Indemnity Clauses – Be Careful What You Wish For

Indemnity clauses are a common feature of many different commercial contracts but their operation and utility can often be misunderstood or unclear. In this focus article, we look at how to recognise some of the common types of indemnity clauses and points to consider when employing such clauses in contracts.

What are they and what do they do?
In simple terms, an indemnity requires one party to pay for loss and damage suffered by another because of the performance of a contract.Types of indemnity clauses
One way of understanding the effect of indemnity clauses is to be able to recognise some of the common types that exist:

• ‘Bare’ indemnities – these operate where Party A indemnifies Party B against losses incurred in connection with certain events or circumstances but without any specific limitation on its operation;
• ‘Reverse’ or ‘reflexive’ indemnities – these operate where Party A agrees to indemnify Party B against losses arising from Party B’s own acts or omissions, such as Party B’s negligence; and
• ‘Proportionate’ indemnities – these operate where Party A agrees to indemnify Party B against losses but not for losses arising out of Party B’s own acts or omissions.

Other types of indemnities exist but the above are most often encountered in commercial contracts.

Reasons to be wary
Of the categories of indemnities mentioned, contracting parties (and not just the party giving the indemnity) need to carefully consider the potential impacts of bare indemnities and reverse or reflexive indemnities.

Bare indemnities can be problematic because of the inherent uncertainty attendant in their meaning and the differing (and difficult to predict) outcomes delivered by courts when called upon to interpret them.

In the case of reverse or reflexive indemnities, the party giving the indemnity may be required to exercise a higher standard of care than normal or accept liability for loss caused by others for whom it is not responsible. A similar outcome may also arise where a party is required to contract out of proportionate liability legislation.

Aside from difficulties associated with the clarity of meaning and operation of such clauses, two common problems encountered are:

• the party giving the indemnity does not have the financial capacity to fund the loss; or
• the party giving the indemnity is exposed to an uninsured liability.

Often, insurance policies (particularly public liability and professional indemnity policies) will specifically exclude cover for liability assumed under an indemnity clause that would not have arisen under general law. However, most policies will contain a ‘write back’ to the effect that the exclusion will not apply if the insured would still have been liable for such loss or liability in the absence of the indemnity clause.

Insurance cover for contractually assumed liability is sometimes available but at substantially increased cost.

Further, where the available insurance offers cover for part but not all of a claim because of the operation of the indemnity clause, resolution may be substantially delayed while the insurer (who may assume conduct of the claim for the party giving the indemnity) determines what is and is not covered or the insurer may dispute whether cover is available at all.

Absent insurance cover and/or a capacity on the part of the party giving the indemnity to fulfil its financial obligations in the event of a loss, there may be no ‘real world’ benefit derived from drafting an indemnity in strict or onerous terms.

In our next article in this series, we look at the contractual allocation of risk under insurance clauses.

How we can support you
McCullough Robertson and our insurance advisory service, Allegiant IRS, can assist you with the drafting and interpretation of indemnity clauses in your contracts.  We can also guide you through the process of placement and renewal of insurance cover that operates consistently with your contract provisions.

For further information on this alert, please contact the below team. 

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.