What is an indemnity?
9 March 2023
An indemnity is a legal term used to describe an agreement between two parties in which one party agrees to compensate the other party for any losses or damages incurred as a result of a particular event or situation. Indemnities are commonly used in commercial contracts to provide protection to one party in the event that the other party breaches the agreement or causes harm to a third party. The purpose of an indemnity clause is to shift the risk of loss from one party to another, thereby providing a measure of protection to the indemnified party.
Types of Indemnities
There are several types of indemnities. An indemnity may be one-sided (one party agrees to indemnify the other party) or two-sided (both parties agree to indemnify each other). An indemnity may be fault based, where it is only triggered by the indemnifier's default (e.g., breach of contract, negligence or breach of laws) or it may be a no-fault indemnity, where loss or damage is compensated regardless of the cause.
Scope of Indemnities
The scope of an indemnity clause can vary depending on the specific agreement and the circumstances of the situation. In general, an indemnity clause will outline the types of losses or damages that are covered by the indemnity, the circumstances under which the indemnity will be triggered, the identity of the parties being indemnified and the limitations on the indemnity.
For example, an indemnity clause in a consulting contract may be limited by providing that the consultant will indemnify the client against any losses or damages arising from the consultant's negligence, but excluding losses to the extent they were caused by the client's own negligence. An indemnity can also be limited by making it subject to a liability cap.
Benefits of indemnity clauses
An indemnity is a useful way to allocate risk in a commercial arrangement. The allocation should be based on considerations of which party is best placed to manage the risk and which party has the capacity to bear the risk.
Under an indemnity there is no obligation on the indemnified party to mitigate their losses.
The amount of damages recoverable by the indemnified party is usually higher than damages for breach of contract.
Unless otherwise specified in the contract, there is no concept of remoteness of damage. All losses are compenseable even if indirect and remote.
Enforceability of Indemnities
The enforceability of an indemnity clause will depend on several factors, including the specific language of the clause and the circumstances under which the indemnity is being invoked.
In general, an indemnity clause will be enforced if the indemnified party can demonstrate that the triggering event has occurred and that it has suffered a loss or damage that falls within the scope of the indemnity. Ambiguous indemnity clauses may be enforceable, as courts will typically interpret any ambiguity in an indemnity clause in favour of the indemnifier.
If the indemnity clause is deemed to be contrary to public policy, or overriden by statute (such as the proportionate liability regime legislation) it may be unenforceable.
Read more about the difference between liability under an indemnity and under general contractual damages.
Here are the key takeaways:
Indemnities are a useful tool for apportioning risk in commercial transactions.
Indemnities should be carefully drafted to meet the commercial needs of the parties and ensure they are enforceable.
Consideration should be given to the type of indemnity required and the elements of: who is indemnified, what losses are covered, what is the trigger event and what are the limitations on the indemnity?