Legalese: Golden rules for drafting indemnities

Indemnities or "hold harmless" provisions are common in commercial agreements. This month’s Legalese attempts to demystify the concept of an indemnity and to help identify common mistakes people make when drafting these clauses.

An indemnity is a promise by one party to pay a sum of money to compensate a particular loss. The perceived advantage of an indemnity for breach of contract (where one party indemnifies another for losses arising from the first party’s breach of contract) instead of pursuing a claim for damages is that various common law rules – e.g. on remoteness of damage and a duty to mitigate – do not apply. In simple terms the rule on remoteness means that if one party breaches a contract and its counterparty sues it for damages – those damages will be limited to losses that ought to have been in the reasonable contemplation of the contracting parties.

Clients (and some lawyers) often see an indemnity as some sort of "plaster" which covers all manner of sins, allowing their client to recover all losses in the event of a breach by their counterparty. Sadly, this is not the case.

Whether an indemnity overrules the common law rules on remoteness or mitigation depends on the formulation and drafting of the indemnity clause itself. If the indemnity is in relation to a debt claim (i.e. a definite sum of money payable on the occurrence of a debt) then the rules on remoteness and duty to mitigate do not apply – so the indemnity does provide a level of certainty in compensation. However, if the indemnity is in respect of a claim for damages – i.e. a claim in respect of a breach of contract, courts will look to the wording of the indemnity itself.

Remoteness

 

Is an indemnity for a breach of contract supposed to be an obligation to pay all losses suffered – whether or not in the "reasonable contemplation of the contracting parties"? That is a question of fact. It is certainly possible for an indemnity to be designed to cover all possible losses (however remote) – however, if this is the intention, the contract should state this expressly.

For example, the language in Example A below is preferable to that in Example B:

EXAMPLE A: "Party A shall indemnify Party B against all liabilities, costs, expenses, damages and losses (including any direct, indirect or consequential losses, loss of profit, loss of reputation and all interest, penalties and legal and other reasonable professional costs and expenses) suffered or incurred by Party A arising out of or in connection with [the relevant breaches]."

EXAMPLE B: "Party A shall indemnify Party B against all liabilities, costs, expenses, damages and losses suffered or incurred by Party A arising out of or in connection with [specify relevant breaches]."

even though Example B would appear to be good and clear drafting.

Duty to mitigate loss

In terms of a duty to mitigate loss – the following wording is generally accepted in indemnities:

"Nothing in this agreement shall restrict or limit Party A’s general obligation at law to mitigate a loss it may suffer or incur as a result of an event that may give rise to a claim under this indemnity."

Negligence

One final thing to note, which also trips up many clients and their lawyers, is that an indemnified party cannot claim under an indemnity for damage or loss suffered if that loss was as a result of his own negligence unless this is expressly stated in the clause. The following wording is nonetheless usual:

"The indemnity in this agreement shall not cover Party A to the extent that a claim under this clause results from Party A’s [gross] negligence or wilful misconduct."

The existence of the word "gross" is moot – a party would in any event not be able to claim for loss suffered as a result of the claimant’s own negligence unless wording similar to the below is included:

"The indemnity in this agreement shall cover Party A notwithstanding that a claim under this clause results from Party A’s negligence or wilful misconduct."

 

This clause would (even in the absence of an editor’s underlining) raise alarm bells – but this exception is worth being aware of nonetheless.

Conclusions

 

· Don’t believe that indemnities offer catch-all protection – they need to be carefully drafted;

· If you have an indemnity that relates to a stated sum of money – you are probably OK in that common law rules of remoteness and mitigation are unlikely to apply;

· If you have a general indemnity for breach of contract (a damages claim) then make sure you set out in full the losses you want covered;

· You will always be under an obligation to mitigate your loss – unless you expressly say that you aren’t (and this approach is likely to be resisted); and

· You will never be able to claim under an indemnity if you caused the loss due to your own negligence – unless you expressly say so (and again, this is likely to be resisted).

For further information and advice, please speak with your usual Trinity contact.