In every contract you sign, you will usually find a reference to indemnities. Indemnities are promises from one party to compensate the other party for certain losses or damage. Indemnities contain important obligations you cannot waive if you have to indemnify someone. Alternatively, you may have additional rights to recover compensation if you receive an indemnity from the other party. This article is an introductory guide to how indemnities affect your business and what you should look for in a contract.
What is an Indemnity?
An indemnity in a contract is a promise by one party to compensate the other party for loss or damage suffered by the other party during contract performance. Not all indemnities are obvious in contracts. Often, they fall under the guise of various names. Furthermore, a party can reference indemnities by using words such as:
- hold harmless;
- defend;
- make good; or
- compensate for.
When there is an indemnity clause, the person who provides the indemnity is known as the indemnifier. The person covered by the indemnity is known as the indemnified party.
Different types of indemnities arise in contracts and contractual relationships. The more detailed and defined an indemnity clause, the more easily compensation will flow.
How to Limit the Scope of an Indemnity
You can introduce limits to the scope of an indemnity to apply only to specific situations or types of claims.
Consider a software supplier who sells software to a customer. The indemnity in the contract may indemnify the customer against any third-party intellectual property (IP) claims. In this sense, the supplier has promised the customer that if a third party outside the contract sues the customer for IP infringement (such as a breach of copyright), the supplier will accept responsibility for the customer’s loss or damage resulting from the claim.
The clause demonstrates how an indemnity can limit:
- the types of claims allowed (limited to third parties only); and
- the types of loss and damage that a supplier will cover under the contract (losses arising from the third-party claim for IP infringement).
For example, in the software supplier case study, the clause limits claims to third-party IP claims over the software supplied to the customer under the contract. The supplier will cover losses related to the claim. However, the clause may not cover the customer’s legal fees.
Continue reading this article below the formWhy Should You Limit Indemnities?
An indemnity clause differs from a standard contractual term because of its potentially broad scope. As the indemnifier, you should closely assess the indemnity clause to limit its scope and minimise the potential financial impact. A broad liability clause may refer to the indemnifier indemnifying the other party against all losses, howsoever arising.
Without limiting that clause, the indemnifier could be subject to paying significant amounts of money if the indemnity clause is engaged. These amounts may also include losses that are not directly related to the contract.
However, suppose you are the party receiving an indemnity. In this case, the broader and more general the indemnity clause is, the more you may be able to recover. For example, a broad indemnity may include costs associated with legal and professional fees and account for acts of the other party’s employees and representatives.
You can amend the broad scope of an indemnity by:
- specifying carve-outs to the indemnity, where certain events are excluded, such as the acts or omissions of the other party;
- stating that proportionate liability will apply; or
- placing obligations on the other party to mitigate their loss.
How Do Indemnities Affect You?
When you receive a contract with an indemnity clause, you should look at the indemnity from both sides. You, the indemnifier, may promise to indemnify the other party. Alternatively, the other party may promise to indemnify you, the indemnified party.
Indemnifier
If you are the indemnifier, you should ask yourself:
- what types of responsibilities apply to you;
- the potential cost to your business if you have to indemnify the customer;
- whether you can afford to meet those costs; and
- whether you have insurance to cover this type of indemnity if it is required.
Most insurance policies will not cover you for liability assumed under an indemnity. You may need tailored insurance that covers your specific liabilities under the contract. Check with your insurance broker if your existing insurance will cover these risks.
Indemnified
If you are the indemnified party, you have a lower threshold to demand compensation for any loss or damages you suffer. Under many indemnities, you do not have to prove that the other party was at fault for causing the loss or damage to receive compensation. You only need to show evidence of expenses related to the claim under the indemnity.
Therefore, an indemnity is similar to recovering a debt. You want an indemnity to cover you broadly for the biggest risks that may occur under your contract. You can still sue for a breach of contract and receive compensation through awarded damages. However, your business is less likely to struggle if you can receive compensation more quickly without the need to prove fault. If you are the indemnified party and providing the contract to the other party, you must determine if your indemnity is fair.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
Appropriately Negotiating Indemnities
When negotiating an indemnity clause, you should consider the following:
- who is giving the indemnity and who is receiving it;
- what types of liability the clause covers; and
- the limitations you will expressly include in the indemnity.
For example, if you are receiving the indemnity, you may request that the indemnity cover your actions and omissions and all legal costs. If you are giving the indemnity, you may want a requirement that the indemnified party mitigate their loss for events within their control.
Key Takeaways
Indemnities are broad promises you give the other party to compensate for losses or damages. Alternatively, the other party can give you an indemnity. When you receive a commercial contract with an indemnity clause, you should understand:
- the types of indemnities you can have in a contract;
- how to limit the scope of an indemnity clause;
- the obligations you have under an indemnity clause; and
- how to negotiate an indemnity clause to limit your liability.
If you need help with your indemnity clause, contact our experienced contract lawyers as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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