Indemnities in business-to-business contracts : A Guide

What is an indemnity?

In simple terms, an indemnity is a promise in a contract to reimburse the other party in respect of a specific loss suffered by that party (usually for costs and expenses) if a ‘specific event’ happens (typically stemming from third-party claims).

Indemnities are typically used to (a) allocate risk between the parties, (b) protect a party from damages and claims that are more efficiently borne by a counterparty, (c) increase the amount recoverable from a paying party who is already liable, (d) simplify claims and (e) make it easier and quicker to recover amounts due.

What is a ‘specific event’?

Anything from covering the costs of a data breach, environmental risks, litigation or product liability to infringement of a third party’s intellectual property rights. Indemnities are useful where a risk is known, whereas warranties protect against the unknown.

How much is recoverable under an indemnity?

An indemnity generally provides for ‘pound for pound’ compensation in respect of a specific loss/event. However, recoverability will depend on the interpretation of the wording of the indemnity clause and its purpose/intention.

How do you claim under an indemnity?

An indemnity clause generally simplifies a claim and makes it easier and quicker to recover amounts due because the contract itself sets out the trigger for payment, the process to be followed to notify a claim and the amount of loss recoverable.

Proof of loss is commonly required for an indemnity to be payable. The indemnity can however be drafted so that there is no requirement to prove a loss to receive payment.

There is an expectation that the indemnified party will take all reasonable steps to avoid losses and that the indemnified party cannot recover losses if they failed to avoid the loss by taking reasonable steps.

How can we limit liability under an indemnity?

There are a number of options available to alleviate risk:

• Exclude certain categories of loss.
• Expressly provide that unforeseeable losses are not recoverable.
• Specify a cut-off date so that no new claims can arise after a set date.
• Require mitigation.
• Impose individual or collective claim thresholds.
• Include indemnities within any overall contractual liability cap, which is ideally tied to insurance coverage.
• Include a ‘conduct of claims’ clause.

Comment

Indemnities are a key tool when protecting a client from risk under a contract. The approach taken towards indemnities will often be a commercial decision weighing the risk under a contract against the wider importance/benefit of the arrangement to an organisation as a whole.

Contact a member of our Corporate & Commercial team if you would like advice in relation to indemnities, they will be delighted to assist you.