Ask for an indemnity.

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Commercial contracts are packed with risks. In fact the contract itself is one big risk. However, ironically, contracts are the safest way to conduct business; we need them! So, since we cannot avoid contracting with each other we have to ensure that we protect our interests in every contract that we sign. A key way to do this, is to ask for an indemnity clause.  An indemnity clause is a contractual transfer of risk between two contractual parties to prevent loss (you are not liable if X happens) or to ensure compensation for a loss (the other party reimburses you for any loss suffered if Y happens) which may occur as a result of a specified event (X or Y event). Let’s take a look at some examples of indemnity clauses:

  1. Basic Indemnities – Party A indemnifies Party B for all liabilities or losses incurred in connection with specified events or circumstances. For example, if you are contracting with a construction company to build your new store, you will want a basic indemnity saying that the construction company will compensate you for all losses if one of its subcontractors fails to do the job to the specification set out in the contract. If a subcontractor tiles the roof poorly, the construction company is liable for all losses ensuing from that subcontractor’s poor job. Pretty good right? However, basic indemnities can be troublesome as they do not set out any specific limitations on the indemnity. They are silent as to whether they indemnify losses arising out of YOUR own acts and/or omissions that cause the subcontractor to tile the roof poorly. What if you give the sub-contractor the wrong instructions or you don’t give the subcontractor access to the site on time?  This basic indemnity operates so that the construction company indemnifies you for the poor job of the subcontractor, even if the poor job was your fault. You may be thinking well, that’s great, but it’s only great if you are the party receiving such an indemnity. That’s why basic indemnities should be avoided where possible.
  2. Proportionate or Limited Indemnities – These indemnities rectify the potential unfairness of a basic indemnity (explained above) as they limit the indemnity. Sticking with the example above, say you obtain an indemnity from the construction company to the effect that the construction company is liable for all losses ensuing from a subcontractor’s poor job – a limited indemnity will go on to state “except those losses incurred as a result of [your] own acts and/or omissions”. If the subcontractor’s poor job is your fault you don’t get compensated. Seems fair.
  3. Third Party Indemnities – If third parties are involved in the operation of the contract, as in the example above, you may not want anything to do with them since you are contracting with them. Following on from the above example, what happens if a subcontractor isn’t paid for their work? You wouldn’t want to be liable for that. You can protect against this by asking the construction company to indemnify you for all liabilities relating to its subcontractors so that the subcontractors are always the construction company’s issue and not yours.

These are very high level examples which would make most lawyers (if they’re good) chuckle. Indemnities can be very complex and they should at the very least always be more than a basic indemnity. Here are some of the things your lawyer should consider when drafting an indemnity clause for you:

  1. Scope – The scope of the indemnity must be clear so that the intended protection is given.
  2. Context – An indemnity clause should always be drafted in consideration of the wider commercial context of the agreement. Is it applicable?
  3. Extent – Who does the indemnity cover and are there any limitations to the indemnity? If the indemnity is given by the other side but not its contractors or representatives, then the extent to which this offers protection will be limited.
  4. Insurance: There is no point in having an indemnity if the indemnifier cannot pay out in an event of breach. An obligation to insure to a level consistent with the indemnity obligation will provide comfort that the indemnifier has the means to back up the indemnity given.
  5. Caps: Indemnities can be capped but any such cap should be subject to careful consideration. Where an indemnity has a financial cap, the indemnified party may, depending on any other limitation clauses, still have an uncapped claim in contract law for any breach of contract.

As with many of my posts, this is a very simplified overview. You really need a lawyer to draft indemnity clauses because they are essentially financial obligations with very serious consequences. The aim of this post is to make you aware of them so that you can ask your lawyer about them. You may want receive indemnities as added protection or you may want to offer indemnities to show the other side that you mean business (they can be great for negotiation)!  So go ahead and ask your lawyer about them. Pick up one of your contracts and check to see if you have a few in there already.

I must also emphasise that an indemnity is a distinct right from the right to claim damages for breach of contract. If the construction company breaches a clause in the contract you still have your common law right to sue for damages. Any limitations under an indemnity will be for that indemnity only. This is important because limited indemnities often exclude any loss ensuing from your own negligence whereas a claim for breach of contract can be brought even where you too have been negligent. Ask your lawyer, they’ll break it down for you!

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