A tale of two deals – just because an indemnity is unfair in one, doesn’t make it unfair in another
This is the second article of McCullough Robertson’s series on What you don’t know about unfair contract terms, which highlight upcoming changes to Australia’s unfair contract terms (UCT) regime, including some of the key contract terms that fall within the ambit of that regime.
In our first article we took a closer look at the non-disparagement clause. In this alert, we delve deeper into indemnity clauses. These clauses, due to their inherent flexibility, may be unfair in certain circumstances, but not others.
The following discussion focuses on the UCT regime under the Australian Consumer Law (ACL). However, these considerations similarly apply to the parallel UCT regime for financial services under the Australian Securities and Investments Commission Act 2001 (Cth).
What makes an indemnity clause unfair?
Indemnity clauses are effectively a promise by one party (indemnifying party) to compensate the other party (indemnified party) for any loss if a certain trigger event occurs (e.g. if there is a breach of any third party intellectual property rights). Indemnity clauses are used to protect against losses traditionally not recoverable under contract law or to get around the common law limitations on damages (i.e. indemnities are generally not subject to remoteness and causation limitations).
It is because indemnity clauses can cover any type of ‘trigger’ event (e.g. any act or omission, negligence, or third party claims) and can cover any extent of loss suffered (e.g. loss of profits or unforeseeable harm), that they have the potential to be unfair. In ACCC v JJ Richards & Sons Pty Ltd  FCA 1224, the ACCC found that a broad one-way indemnity was unfair because it did not require wrongdoing by the indemnifying party and covered losses that could have been avoided or mitigated by the indemnified party.
There are several strategies to seek to reduce the potential unfairness of an indemnity clause:
- Mutuality: a mutual indemnity clause seeks to reduce any imbalance in the rights of the parties. However, even mutual indemnities may be unfair if one party is more likely to be liable under those indemnities than the other.
- Scope: narrowing the scope of the indemnity to specific third party claims or clearly identified risks ensures the indemnity doesn’t become a catch-all provision. Generally this involves reviewing the potential risks in the business relationship and crafting the indemnity clause to specifically address those. The indemnity should never cover circumstances that were never within the control of the indemnifying party.
- Carve-outs: losses caused or contributed to by the indemnified party should be excluded from the indemnity. This ensures the indemnifying party is not unfairly burdened and promotes the parties to act diligently.
- Duty to mitigate: ensure the indemnified party has a duty to mitigate their losses. This ensures they cannot claim compensation for losses that could have been reasonably avoided.
One or more of these remediation techniques may be necessary to alleviate any potential unfairness in an indemnity clause. However, it will always depend on the specific circumstances of the deal. As you can see, the inherent flexibility in indemnity clauses means that they may be unfair in certain circumstances but not others. Ultimately, it turns on whether the indemnity allows a party to recover loss that ought reasonably to be recoverable.
Why does this matter?
The new penalties under the UCT regimes are no laughing matter. From 10 November 2023, businesses that are found to propose, apply, or rely on an unfair contract term, may receive substantial fines. For an overview of the key changes of the regime and new penalties see our article Major changes to unfair contract terms laws are coming – 6 months to go.
What should I do now?
With the reforms fast approaching, it’s time for businesses to understand the extent to which they are impacted by the changes, and to prepare accordingly. In particular, it is important to:
- identify template contracts used by your business and assess if they may be a standard form contract (and whether counterparties are given a meaningful opportunity to negotiate them);
- assess the nature of counterparties to those standard form contracts, to determine whether you enter into contracts with consumers, or with parties with less than 100 employees or whose annual turnover is less than $10m;
- identify any one-sided, unfair or excessively favourable terms in those standard form agreements; and
- identify and document your company’s legitimate business interests, which can be used to justify the inclusion of contractual terms that would otherwise be considered risky from a UCT perspective.
If you would like to discuss the practical implications of the changes, or need assistance in conducting a UCT review of your standard form contracts, please get in touch with a member of our Digital and Intellectual Property 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.