Indemnity Clauses: The Pitfalls

Indemnity clauses are ubiquitous in contracts. However, people who draft or negotiate indemnities frequently fail to appreciate their numerous pitfalls.

So, what is an indemnity?

An indemnity is simply a contractual promise to pay for a loss if it occurs as a result of a specified event. In that way, an indemnity is not dissimilar to insurance, except the indemnifying party does not have the benefit of the many conditions protective of the insurer one finds in an insurance policy, nor does the indemnifying party get paid a premium for giving an indemnity.

Some of the more common types of indemnity encountered in contracts include:

  1. indemnity for claims by third parties;
  2. indemnity for damage to property or personal injury;
  3. indemnity for breach of contract and/or negligence;
  4. indemnity for infringement of intellectual property rights of a third party.What people often fail to realise is just how broad and untamed liability under an indemnity is. In our recent update, we talked about liability for a breach of contract. You may recall that under the common law there are some restraints on the extent of liability, being causation (losses must be caused by the breach), remoteness (losses must be reasonably foreseeable at the time of the contract) and mitigation (losses could not have been reasonably mitigated). These restraints do not apply to liability under an indemnity. Under an indemnity, a loss is recoverable if it simply falls within the (invariably broad) scope of the indemnity.

Furthermore, many indemnities do not even require fault or wrongdoing on the part of the indemnifying party. For example, it is common to find in supply or services contracts an indemnity for damage to property in connection with the goods or services. Therefore, all that is required for an indemnity to operate is a “connection” between the damage to property and the goods/services, not any negligence or fault by the supplier.

Another common pitfall is the duration of liability under an indemnity. Normally, a claim for a breach of contract under common law can be made only within six years after the relevant breach under statutes of limitations. Liability under an indemnity is not subject to statutes of limitations and usually continues indefinitely.

Despite all of this, indemnities have almost become “boilerplate” in contracts. It is important to realise that far from being innocuous, indemnities usually entail open-ended and unlimited liability.

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Contact Source Legal for preparing, reviewing and negotiating any contracts.

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