The indemnity is ubiquitous in in commercial contracting, often hailed as a powerful risk allocation tool. But how strong is the indemnity in reality? Is the indemnity a superpower or overrated?
The “indemnity”, like its contract cousin the illustrious “warranty”, occupies a hallowed position in contracting folklore. Regularly included in commercial agreements, and often-times heartily resisted by the party asked to give one, the indemnity is perceived by many lawyers and clients as a high value clause; great to have the benefit of, but to be stoutly resisted providing wherever possible.
However, the power of the indemnity can be overstated and misunderstood. Whilst possessing some key strengths, these strengths can be whittled away through the process of commercial negotiation, or absent from the outset if improperly drafted. The importance of proper drafting and proper advice is everything.
An indemnity is a contractual promise where Party A agrees to compensate (or ‘hold harmless’) Party B for loss suffered as a result of a defined event. E.g., for an IP breach claim brought by a third party against Party B regarding the use of IP that has been licensed by Party A.
An indemnity is distinguishable from an ordinary breach of contract claim. As stated by Victorian Barrister Peter J Booth, a claim under indemnity is ‘more in the nature of a debt, albeit unquantified at the time of entry into the contract’.
At its core, an indemnity is simply a duty to pay money.[1]
At its core, an indemnity should put a claimant in a stronger position than it would be under a general breach of contract claim. Below we have rounded up five big advantages of a well-drafted indemnity.
Typical Claim Challenge |
How Indemnity Can Help |
Take-Out Benefit of the Indemnity |
|---|---|---|
| 1. Remoteness: The claimant can only recover damages considered not too ‘remote’ under the two limbs of Hadley v Baxendale. I.e.: (a) The damages need to arise naturally; or (b) The damages need to be supposed to have been reasonably in the contemplation of the parties at the time they made the contract as the probable result of its breach. | The claimant may be able to recover damages considered ‘remote’ under Hadley v Baxendale. | Indemnified party has access to potentially wider classes of damages. |
| 2. Causation: The claimant can only recover damages where there is a causal relationship – ‘but for’ the event would the loss have occurred. | Establishing causation may be less onerous. E.g., it is common for losses to have to ‘arise out of or relate to’ the matters in an indemnity, which is wider than the causal ‘but for’ test. | Indemnified party has less onerous causation nexus. |
| 3. Mitigation: A claimant is obliged at common law to mitigate its loss. | A claimant is not obliged to mitigate its loss, unless expressly required under the indemnity. | Indemnified party can “sit on its hands.” |
| 4. Evidence: A claimant must typically prove a breach of contract claim. | A claimant need only provide evidence that the relevant trigger event occurred. E.g., that the indemnifying party breached the contract. | Indemnified party has an easier job in compiling proof of claim. |
| 5. Limitation Period: The statutory limitation period on bringing a claim starts on the date on which the breach occurred. | The limitation period typically starts running later, and so ends later. This is typically from the time when the indemnifying party fails to comply with a demand made by the claimant, not from once the claim occurs. | Indemnified party has longer period to bring claim before statutory bar kicks in. |
As indicated above, the strength of the indemnity significantly depends on how it is drafted. A broadly worded indemnity (e.g. for loss “directly or indirectly arising out of” an event) will provide more extensive protection to an indemnified party than a more narrowly drafted indemnity (e.g. for loss “directly caused by or as a result of” an event).
This is particularly important considering that any ambiguity in an indemnity clause can weaken its enforceability for the claimant. This is due to the principle of strictissimi juris adopted by courts, where any ambiguity in an indemnity will be interpreted in favour of the indemnifying party.
Whilst offering significant advantages over breach of contract claims, the indemnity is not always the superpower it is made out to be, and its value can be whittled away through the process of negotiation, or be fatally flawed from the outset through improper drafting.
Are you negotiating a contract with an indemnity? For specific advice on getting the best result, please contact us below. Edwards + Co Legal provide corporate and commercial legal advice to modern Australian businesses.
[1] Felicity Maher, ‘The limitations of contractual indemnities’ (2020) 31 ILJ 1.
