Put simply, an indemnity is a very powerful clause in a contract that means if one party incurs a liability, then the other party is required to make good that amount.
Frequently, people make the mistake of thinking that an indemnity clause is ‘standard’, and can’t be negotiated. This is simply not the case.
If you fail to properly consider the nature and effect of an indemnity before you sign a contract, you could end up with a significant liability that you weren’t expecting – even if the liability or damage was not your fault.
If you see the word ‘indemnity’ in a contract you are considering entering, don’t panic! BUT, do seek legal advice – BEFORE you sign the agreement!
Why do people include indemnities?
A properly drafted indemnity clause carries benefits for the party who is protected by the clause. These benefits include:
- The measure of ‘compensation’ you can claim under an indemnity is potentially greater than common law ‘damages’ for ‘breach of contract’. The point here is that an indemnity is like an agreed-value insurance contract. The protected party does not need to prove that the other party caused the loss or damage, or even necessarily that an overall loss or damage was suffered;
- Proving loss can be easier for the purpose of an indemnity. This is because all that needs to be established is that the identified liability was incurred, or the relevant event occurred;
- The requirement to ‘mitigate losses’ (i.e. to take steps to ensure that loss is minimised) does not apply under an indemnity (unless the clause specifically says it does);
- The limitation arising from the notion of ‘remoteness of damage’ (i.e. limiting damages to what usually flows from a breach of contract) does not apply under an indemnity (unless the clause specifically says it does);
- Risk can be transferred to or from a party by agreement – rather than requiring a chain of ‘causation’ to be established as a fact; and
- The ‘proportionate liability scheme’ may not apply to the indemnity (more on this below).
So overall, if you are looking to protect yourself against certain liabilities or events under a contract, an indemnity is the way to go. However, if you are the party being asked to give the indemnity – beware!
Types of indemnity clauses
There are different types of indemnity clauses. Some are more appropriate than others, depending on the circumstances. There is no ‘one size fits all’ approach.
For example, imagine a scenario involving a developer, a builder, and the builder’s subcontractor.
The builder and the property developer enter a contract whereby the builder will build a block of units on the developer’s land. The subcontractor is not a party to the contract between the developer and builder. Each of the following scenarios would result in a different outcome for the parties:
- The builder indemnifies the developer against losses incurred in connection with given circumstances.
The developer suffers loss because the builder did not complete the project on time. Two sales of units fall through due to the delay, and property prices have now come down. The property developer can recover these losses from the builder.
- The builder indemnifies the developer against losses incurred by the developer, irrespective of whether the developer contributed to those losses being incurred.
The developer suffers loss because the builder did not complete the project on time (the indemnified event). However, the reason for the delay was because the developer failed to make the site available to the builder (the developer’s omission). Even so, the developer can recover its loss from the builder.
- The builder indemnifies the developer against losses, except losses incurred as a result of the developer’s own acts or omissions.
The developer suffers loss because the builder did not complete the project on time. The reason for the delay was because the developer failed to make the site available to the builder. Under this clause, the developer’s loss was due to its own omission, so it cannot recover its loss from the builder.
- The builder indemnifies the developer against losses caused by the subcontractor.
The subcontractor working on the site is injured and sues the developer. The developer is able to recover the loss suffered by the subcontractor from the builder under the indemnity. This is despite the fact that the builder did not cause the loss.
- The builder indemnifies the developer against losses incurred if the subcontractor fails to repay financial accommodation to the developer.
The subcontractor owes money to the developer. The builder is liable to pay the developer the money owed if the subcontractor defaults on payment.
- The builder and the developer indemnify each other for losses occasioned by their breach of contract.
The builder breaches the contract by failing to complete the project on time. The delay is the builder’s fault. The developer suffers loss and is able to recover this loss from the builder.
Meanwhile, the builder’s equipment is damaged because the developer failed to keep the site secure, as required by the contract. The builder has suffered loss and is able to recover this loss from the developer.
As you can see, each of these scenarios would result in a vastly different (and sometimes unexpected or unfair!) result.
Proportionate liability scheme
An Australia-wide reform of ‘apportionment of liability’ was introduced in 2006. The scheme operates to allocate responsibility for certain losses among parties to a contract. The scheme is different in each state and territory and does not apply to personal injury claims.
The scheme applies to situations where multiple parties have separately caused loss or damage to property, and in some circumstances will trump contractual indemnities agreed between the parties.
The effect of the scheme is that, in some states and territories, you may not be able to recover an amount from another party under an indemnity in a contract. Or put another way, even if you have given an indemnity, your liability may be reduced or eliminated completely.
Taking one of our examples above, where the builder indemnifies the developer against losses incurred in connection with the contract. The builder engages a subcontractor to connect the plumbing. The subcontractor’s works turn out to be faulty and the developer suffers loss. Despite the contract saying that the builder fully indemnifies the developer, the builder may be able to rely on the proportionate liability scheme and claim they are not liable for the developer’s loss.
Whether you can contract out of the proportionate liability scheme depends on which state’s legislation governs the contract.
What should you do?
Before you sign any contact with the word ‘indemnity’ in it – call us on 1300 654 590. We will advise you on the effect and appropriateness of the indemnity, and negotiate the wording of the clause so that you are comfortable with the level of risk you are taking on.
The information contained in this post was reviewed on 8 February 2022