnities even responsibility to the extent that we
further. are each to blame; and
It can be argued that consequential • if someone not under our control is
loss clauses are not normal or reasonable to blame, we are not responsible.
commercial terms. Anyone involved in the review or
By their very nature, consequential acceptance of commercial contracts
losses are uncertain and difficult to owes it to themselves and to their
quantify. The argument against the use employer to have an understanding of
of a consequential loss clause is that it the fundamentals of indemnity
allows the category of damages that can clauses. q
be claimed to be unfairly broadened and
extends liability beyond the normal Frank Adoranti,
commercial realm. Corporate Legal Education
Consequential loss clauses involve the and Development,
acceptance of responsibility for risks that <www.cled.biz>, <info@cled.biz>.
2 .............................................................................................................................................................................. vol ❶ no ❿ December 2004/January 2005
