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What is an indemnity?

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Many contracts contain what are called “indemnity” clauses.   An indemnity is a legally binding promise by which one party to an agreement agrees to accept the risk of loss or damage that another party may incur, as a result of a certain event occurring.

An example is an indemnity from one party to the other for personal injury or damage to property.  Such a clause could read as follows:

“X hereby indemnifies Y against any loss, cost, expense or damage which Y may suffer or incur as a result of any personal injury or damage to property caused by X.”

Indemnities are common place in most commercial agreements.  In addition to indemnities for damage to property or personal injury, you often see indemnities for losses incurred from:

  • A breach of the agreement
  • Negligence
  • Legal proceedings instituted by a third party as a result of an act or omission of the party giving the indemnity
  • Breaching intellectual property rights

As indemnities become more common place, we often find that parties to commercial agreements gloss over their meaning and do not truly understand their intended effect.   Indemnities, if not properly reviewed, may place liability and risk on the indemnifying party which is well above the amount of damages payable at law if the indemnity was never given.  They may also place the indemnifying party in breach of their professional indemnity insurance or public liability insurance policies.

Conversely, the party receiving the indemnity needs to ensure that the indemnity is appropriate and covers their anticipated losses from the relevant event.

It is important therefore to seek advice when considering indemnity clauses.  In particular with each indemnity clause parties need to consider:

  • Who is being covered by the indemnity?  Can third parties be covered if appropriate?
  • What is being covered by the indemnity?  For example, will the indemnity apply to consequential losses and will the amount of the indemnity be capped?
  • In what circumstances or to what events will the indemnity apply?  For example, costs for which a party is “liable” may be different or occur at different times to costs which are “incurred”.
  • How is the indemnity being triggered?  For example, will the indemnity be triggered when there is a personal injury or just damage to property?

Parties also need to consider each indemnity clause in the context of the overall assumption of risk by each party under the relevant contract.  Who assumes what risk and who grants what indemnity will usually be dictated by the parties’ relative bargaining power and what is appropriate in the circumstances.

Indemnity clauses are closely scrutinised by the courts and therefore need to be carefully drafted.  They can turn on individual words or even punctuation.  On this basis advice should be sought when either drafting or reviewing an indemnity clause.

For further information on indemnity clauses or interpreting contracts generally, please contact one of our experienced Corporate Advisory lawyers.

Author: Darren Sommers

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