The Holding Redlich Construction, Infrastructure and Projects Group works closely with clients to effectively manage contractual and commercial risk and to avoid, minimise and resolve disputes. In this article, Holding Redlich examines issues relating to indemnity clauses.
Indemnities allow parties to identify and allocate risk under a contract. This can either be between themselves or to a third-party. They do this by requiring one party (the indemnifier) to cover the loss or damage suffered by the other party (the beneficiary) under an agreement.
Importantly, indemnities are capable of covering loss or damage that would ordinarily be deemed too remote under common law. For example, if:
1. Bob had a contract with ACME to build a tower which contained a milestone bonus if the work was complete before Christmas.
2. Bob entered into a separate contract with Wendy to hire a crane to construct the tower.
3. Wendy failed to deliver the crane on time, meaning Bob was unable to complete the tower before Christmas and misses out on his milestone bonus.
This type of loss could be deemed too remote for Bob to recover against Wendy.1 However, Bob is able to mitigate this risk by including an indemnity clause in the contract requiring Wendy to compensate (indemnify) Bob for the loss of the milestone bonus if she fails to deliver the crane on time.
Wendy may not even realise she could be liable for this type of loss at the time she enters into the contract unless she has read the fine print in careful detail!
Things to consider when drafting indemnity clauses:
How an indemnity operates is a matter of construction. Importantly, indemnities will be read against the interests of the person who receives the benefit of the indemnity (contra proferentem). Therefore if you are in the habit of putting broad indemnities in a contract, make sure you carefully consider how the work with the balance of the contract terms.
The below is a non-exhaustive list of some of the other things you should keep in mind when reviewing/drafting an indemnity:
1. What are the risks/losses that are being indemnified? Is the indemnity intended to be general or specific (e.g. all loss or liability arising under the contract or only certain losses arising from a specific breach)?
2. Are there any limitation of liability clauses under the contract and how do these operate in relation to the indemnity (e.g. if you intend to limit the type or amount of loss recoverable under the contract, do you intend for this to extend to the indemnity)?
3. Does the party providing the indemnity have the capacity to deliver it if called upon? There is little benefit in seeking an indemnity from a shell company for all loss and damage that could arise in relation to multi-billion-dollar construction contract. It is also important to consider if the party providing the indemnity has the authority to do so (e.g. government agencies, entities incorporated under statute or trustees may not have authority to provide the indemnity sought).
4. Is the indemnity intended to protect a party from losses caused by its own breaches or negligence (the general rule is an indemnity will not cover a party’s own negligence unless there is specific drafting to that effect)?
5. What is the duration of the indemnity – is it intended to remain after the conclusion of the contract?
6. Does/should the indemnity contain any rights of subrogation, or can the indemnified party settle the claim(s) without consulting the indemnifier (e.g. in an insurance contract, insurers will often be able to “step into the shoes” of the indemnified party for the purpose of any litigation)?
The above long shopping list of questions shows that there are numerous factors to consider when drafting an effective indemnity clause, including the context of the contract.
It is generally not sufficient to “copy and paste” an indemnity clause from another contract as the interpretation of an indemnity clause and the way in which it is meant to operate usually requires consideration of the contract as a whole.
Obtaining legal advice is a practical way to ensure that the indemnity clauses in your contract are properly drafted to protect your interests.
In part 2 of this article, we will look at two different indemnities often provided in crane hire agreements and unpick what they really mean.
1 The above is only provided as an example and there are several circumstances where this could be recoverable, such as if the loss of the milestone bonus was reasonably in contemplation of the parties at the time
of entering into the Contract.