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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. Indemnities are the subject of much discussion in contract negotiations. Indeed, this is essentially because they make one party liable for the liability of the other party. Therefore, a properly drafted indemnity can significantly alter the common law, equitable and statutory rights of a party. Indemnities are often poorly drafted or understood, which can have unintended consequences for parties. 

Not all indemnities are obvious since parties do not always label them as such. Words such as “hold harmless”, “defend”, “make good”, or “compensate” often indicate the clause is, in effect, an indemnity clause. This article will look at three common types of indemnity clauses and how to spot each one.

Note that 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. 

Note: 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.

“Hold Harmless” vs. “Make Good”

A lawyer may write an indemnity into a contract as either a “hold harmless” clause or a “make good” clause. The former is a promise by the indemnifier to hold the indemnified party harmless against loss or damage due to entering into a transaction. The indemnifier will be in breach as soon as the indemnified party suffers loss or damage. This is subject to the agreed indemnity or the occurrence of the relevant event or circumstance covered by the indemnity.

A “make good” clause puts the indemnified party back in its original position before the claim. This clause means the indemnifier must compensate the indemnified party if loss or damage is suffered. This means that it is more of a debt than a liability for breach of contract.

The scope, risk and benefit of an indemnity can vary greatly. This will largely depend on the circumstance and bargaining power of each party. It is therefore vital to understand what your indemnity does and does not cover before signing your contract. Any ambiguity in drafting may lead to an indemnity not covering losses that you expected to be covered. 

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. 

1. Bare indemnities

This is where the supplier indemnifies the customer for loss caused by a set of circumstances under the contract. Losses from other events are not covered, even if the customer is at fault. Therefore, it is best practice to define what constitutes ‘loss’.

For example, “the supplier agrees to indemnify the customer for any loss or damage suffered in connection with the goods and services supplied.

2. Proportionate indemnities 

Here, a supplier indemnifies the customer only for losses that flow from the supplier’s acts or omissions. 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. 

For example, “the supplier agrees to indemnify the customer for loss or damage suffered in connection with the goods and services supplied to the extent caused by the supplier’s acts or omissions.

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. 

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.

For example, “the supplier agrees to indemnify the customer for any loss or damage suffered by, or claims arising against, a third party in respect of the goods and services supplied.

In addition to acts or omissions of a party, including performance under the contract, other common areas of coverage of an indemnity clause include:

  • negligence;
  • personal injury and death;
  • infringement of third party intellectual property rights;
  • property loss or damage; and
  • breach of privacy and confidentiality provisions.

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, or placing obligations on the other party to mitigate their loss. 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.

Reminder

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. 

Note: 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. To ensure you are fully aware of your obligations under an indemnity clause, speak to a lawyer. 

If you need further advice on indemnity clauses, call LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

What is an indemnity clause?

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.

Will my insurance cover indemnity damages?

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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