April 2, 2024
What is an Indemnity Clause
Indemnity clauses can be one of the most heavily negotiated provisions of a contract, as they are the enforceable agreement by which one party agrees to compensate another for loss, damage or expense. The purpose of an indemnity is to alter the statutory rights and common law position of the contracting parties, which can have a significant effect on relevant risk allocations. As such, it is essential that each party carefully considers the extent to which they seek to alter those rights.
Importance of an Indemnity Clause
To understand the weight of an indemnity clause, it is useful to contrast the common law position for breach of contract against the position under a contract when an indemnity is invoked.
Standard Breach of Contract
Put simply, absent other remedies, when one party breaches the terms of a contract causing the innocent party to suffer loss, the innocent party may recover that loss as damages from the defaulting party. The quantum of these damages is the amount that will put the innocent party in the position it would have been in if that contract had been performed without breach. In determining this, the court will only award damages for loss that was directly caused by the wrongdoer’s action. At common law, the innocent party is required to mitigate its loss and damage will not be entitled to recover losses that were unreasonably incurred.
Indemnity Clause
Under an indemnity clause, the scope of damages can be as wide as to include all losses, or a loss that arises from a specific event. Ultimately, depending on how the clause is drafted, it can extend to include losses that are not recoverable as contractual damages.
A claim for indemnity requires an unbroken chain of causation which involves reference to the reasonable contemplation of the parties.
The effect of an indemnity clause turns on the particular:
- terms of the contract;
- wording of the indemnity; and
- circumstances which trigger the indemnity,
but (depending on the specific language used) has the potential to make the following recoverable:
- loss or damage that was not caused by an act or omission of the indemnifier;
- loss or damage that is not a direct consequence of a breach by the indemnifier; and
- unreasonably incurred costs.
It is important that the indemnity clause is clearly drafted to avoid any ambiguity. Where an indemnity clause is ambiguous, it will be construed in favour of the indemnifier[1] (to the extent it does not rectify unfairness in favour of the indemnifier[2]).
Drafting an Indemnity Clause
There are different types of indemnities, including:
- Bare Indemnities: Party A indemnifies Party B against any and all losses and liabilities that occur in connection with the contract;
- Reflexive Indemnities: Party A indemnifies Party B against losses that occur as a result of Party B’s own conduct;
- Proportionate Indemnities: Party A indemnifies Party B against all losses, except those that arise out of Party B’s own conduct;
- Indemnities for Third Party claims: Party A indemnifies Party B against claims by third parties arising out of contract;
- Indemnities excluding Third Party claims: Party A does not indemnify Party B against claims by third parties arising out of the contract;
- Party/Party Indemnities: Each party indemnifies the other for losses incurred as a result of the other party’s breach; or
- Indemnities by Third Parties: Party C indemnifies Party A against any and all losses and liabilities that arise as a result of Party B’s breach of a separate contract or negligent conduct (usually financiers or insurers).
Traditionally, courts have taken the approach of considering the natural and ordinary meaning of the words used the clause, in the context of the contract as a whole[3] (only when there is ambiguity does the contra proferentem rule apply[4]). Consequently, boilerplate indemnities must be used with caution as it may not necessary be interpreted the same way under different contracts. The context and purpose of the indemnity are important in construing its meaning but does not override the natural and ordinary meaning of the words.
Exposure
The indemnifier must carefully consider its potential exposure under the indemnity. This may turn on the use of the words:
- “in connection with” or “as a consequence of” which are considered words of “the widest import”, not requiring any direct or proximate relationship with the contract but must have some causal or consequential relationship with it;[5] or
- “arising out of” which is considered of particularly broad expression but is not open ended. More is required than the mere existence of connecting links between an act, neglect or default, and the liability incurred.[6]
The indemnifier may limit its exposure by:
- obliging the indemnified party to mitigate its loss;
- limiting liability for matters which are not reasonably foreseeable or which may be classed as “consequential loss”;
- limiting the total value of liability; or
- limiting the obligation to rectification of impacted contract works.
Indemnified Losses
When considering the scope of the indemnity, parties also ought to consider the type of loss or damage that ought to be indemnified, for instance:
- any and all breaches of the contract;
- breach of specific obligations;
- damage to real or personal property owned by one or both contracting parties;
- damage to real or personal property owned by third parties;
- injuries suffered by employees, subcontractors, or the general public; or
This should be specifically identified in the clause. Notably, Andar[7] provides that if a contractual indemnity does not expressly transfer liability to the extent of the head contractor’s negligence, then the indemnity will be read down, and the parties will be liable only to the extent of their breach of duty of care, statutory duty or breach of contract.
Key Takeaway
It is important that mechanisms to mitigate current industry risks are carefully considered during initial project establishment. Further, during the tender phase, it is critical to understand what a party’s obligations are under the contract and the extent to which they may alter potential liabilities and risk allocations.
Lamont Project & Construction Lawyers
The Lamont Project & Construction Lawyers team has extensive knowledge with various contract mechanisms to mitigate current industry risks for both Principals and Contractors. With this knowledge and expertise, Lamont Project & Construction Lawyers can provide the required support and advise on major projects with respect to design risks across the life cycle of a project.
If you would like to discuss any matters raised in this article as it relates to your specific circumstances, please contact Lamont Project & Construction Lawyers.
The content of this article is for information purposes only and does not discuss every important topic or matter of law, and it is not to be relied upon as legal advice. Specialist advice should be sought regarding your specific circumstances.
Contact: Peter Lamont or Kathryn Easton
Email: [email protected] or [email protected]
Phone: (07) 3248 8500
Address: Level 2, 349 Coronation Drive, Milton Qld 4064
Postal Address: PO Box 1133, Milton Qld 4064
[1] Andar Transport v Brambles Limited (2004) 217 CLR 424 at [17] – [23].
[2] Samways v Work Cover Queensland & Ors [2010] QSC 127 at [67].
[3] Erect Safe Scaffolding (Aust) Pty Ltd v Sutton (2008) 72 NSWLR 1 per Giles JA at [5].
[4] Andar Transport v Brambles Limited (2004) 217 CLR 424.
[5] State of NSW v Tempo Services Ltd [2004] NSWCA 4 per Meagher JA
[6] In F & D Normoyle Pty Ltd v Transfield Pty Ltd [2005] NSWCA 193.
[7] Andar Transport v Brambles Limited (2004) 217 CLR 424.