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Indemnities Laid Bare: How to Limit Your Exposure

Tue 29 Sep 2015

We all want one but hate to give one. Parties with the benefit of an indemnity can claim for the amount of loss suffered, however much that loss may be, so long as the loss and the event that caused it is covered by the wording of the indemnity. Great to be indemnified but unnerving and uncertain if you are the indemnifier.

Having the benefit of an indemnity

The law on indemnities is murky to say the least. Case law has demonstrated, that if poorly drafted, indemnities can give little more to the indemnified than damages that they would be entitled to under a normal contractual clause. Unlike indemnities, where a loss will be compensated pound for pound, normal contractual damages are assessed by the courts and the amount of claimable loss will be reduced (perhaps to zero) if the causal link between the event triggering the loss and the loss suffered is too tenuous, or if the claimant party has failed to mitigate that loss.

Should you wish to be benefit from an indemnity, it must be carefully drafted to ensure that such rules regarding remoteness and mitigation are excluded, preferably expressly, to ensure that there is no doubt that the party giving the indemnity must compensate the benefitting party for all of the loss suffered. Unambiguous drafting and the use of the word “indemnity” or “indemnify” would certainly help. If you want an indemnity – call it an indemnity.

When you have to give an indemnity

Should a party insist on an indemnity firstly it may be worth trying to argue that such a clause would not be appropriate for commercial reasons, such as a normal contractual provision being better suited to the circumstances.

However, there are occasions where no amount of sharp negotiation or commercial reasoning will persuade a party to budge from requiring an indemnity. As frustrating as this may be there are ways of limiting exposure to an indemnity, some obvious and some less so…

Keep a lid on it

Simple, but nevertheless effective – do not be on the hook for an unknown amount of unlimited damages: cap the indemnity at a level that is commercially acceptable for you. Be aware that insurance policies may prevent you from giving indemnities over a certain level and so ensure that any cap agreed is within the constraints of the insurance policy documents so that any exposure is covered.

The wording of the cap must also be drafted carefully. Case law indicates that an indemnified party can sue up to the cap under the indemnity clause and then claim under normal breach of contract for the rest of the loss that exceeds the cap. It is therefore important to ensure that the wording of such a cap limits any claimable loss available for breach of contract over and above the indemnity cap.

A loss is not a loss

Loss of profits? Direct loss? Indirect loss? Topics of articles in themselves, each with subtly different and confusing characteristics. If you have to give an indemnity, try to limit the type of losses recoverable to certain and quantifiable losses such as direct loss - a crude example of which is a breach of a construction contract causing damage to a building – the direct loss would be the cost of the damage.

Indirect loss is far less certain and might include unknown potential claims. An example could the breach of a development agreement causing delay to the completion of a site, meaning that a lucrative contract to purchase units above the market rate (the existence of which is unknown to the indemnifier) is rescinded. In this instance the connection between the breach of contract and the loss (the loss of supernormal profits under the lucrative contract with a third party) is indirect.

Under a pure indemnity, the indemnifier will be liable for all losses suffered provided that they fall under the wording of the indemnity clause. So, restrict them. Unknown quantities such as indirect loss of profits should be excluded wherever possible.

Limit the scope of the indemnity wherever possible to ensure that you are aware of and understand your exposure under the contract.

Make sure the indemnified is required to mitigate its loss

Under normal breaches of contract, a party is under a duty to mitigate its losses. This means that should a party suffers a loss it must take reasonable steps to reduce the loss suffered. Correctly drafted, a pure indemnity will not impose such a duty on the indemnified. Expressly including a duty to mitigate in the contract will limit the potential exposure of an indemnifier and ensure that when a loss is suffered it does not spiral through inaction on the part of the indemnified.

Who is being indemnified?

Ensure that the entities that are being indemnified are kept to a minimum. If you are contracting with a group company make sure that parent and subsidiary companies cannot bring a claim under the indemnity.

Conclusion

Poorly drafted indemnities can either expose an indemnifier to extensive liability or entitle the indemnified to little more than normal contractual damages. Whether giving an indemnity or receiving one, clear drafting is essential to ensure that the contemplations of the parties are articulated in the indemnity.

Where forced to give an indemnity negotiate limitations, whether financial caps, the types of loss covered by the indemnity, express provisions for the indemnified to mitigate their loss or the number of parties who have the benefit of the indemnity, to ensure that any exposure is as small and as certain as possible.

 

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