In every contract you sign, you will usually find a reference to “indemnities”. In basic terms, they are promises from one party to compensate the other party for certain losses or damage. Indemnities contain important obligations that 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 you should look for in a contract. 

What is an Indemnity?

An indemnity is a promise by one party to compensate the other party for loss or damage suffered by the other party during the performance of the contract.

An indemnity is also known as a ‘hold harmless’ clause as one party agrees to hold the other party harmless. Alternatively, they are ‘make good’ clauses where the other party is put back in their original position before the claim. 

When there is an indemnity clause, the person who provides the indemnity is known as the indemnifier. The person who is covered by the indemnity is known as the indemnified party.

An indemnity comes in various forms. For ease of explanation, a goods supplier is the indemnifier, a customer is the indemnified party.

 

Name  Explanation
Bare indemnity The supplier indemnifies the customer for losses caused by a set of circumstances under the contract. The indemnity does not specify other events such as losses caused by the customer. 
Reverse indemnity The supplier indemnifies the customer for any customer acts or omissions during the contract. 
Proportionate Indemnity The supplier indemnifies the customer only for losses that flow from the supplier’s acts or omissions during the contract.
Third-party Indemnity The supplier agrees to be responsible for any losses because of a claim against the customer by a third-party related to the contract.
Party/Party Indemnity The supplier indemnifies the customer where the supplier breaches the contract. It also requires the customer to indemnify the supplier where the customer breaches the contract.

How to Limit The Scope of an Indemnity

You can introduce limits to the scope of an indemnity to apply only to certain situations or types of claims.

For example, you have a software supplier who sells software to a customer. The contract says the supplier gives the customer an indemnity where a third party makes an intellectual property (IP) claim against them. The supplier has promised the customer that if a stranger 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. 

A clause in the contract could look like the following paragraph below.

Despite anything to the contrary, the Supplier shall indemnify the Customer against any loss, cost, damage, expense, liability or claim (Claim) suffered or incurred by the Customer which relates to or arises out of any third party claim that the Software, or the Customer’s use of the Software, infringes the Intellectual Property Rights of any third party.

The clause demonstrates how an indemnity can limit: 

  • the types of claims allowed; and
  • the types of loss and damage that a supplier will cover under the contract.

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 will not cover legal fees from the customer. Therefore, the clause means that while you will provide an indemnity, you will not extend its scope to cover every type of loss.

Why Should You Limit Indemnities?

An indemnity clause differs from a standard contractual term because of its broad scope. A standard clause will refer to a supplier indemnifying the customer against all kinds of loss. If you do not add limits to that indemnity clause, you could be unfairly held responsible for losses that are out of your control. A standard indemnity, without any amendments, does not:

  • exclude liability for remote losses or damage that are not linked to the original contract breach (for example, requiring medical expenses for stress over software failure is a remote loss);
  • require the other party to limit the extent of their loss (for example, delaying the report of a software virus until the documents are destroyed);
  • usually limit the time period for the affected party to take legal action (for example, the customer may sue you ten years after buying the software).
  • limit your liability to any liability directly caused or contributed to by yourself or the customer, otherwise known as proportionate liability (for example, you may be liable for the customer destroying the software by accident); and
  • has no limits on where and when you can recover compensation (for example, having to compensate medical expenses for stress over software failure).

 

How to Avoid Standard Indemnities

If you see a standard indemnity clause, you should always ensure that the indemnity is reworded to include limits on the responsibilities you are prepared to accept.

You can amend the broad scope of a standard 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 may be promising to indemnify the other party (the indemnifier) or the other party may be promising to indemnify you (the indemnified party). 

Indemnifier

If you are the indemnifier, you should ask yourself questions, such as:

  • what are the types of responsibilities that apply to you?; 
  • what is the potential cost to your business if you have to indemnify the customer? 
  • can you afford to meet these costs?; and
  • if you cannot afford these costs, do you have insurance to cover this type of indemnity?.

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 that 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 for the biggest risks that may occur under your contract. You can still sue for a breach of contract and receive money through awarded damages. However, your business is less likely to struggle financially if you can receive compensation more quickly without having to prove fault.

How to Negotiate Indemnities in Contracts

An indemnity can significantly affect the rights of suppliers and customers if there is a breach of contract. Therefore, indemnity clauses are often the focus during contract negotiations. The meaning of indemnity clauses differs depending on individual situations and the contract itself. 

However, regardless of your industry or contract type, you should ask yourself questions such as:

  1. who is giving the indemnity and who is receiving it?;
  2. What are the types of liability covered under the indemnity?; and
  3. What kind of limitations will you expressly include in the indemnity?.

For example, if you are receiving the indemnity, you may request that the indemnity covers your actions and omissions as well as covering all legal costs. If you are giving the indemnity, you may want a requirement that the indemnified party must mitigate their loss for events within your control.

Key Takeaways

Indemnities are broad promises that 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 have any questions or need assistance in reviewing an indemnity, get in touch with LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

Jacqueline Gibson
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