Indemnities and commercial contracts

What is an ‘indemnity’ and when is a Council likely to come across one?

An indemnity clause is often found in commercial contracts. In traditional legal language, it is a promise to ‘hold harmless’ the other party, should a particular event occur. An example of where a Council might come across such a clause is in its procurement contracts (where the Council may ask the other party to give indemnities).

An indemnity means making good any relevant loss that arises. The event typically includes a breach of the relevant agreement – but it might also extend to other events, including events over which the indemnifying party has no control. For the party receiving the benefit, it is rather like being insured against the loss. It is therefore obviously a very serious obligation.

When considering an indemnity, you are really looking at a risk allocation issue: the party giving the indemnity is being asked to assume the risk of particular events occurring. Risk allocation between the parties to contracts is of course a fundamental part of contract negotiation, in which each party typically wants to push off as much risk as possible to the other party. That sounds good if you are the party that has all the power in a negotiation – you might be able to force the other party to accept all sorts of quite unreasonable risks – but where power is more equally balanced, asking the other party to accept a wide range of risks is likely to cause ‘push back’ from the other party – and extra delays and costs in reaching final agreement and a signed contract

So what does an indemnity clause looks like?

They come in all shapes and sizes, but you might see something like this:

The Contractor shall at all times indemnify and hold the Customer and its directors, officers, employees, sub-contractors and agents, harmless from and against any costs (including reasonable legal costs on a solicitor and client basis), claims, demands, expenses, losses or other consequences suffered by the Customer in relation to any breach by the Contractor of this Agreement, or arising out of any act or omission, breach of statutory duty, negligence or wilful default of its directors, officers, agents, employees or sub-contractors or of any other person for whose acts or omissions it is vicariously liable.

Breaking it down…

The first part of the clause contains an indemnity against any loss arising from breach of the agreement. But why would you need such a right, if, as is well known, you can sue the other party for damages for breach? It is a very good question!

Damages are limited by well-established legal principles and it is not every consequence, however remote or unforeseeable, that will at law result in compensation. Damages for breach of contract are designed to put the innocent party into the same position as it would have been in, had the contract been performed. But damages must be shown to have actually been caused by the breach, and are usually limited to those that can be said to have arisen naturally and in the usual course, or where, beforehand, some specific risk was made known.

If you are the contractor, you might well say that the indemnity clause should be deleted from the contract because, if there is a breach, the Customer’s rights under the general law are perfectly reasonable and adequate, and the Contractor should not be liable for anything beyond what well established legal principles would allow.

On the other hand, if you are the Customer, you might argue that you want the Contractor to be liable for anything that arises from the breach of the contract, and that damages should not be artificially limited by the principles that a court would be obliged to apply.

If the indemnity is to stay, then the next step might be to negotiate the insertion of words limiting the scope of the indemnity in certain ways – eg to ensure that only certain sorts of losses are claimable (such as direct losses, and excluding certain types of consequential losses, like loss of profits), and to provide that the innocent party has a specific obligation to mitigate its losses (an obligation that would arise under general contract damages principles but may not apply to a claim under an indemnity).

The second part of the clause contains an indemnity against losses arising from other causes. This indemnity is very broad. It might well be objected to on at least the following grounds:

• Generally, the clause purports to go well beyond any breach by the Contractor of its obligations under the contract;

• It purports to impose liability for ‘any act or omission’. That could mean that the Contractor could be liable despite not having been at fault in any way;

• It purports to impose liability on the Contractor for acts of others; ie directors, officers, agents, employees and sub-contractors, and certain others. Why should there be a possible liability there for the Contractor which would go beyond the liability that the general law would impose upon the Contractor for such matters?

A response to such objections might be to say that a court would be likely to limit the literal interpretation of the clause in some ways – eg to construe the words ‘act or omission’ to cover these only where a breach of a legal duty is involved, or to limit those for whom the Contractor is liable to those where the law would have imposed a liability anyway. The response to that might be to say, ‘If that is right, why do we need the clause at all? It only creates uncertainty’. Alternatively, sensible limits on the scope of the indemnity can be negotiated and dealt with by wording added to the clause to soften its effects. You might consider something along these lines:

except to the extent that the costs, claims, demands, expenses, losses or other consequences are indirect, consequential, special, exemplary or incidental loss or damage, and except to the extent that any of them is caused or contributed to by the default or negligent or wrongful act or omission of the Customer or the Customer’s servants or agents.

Another difficulty that can arise with an indemnity is where a party such as the Contractor has liability insurance that may be prejudiced by the assumption of an obligation under an indemnity. A public liability policy can be expected to exclude liability assumed by way of contract, unless that liability would have existed in the absence of that contract. Similarly with a professional indemnity policy – the following is a sample of the wording in such a policy:

‘the Insurer will not be liable for any liability assumed by the Insured under any express warranty, guarantee, hold harmless agreement, indemnity clause or the like unless such liability would have attached to the Insured in the absence of such agreement.’

These limitations provide a strong basis for an argument by the Contractor to the effect that it has all reasonable and prudent insurances – so why should it assume a liability under the contract beyond its liability at general law, against which it cannot insure itself?

Other issues

Further issues that can arise in this context include:

• The desirability for a party giving an indemnity to ensure that any liability that may arise is subject to the same limits (eg caps on the time during which claims can be made, caps on claim amounts, liquidated damages) as apply to other claims under the contract;

• Dealing with proportionate liability issues (eg to ensure that any limits that arise under the Civil Liability Act remain applicable, so that the indemnifying party is not responsible for more than its fair share of a loss);

•  Considering an exclusion of liability under the indemnity:

  • for the acts of third parties, and in other circumstances where the indemnifier has no control over the relevant circumstances;

  • for liability to third parties;

  • where the party indemnified has some level of responsibility for the loss or damage

• Considering whether reciprocal indemnities are appropriate or not;

• Considering the appropriateness and extent of indemnities against liability for breach of IP rights – eg where one party makes materials available to another, where those materials may be the subject of third party rights;

• Considering whether fines or statutory penalties that can arise in particular circumstances are able to be the subject of an enforceable indemnity.

Author: John Elmgreen