An indemnity clause typically features in a construction contract and is a key point of negotiations. Indemnity clauses, where one party promises to cover the loss the other party suffers from a breach, can vary widely in their wording. The party providing the indemnity, often the contractor, should think about the following:
- What does the indemnity cover – is it the principal’s losses generally or losses caused by the contractor’s conduct only?
- Does it include losses resulting from third parties, and is the contractor also responsible for these as well?
- Is the principal’s negligence specifically excluded?
Contractual Losses Generally
Under the general law of contracts, where one party breaks a promise to do something for the other party under a contract, the innocent party can claim from the other losses which either:
- naturally flow from the breach; and/or
- losses which were reasonably foreseeable at the time of entering into the contract.
Key to the assessment of damages is whether the parties anticipated the losses when they entered into the contract, and the extent the innocent party could reasonably have been expected to take steps to mitigate their losses.
Limitations legislation across each state places limits on how long an injured party has to bring a claim for a breach of contract.
For example, under the Limitation Act 1969 (NSW), section 14 provides that a party cannot bring a cause of action based on a contract more than six years from when the action first accrues. If the cause of action is founded on a deed, section 16 of the Act provides that the limitation period is 12 years.
When an action ‘first accrues’ is generally from when the circumstances giving rise to the claim first occurred (i.e., when the party breached the contract). The qualification to this is that, where the loss is solely economic, the cause of action accrues when the loss first becomes apparent or can be discovered through reasonable diligence (see, for example, Melisavon Pty Ltd v Springfield Development Corporation Pty Ltd  QCA 233, a case discussing latent defects).
As we will see, indemnity clauses can affect both the general law position on what losses can be claimed for a breach of contract and further, when the limitation period is deemed to have commenced.
An indemnity can be understood as an agreement by one party to cover the loss and damage the other party may suffer as a result of a breach of contract. Depending on how the indemnity is drafted, there can be significant consequences, and as such they are often a point of negotiation.
An indemnity clause can provide that party A indemnifies party B against any and all losses and liabilities that occur in connection with the contract. Where the clause is left at that, it is called a ‘bare’ indemnity, as there is no clarification as to whose conduct will give rise to the right to claim indemnity losses.
The indemnity may also be:
- Reflexive – where party A indemnifies party B against losses that occur as a result of party B’s own conduct (often, negligent conduct); or
- Proportionate – where Party A indemnifies party B against all losses, bar those that arise out of party B’s own conduct.
An indemnity clause may also provide that party A either does or does not indemnify party B against claims by third parties arising out of the contract, or that each party will indemnify the other for losses they incur as a result of the other’s breach.
The end goal of an indemnity clause is to provide a contractual right to payment for the losses a party incurs as a result of a breach. Consequently, an indemnity clause circumvents the need to establish loss to prove a breach and that a party suffered a loss. Those issues become the problem of the indemnifier if they wish to dispute the indemnified party’s claim.
When Does a Cause of Action Accrue Under an Indemnity?
The general law position is that the time for claiming loss or damage on an indemnity is when a party first suffers the loss or damage. That is, when the loss has been ascertained or is ascertainable (see the High Court decision of Wardley Australia Ltd v State of Western Australia (1992) 175 CLR 514).
As loss or damage is a prerequisite to a claim under an indemnity clause, the statutory limitation period for the claim will not begin to run until the party has suffered loss or damage.
Much will also depend on how the contract defines ‘loss’. Ascertaining the loss that a party has suffered depends on what is identified as the event that causes the loss. This is because the loss and the event which causes the loss may not always coincide. In some instances (which always depends on the wording of the contract), the loss will not have occurred until the principal carries out remedial works, because the contract may specify that loss is the costs associated with remedying defects in the works.
What is clear is that careful wording of indemnity clauses can mean that a statutory limitation period does not begin until some time after the breach has occurred, because the cause of action will not have ‘accrued’ until the loss (as covered under the indemnity) becomes apparent.
Importantly, section 109ZK of the Environmental Planning and Assessment Act 1979 (NSW), and similar provisions in other States provides that the issue of an occupancy permit is the event which triggers the start of the limitation period for building actions to which the Act applies.
Indemnity clauses can be drafted in a number of ways, and it is important that a contractor (or other party providing an indemnity under a contract) is aware of the extent of their liability, both in scope and duration. Likewise, it is important that a principal knows what losses they can claim, and in what circumstances.
Whether you are a principal or a contractor, you should have your indemnity clause reviewed before you enter into a construction contract, as there can be significant implications many years down the track.
If you have any questions, get in touch with our building and construction team on 1300 544 755.