Back to basics: ensuring effective indemnity clauses
With the challenges found in the current economic climate such as high rates of inflation, supply chain issues and labour shortages, and with some economists predicting a looming global recession, it is particularly important for businesses entering new contracts, or reviewing existing contracts, to consider indemnity clauses.
What is an indemnity?
An indemnity is an obligation by one person to compensate certain claims brought against another person in specified circumstances. In other words, it is an undertaking by A to provide a benefit, usually money, to B if a particular event happens and B suffers a defined loss or incurs a defined cost. Common types of indemnities include those for third party claims (for example, intellectual property claims), claims by the promiser (for example, settlements), or performance by a third party (for example, parent company guarantees).
Indemnities amplify the amount recoverable compared to regular damages. If there is an obligation to compensate under an indemnity, the damages are payable under the contract, and therefore other rules of damages will often not apply.
As opposed to damages for a general breach of contract, liability under an indemnity may extend to cover loss or damage that is not ordinarily recoverable because the damage caused is deemed to be too remote. Furthermore, there is no expectation to mitigate loss prior to breach and there is no breach until loss is sustained. It may be easier to establish an indemnity, and the statutory limitation period for causes of action can in effect be extended under a contractual indemnity.
Drafting indemnity clauses
There are a few considerations to keep in mind when drafting an indemnity clause. Parties should consider the following approaches:
- tailor the clause to the particular circumstances of the contracting parties;
- ensure the obligations under the indemnity can be met;
- consider the intended duration of an indemnity at the time of drafting, so that the indemnity clause reflects the intent of the parties;
- compare any insurance being relied upon to the scope of the indemnity and consider whether there are gaps; and
- consider whether it is appropriate to include an obligation to mitigate loss.
Given the challenges found in the current economic climate, it is even more crucial for businesses to revisit and consider indemnity clauses when undertaking contract reviews or entering new contracts. This will help to ensure your business is appropriately and adequately protected.
This article provides general commentary only. It is not legal advice. Before acting on the basis of any material contained in this article, seek professional advice.
Author: George Panayotopolous, lawyer in our transactions practice