By Megan Sanders

30 July 2019

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. Megan Sanders from the 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 Megan Sanders or another member of the Tisher Liner FC Law Commercial Team for further advice.

 

Disclaimer
The material contained in this publication is meant to be informational only and is not to be construed as legal advice. Tisher Liner FC Law will not be held liable or responsible for any claim, which is made as a result of any person relying upon the information contained in this publication.

Related Articles

View All
Business Law / Property & Development / Developments

TLFC Law Triple Finalists in the Lawyers Weekly Australian Law Awards 2019

Celebrating its 19th year, the Australian Law Awards, in partnership with UNSW Law, is the pinnacle of award programs...
Read More
Business Law / Franchising & Licensing / Real Estate Agents

Thinking of buying or selling a Rent Roll?

However, rent rolls are regulated by the Estate Agent’s Act and it is important that the contract to buy or sell the...
Read More
Information Technology & Innovation / Developments / Business Law

Cyber Security and Protection from Cyber Fraud

Email communication is an inherent part of modern day business It is not uncommon to run an entire transaction online,...
Read More
Employment Law / Business Law / Litigation & Dispute Resolution

What employers need to know when letting someone go

A staff member may need to be let go because the business can no longer afford them, or perhaps they are just not...
Read More
Business Law / Leasing & Lease Disputes / Real Estate Agents

Retail Leases Update for Agents and Landlords

Pursuant to Section 15 of the Retail Leases Act 2003 (Vic), as soon as a landlord enters into negotiations with a...
Read More
Business Law / Commercial Contracts & Agreements / Franchising & Licensing

Franchisors Beware – the ACCC means business!

The action taken by the ACCC against the franchisor related to acting in breach of good faith and making false or...
Read More
Business Law / Personal Property Securities / Small to Medium Enterprises

Personal Property Securities Register (PPSR) Celebrates its 7th Birthday

Financiers who have registered security interests on the PPSR should be aware of this date, as seven-year registrations...
Read More
Business Law / Property & Development / International Investors

Self Managed Superannuation Funds and Property Investment Part 2: Stamp Duty when Transferring Property Assets

Whether the SMSF has purchased this property outright or though the assistance of a Limited Recourse Borrowing...
Read More
Business Law / Property & Development / International Investors

Self-Managed Superannuation Funds and Property Investment Part 1: Using Borrowed Funds for Real Property Investment

There are potentially numerous benefits for purchasing property via a SMSF including asset protection and concessional...
Read More
Business Law / Real Estate Agents

Underquoting Agent cops $720,000 fine

What was the case about The case involved 20 breaches of the Australian Consumer Law for underquoting The Agency had...
Read More
Business Law / Intellectual Property / Information Technology & Innovation

Protecting your brand: the importance of a trademark

You may think your business name or logo is super catchy… witty… and perfectly encompasses the goods/services your...
Read More