Clients often tell us they spend the most time negotiating indemnity clauses in contracts but they value the outcome of this process the least. It is, unfortunately, a necessary evil in any properly negotiated contract.
This article will break down the fundamentals of an indemnity and give you some tips to consider them from a strategic perspective the next time you face negotiating an indemnity provision.
What is an indemnity?
An indemnity is a powerful mechanism to allocate risk in a way which is not provided for under a contract or it can reinforce a party’s right to remedy for specific circumstances or certain contractual breaches.
As someone who seeks the benefit of an indemnity, you could look at it as a type of insurance that is written into your contract. Therefore, unless you know there is substance behind the indemnity provider, there is no point in arguing over the details of the indemnity provision and incurring legal costs to negotiate a clause that seemingly protects you comprehensively for all eventualities.
Common issues related to indemnities
When negotiating an indemnity for your benefit, the common issues to look out for are:
- Who has the benefit of the indemnity? Is it just yourself or does it cover other entities if you are part of a wider group of companies? Does it cover your directors and employees?
- Why are you requiring the indemnity? What risk are you trying to protect or reinforce?
- What types of losses are covered by the indemnity? Does it cover special or consequential losses such as loss of profits? If you seek to recover legal costs, is it on a full indemnity basis or are you happy to recover reasonable costs?
- Is there any attempt to reduce liability by the indemnity provider by stipulating a cap on liability or reducing their liability to the extent of your contribution to the loss suffered?
On the other hand, if you are giving the indemnity, all of the issues above apply to you too, but you would seek to limit the impact of the indemnity in every possible way. Negotiating a cap would be the most practical way to manage your overall risk. For example, service providers often seek to limit their liability by reference to the fees received over the course of a period of time.
Approaches to limiting the impact of indemnities
Common approaches to limiting the effect of indemnity provisions are the following:
- Reduce the scope of subject matter of the indemnity
- Limit to losses you directly cause and only to the extent you cause any loss
- Reduce your liability to the extent the other party has caused or contributed to any loss
- Exclude consequential losses
Insurance as a mitigation tool
A mitigation tool you can use to minimise risks associated with giving broad indemnities is insurance. It is extremely important that you do not agree to any contractual indemnity that might affect your ability to make a claim on any insurance you have in place to manage your business risks. You don’t want to be in a position where you don’t have insurance cover for an indemnity you have agreed to give! In short, know what risks you have insurance for and negotiate within the limits of the cover. Do not agree to provide an indemnity so extensive that it might cause you to incur catastrophic consequences to your business which you cannot bear.
Contact us here if you would like to set up a time for a free initial consultation or call us on 1300 85 99 65 for more information.
Aspect Tip: An indemnity is not worth the paper it is written on unless it has meaning to you. You should never agree to anything you do not fully understand and are able to manage.