In Short
- An indemnity clause holds one party liable for compensating the other for losses incurred during a contract.
- There are three main types: bare indemnities, proportionate indemnities and third-party indemnities.
- Ensure indemnity clauses are clearly drafted to prevent unexpected liabilities or coverage gaps.
Tips for Businesses
Before agreeing to an indemnity clause, carefully review the terms. Understand the scope of coverage and ensure it aligns with your expectations. Limit your liability by defining specific circumstances and consider including exclusions where appropriate. This will help protect your business from unintended risks.
If you are a business owner who has entered into any kind of contract, you may have come across indemnity clauses. Understanding these clauses is crucial because they can shift significant financial risks from one party to another. In some cases, you might find yourself responsible for losses that you did not directly cause or that go beyond what you would normally be liable for under the law. This article highlights how to identify and indemnity clause and three common types you are likely to encounter.
What is an Indemnity Clause?
An indemnity is a promise to compensate someone else for certain types of losses or damages they might suffer. In other words, an indemnity clause says, “If something goes wrong and you lose money because of it, I’ll cover those losses for you”. This might sound straightforward, but indemnities can be complex and far-reaching.
The party who provides the indemnity is known as the indemnifier. The party that is covered by the indemnity is known as the indemnified party.
What is a ‘Hold Harmless’ or ‘Make Good’ Clause?
When you are reviewing your contract, you might come across terms like “hold harmless” or “make good”. These are types of indemnity clauses, and it is important to understand what they mean for your business.
Hold Harmless
A “hold harmless” clause is a promise an indemnifier makes to ‘hold’ the indemnified party ‘harmless’ against any loss or damage they may face as a result of entering the contract. In other words, a “hold harmless” clause is like a shield.
For example, if you are a catering business hired for an event, you may see that the venue’s contract includes this clause in their contract with you. This means that if a guest slips on some spilled food and sues the venue, you have agreed to protect the venue from any costs. You shield the event venue in the event that something goes wrong because of your work.
Make Good
On the other hand, a “make good” clause is more like a promise to fix things or, in more legal terms, to put the indemnified party back into its original position before the claim. This means that you will compensate the other party if loss or damage is suffered by the other side.
If you are a service provider, such as a painter, hired to paint an office and your paint job starts peeling after a month, a “make good” clause would require you to repaint at your own expense, putting the office back in the condition it should have been in initially.
Both types of clauses can vary widely in their scope and impact. For example, if you are a caterer, you might agree to a “hold harmless” clause for accidents directly related to your food service, but not for issues caused by the venue’s faulty equipment. Comparatively, if you are a painter you might agree to “make good” on your work for a year, but not for damage caused by the building’s poor ventilation.
In the following examples of indemnity clauses, consider a goods and service supplier to be the indemnifier, and the customer to be the indemnified party.
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1. Bare Indemnities
This is where the supplier indemnifies the customer for loss. A bare indemnity is a promise to cover certain costs if something goes wrong. However, it is “bare” because it’s basic and does not include a lot of exceptions or conditions. Bare indemnities can be very broad and cover any liability arising out of a contract.
If you were a supplier of fitness equipment to a gym. If the equipment you provided malfunctions and causes injuries to some gym members, you may be responsible for the following if there is nothing but a bare indemnity in your agreement with the gym:
- the injury suffered by gym members;
- drop in membership renewals and new sign-ups as a result of the faulty equipment;
- expenses from replacing all the faulty equipment; and/or
- reputational damage suffered by the gym.
2. Proportionate Indemnities
Here, a supplier indemnifies a customer only for the portion of the losses that flow from the supplier’s acts or omissions. It means the supplier is only responsible for the part of the problem that the supplier directly caused. These must have occurred or been omitted during the contract term. The indemnity will not cover loss or damage that does not flow from the supplier’s acts or omissions.
If you are an engineering consultancy firm, agreeing to provide structural design services to a builder, you may include the above ‘proportionate liability’ clause. If there is a flaw discovered during construction that is directly related to your miscalculations, you will be responsible for the costs of remedial work. However, if investigations found that the flaws were partially caused by the lower-grade materials used by the building company, you may only be responsible for 60% of the losses suffered.
If you are giving an indemnity, you should ensure it is reduced proportionately to the extent the other party causes such an act or omission.
This type of indemnity is often seen as fairer than a bare indemnity because:
- you are only responsible for your own mistakes or oversights; and
- if a problem is partly your fault and partly the client’s fault, you only have to cover your share of the responsibility.
When you are negotiating a contract, it is a good idea to push for this type of indemnity if possible. It protects you from being held responsible for issues that are not your fault.
3. Third-Party Indemnities
This is where a supplier agrees to be responsible for any losses due to a claim against the customer by a third party to the contract. These indemnities often arise when you agree to provide services or goods to a client, and the client then relies on your services or goods to provide to another party.
Third-party indemnities often cover a range of issues, including:
- negligence (for example, if your product was not as safe as it should be);
- personal injury or death caused by your product;
- intellectual property disputes (like copyright or patent issues, often referred to as an infringement of third-party intellectual property rights);
- property damage caused by your product; and
- privacy or confidentiality breaches related to your product or service.
It may not always be possible to remove an indemnity clause entirely from your contract. However, you should ensure that it is worded to include limits on the responsibilities you are prepared to accept. For example, you should:
- exclude acts or omissions by the other party;
- place obligations on the other party to mitigate their loss; and
- exclude consequential losses (consequential losses are any indirect damages that occur as a result of an initial problem that is beyond the immediate and direct costs of fixing the initial problem).
If not, a broad indemnity could mean you are unfairly held liable for losses not linked to the actual breach. Further, you may be held liable for losses that were caused or contributed to by the indemnified party.
Continue reading this article below the formReminder
Unfair Contract Term provisions of the Australian Consumer Law will apply to unbalanced, unfair and unreasonable indemnities. For example, an indemnity clause that holds customers responsible for losses outside of their control. Asking your customers to provide you with an indemnity for any negligence you cause would also be a potentially unfair contract term.
In addition to any rights under any indemnity, a party may also have the benefit of certain rights under common law.
Key Takeaways
An indemnity clause is a common provision in a contract where one party agrees to compensate the other party if harm or loss is incurred. It is an essential clause in a contract as it can have heavy consequences for the party offering the indemnity. Review these carefully if your contract includes a “hold harmless” or “make good” clause. Also, consider the coverage of your indemnity clause and whether it is a bare indemnity, proportionate indemnity, third-party indemnity or all three.
If you are drafting an indemnity clause, our experienced contract lawyers can assist 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.
Frequently Asked Questions
An indemnity clause 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.
Most insurance policies will not cover liabilities that go beyond what is recoverable at common law. That means they will only cover the contractually assumed liabilities. Therefore, it is unlikely you will be able to rely on insurance to cover you for liability under an indemnity. If the insurance is suitable, it needs to be in place for the duration of the indemnity.
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