to be frank by maclaren1


       management                                                                                       IN PRACTICE

Information contained in this newsletter is current as at January 2005                                    Volume 1 Number 10
                                                                                                       Print Post Approved 255003/00769

                                         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.
  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                                               <>, <>.

2   ..............................................................................................................................................................................   vol   ❶ no ❿ December 2004/January 2005

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