Negotiating Indemnities: Some Practical Tips
Indemnities take various forms and are all about allocating (or reallocating) risk in commercial transactions. However, achieving the correct balance is frequently contentious and can be a real headache if you get it wrong.
An appropriate indemnity can provide a valuable mechanism for risk allocation between parties to commercial dealings but only if you get it right. Our Commercial Team provides some useful tips.
Indemnity Basics
An indemnity is an obligation written into a contract that legally binds one party to bare the risk of loss that another party may suffer in specified circumstances.
Depending upon drafting, an indemnity can allow the indemnified party to alter factors which limit its rights to recover damages for breach of contract. These factors include:
- Remoteness: Whether the loss flows in the usual course of things or was in the reasonable contemplation of the parties at the time of centering into the contract ;
- Mitigation: The extent to which a party has taken reasonable steps to mitigate its loss;
- Limitation of Actions: Ordinarily a claim for breach of contract must be made within 6 years of the breach rather than 6 years from the time of suffering the consequent loss. Where there is an indemnity claim the 6 year period will be triggered by failure to indemnify the loss; and
- Proportionate Liability: The apportionment of loss between concurrent wrongdoers.
Common Difficulties
Unfortunately, it is not uncommon for even highly experienced parties to reach an impasse whilst trying to negotiate an acceptable indemnity or, worse, to find themselves unacceptably exposed by what they have signed.
These issues arise for a variety of reasons, but often it is a case of:
- Poor drafting and or reliance “boiler plate” (precedent based) clauses;
- Outcomes being driven by a disparity in bargaining power between the parties and without due regard to who is best placed manage the risks involved;
- The contingent liabilities involved being difficult to quantify and or more than an indemnifying party is comfortable assuming;
- Failure to obtain proper advice or work through the issues.
5 Considerations to Keep in Mind When Negotiating Indemnities
1. Do not just accept boiler plate provisions: An appropriate indemnity should be crafted by the parties’ lawyers having due regard to the nature of the transaction and particular risks to the parties. Eg.
a. Who should be indemnifying? If more than one party, should liability be joint and several?
b. What are the key areas of risk for loss and damage? Who would ordinarily be liable? Who is best placed to manage these risks?
c. Who should be covered by the indemnity? Should it include directors and officers?
d. How long should the indemnity operate for?
2. Understand the asset position of the indemnifying party: An indemnity is only valuable if the indemnifying party has assets to recover against. When dealing with special purpose vehicles or parties with limited assets or significant secured debts, particular caution should be exercised. The indemnified party may need to consider:
a. whether to include an express obligation on the indemnifying party to take and maintain insurance covering particular liabilities; and or
b. seeking appropriate security (eg. personal guarantees, retention amounts, bank guarantees, PPSR security interests).
3. Understand the insurance position of the indemnifying party: The indemnifying party should confirm the extent of any insurance coverage to be relied upon with their insurer. This is critical for understanding exposure. Many policies contain contractual liability exclusions in relation to losses which are assumed under a contract but would not have otherwise attached to the insured. Knowledge of coverage and applicable claims limits can also often be a good starting point for negotiating caps or exclusions (discussed below).
4. Generate greater certainty through carve outs and caps: Do not be disheartened if you are asked for an extremely broad indemnity. Whilst there are situations where a party might ultimately choose to walk away, most impasses are resolved via series of carve outs and caps in favour of the indemnifying party. Depending upon the nature of the transaction, some of the more common to consider are:
a. Limiting the scope to specific types of loss (eg. taxation liability, injury, death or property damage at a particular location, employee claims, third party claims for intellectual property infringement or product defects);
b. Limiting the parties covered (eg excluding indemnification of directors, officers or employees);
c. Capping the total aggregate amount of an indemnifying party’s liability under the indemnity or the liability amount in respect of a particular type of claim;
d. Excluding liability for loss to the extent caused or contributed by the acts or omissions of the indemnified party or its officers, employees or agents (or a variant such the “breach, wrongful act or negligence of those parties”);
e. Limiting loss to “direct” and or “reasonably foreseeable loss”;
f. Limiting recovery of costs to “reasonable” costs;
g. Limiting the duration of how long the indemnity or claim for a particular type of loss to run for;
h. Expressly obliging the indemnified party to take reasonable steps to mitigate its loss;
i. Granting the indemnifying party rights to step in/control third party claims against the indemnified party.
5. Consider alternatives: Often a key motivation behind the push for broad indemnity is the need to manage an unknown risk. In certain situations such as sale contracts it may be possible to instead offer comfort in the form of a warranty and or further disclosure.
If you require any assistance negotiating, drafting or interpreting a commercial contract or indemnity provision, please contact a member of the Tisher Liner FC Law Commercial Team for further advice.
