Indemnity provisions in contracts – are they that important?

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What are indemnity provisions?

Indemnity provisions, also known as “indemnities” or “indemnity clauses”, are commonly included in contracts to allocate risk between contracting parties. If properly included, the indemnifying party (the “indemnifier”) will be obliged to compensate the indemnified party for losses which may occur as a result of a specified event, sometimes referred to as an indemnified event.

A simple indemnity provision might be:

“Party X agrees to indemnify and hold Party Y harmless from any and all claims, losses, damage and lawsuits, including reasonable legal fees and costs, arising out of or in connection with any breach by Party X.”

If you are the indemnified party for example, it means that the indemnifier is promising to hold you harmless against losses that fall within the scope of the indemnity.

Such losses may arise from any event defined by the contracting parties, such as

(a) a breach of contract;

(b) a party’s fault or negligence; or

(c) third-party claims for infringement of intellectual property rights.

Generally, how wide an indemnity provision will be all depends on the intention of the parties and their respective bargaining power. However, provisions which are too broad or poorly-worded can lead to several complications, which we shall explore further below.

Importance of indemnity provisions

Indemnity provisions are ideally supposed to allow risks to be placed in the hands of parties best suited to manage them. Due to the protection they provide, indemnity provisions are especially useful in commercial contracts where there is high risk and large amounts of money at stake.

Indemnities are of critical importance in any scenario where a party could potentially face any huge loss caused by the other party, especially when it is impossible to tell how big the loss could be or how likely it would be to occur.

For example, indemnities are commonly found in construction contracts, where a contractor would usually indemnify the property developer from any harm arising from the contractor’s actions or omissions during the construction. One big mistake by a contractor in the construction of a building could kill hundreds of people and result in claims against the developer that would be big enough to bankrupt most companies.

Retailers usually seek an indemnity from manufacturers against product liability claims from consumers. Again, if a product has a defect that has the potential to harm anyone who uses it, it could result in a huge number of potentially large claims against a retailer for something that is the manufacturer’s fault, so insisting on an indemnity from a manufacturer in these circumstances is entirely reasonable.

Pros and cons of indemnity provisions

Causation

With an indemnity provision, the indemnified party does not need to show the link to their financial loss. Once an indemnified event occurs, the indemnifier must pay.

In contrast, without an indemnity provision, the party who suffered a loss is required to prove that the actions or omissions of the other party caused the loss. This can make a claim for damages an arduous process and the outcome uncertain.

Removes the need for legal proceedings

Once the indemnity provision is triggered, the obligation to compensate the indemnified party can be treated as a debt due to them.

This allows for a more straightforward recovery process, as indemnity claims are harder to resist and parties do not need to resort to lawsuits to establish the indemnifier’s liability to pay.

Although getting an indemnity is usually a good idea, they do not always operate as intended if they are not properly drafted.

Overexposure to liability

If the provision is crafted too broadly, the indemnifier could be obligated to compensate the indemnified party even in unintended scenarios. It is important to add limits to indemnity provisions in order to prevent overexposure to liability, so that an indemnifier would not be unfairly held responsible for losses that were not within its power to avoid.

Ambiguity

In indemnities with ambiguous language, both the indemnifier and indemnified party could be adversely affected. An ambiguously worded provision presents a risk that it will not be held to cover losses which the parties expected it to cover. As above, poorly worded provisions could also lead to overexposure to liability, where the indemnifier will be held to cover losses that were not contemplated.

In order to ensure that the indemnity provision achieves the desired effect, it is important that it is precisely defined and properly reflects the intention of the parties.

In general, greater caution should be exercised when relying on standard boiler-plate provisions, as they are often broadly worded and generic in nature.

Should you include indemnity provisions in your contracts?

An indemnity provision is a powerful risk-shifting tool that can dramatically alter the rights of the parties in a contract. Because of this, indemnity provisions are often heavily negotiated and scrutinized, in order to ensure that parties are well-protected and are placed in the best possible position.

If you are considering including an indemnity provision in your contract, be sure to read it carefully and fully understand its language. The provision should be tailored to your specific circumstances and needs to provide the appropriate level of protection.

Indemnities are just one of several tools available to you to manage risk in your contract. You should seek legal advice in order to properly identify the risks involved in your contract and figure out the most appropriate way to manage them.

THIS IS A REPRODUCTION OF AN ARTICLE WRITTEN BY NADIA MOYNIHAN WITH THE ASSISTANCE OF JERELD LIM AND FIRST PUBLISHED BY ASIA LAW NETWORK. THE ORIGINAL ARTICLE CAN BE FOUND HERE.
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