Albert Einstein
Einstein is credited with stating that things should be made as simple as possible, but no simpler. In a similar vein, it might be said that indemnity clauses are all about making risk as low as possible, but no lower.
In essential legal speak, indemnity clauses are a promise of one party (the indemnifier) to hold harmless another party (the indemnified), should a particular event occur.
A claim made as a result of indemnification provisions will ask that the indemnifier pay damages as a result of a particular undesired event. That is, the indemnifier will need to pay sufficient restitution that the party seeking damages will be restored to the position they were in prior to the event occurring.
Intent, wording, and execution
It may be assumed that an indemnity clause will contain the word indemnify. As with us humans, indemnity clauses come in all shapes, sizes and guises, to suit different circumstances. Words and phrases such as hold harmless, reimburse, be liable for, and make good, may all be used with similar effective meaning.
While indemnity clauses will be structured to define with some certainty the circumstances that may result in claims for damages being made, it is also true that not every conceivable scenario can be either imagined or defined. As such, claims may later be made by the indemnified party that are beyond the intent or expectation of fair and reasonable business practice and risk management.
It therefore becomes relatively common for indemnifiers, that is, the party offering indemnity, to object to some claims.
Reasons for objection may be such things as:
- The indemnifier should not have to pay damages resulting from circumstances over which they have no control.
- The indemnifier should not have to effectively act as the indemnified party’s insurer.
- The indemnifier should not have to have liability determined other than by reference to common law.
It is also the case that indemnity clauses may well anticipate the indemnified party will act in a responsible manner and take every reasonable course to mitigate potential risk and resultant damage or loss.
Certainly, the indemnifier should not be responsible for another party’s illegal behaviour, fraudulent actions, breach of contract, or negligence, and clauses will be so worded to cover such circumstances.
Those offering indemnity may well do so from a position of relative business weakness. That is, to lock in a much-desired commercial contract, indemnity beyond the scope anticipated may need to be included as a sweetener.
That said, clauses may be constructed in such a manner that potential liability may be reduced. Wording that refers to reasonable losses, or excludes actions by third parties, may be used to dilute obligations.
Other circumstances may be such that the claim being made is essentially uninsurable, and therefore the indemnifier will have no ability to spread its own risk through insurance coverage. Such a claim made by a powerful claimant may well result in an overwhelming liability from which a smaller entity may not recover.
In the final analysis
Those offering indemnity should make absolutely sure that the clause is constructed such that the intended meaning is clear and legally enforceable. Recipients of indemnity must be certain that a contract clause means what they understand it to mean. Indemnity clauses, as with all areas of commercial contracts, are best not left to assumption.
Properly constructed indemnity clauses are powerful instruments, and professional advice from an experienced commercial lawyer is vital if they are to be used effectively.