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Indemnity Clauses – what they are, how they work
and how to make them work for you
Introduction
• Effective risk transfer technique so apply the ISO
31000 framework before the contract is signed
• They are...
Risk Identification and Allocation
• Critical part of pre-contractual negotiation
• The party with the greatest capacity t...
How are contractual risks
allocated?
• A party should bear the risk where:
– It lies within their control
– It is economic...
Definition – what is an indemnity
clause
• A promise – ‘I (the indemnifier) promise to protect
you (the beneficiary) in th...
Different to a guarantee and a right
to claim damages
• With a guarantee – I (as guarantor) agree to answer for
a debt or ...
The common law position in
relation to consequential loss
• At common law, if one party to a contract when carrying out
th...
The Australian position on
consequential loss
• The second limb in Hedley v Blaxendale has been
reconsidered in Australia ...
Types of indemnity clauses
• Third party indemnity –where the indemnifier
(party A) agrees to compensate or hold harmless,...
Three more for the sake of
completeness!
• Reverse indemnity - Party A indemnifies Party B
against losses incurred as a re...
Why are indemnity clauses
important
• When they are properly used, indemnities are an
effective risk management tool. If t...
What to think about when
constructing or negotiating an
indemnity clauseUnderstand what the parties are contracting about ...
Approach of the Courts
• Interpretation based on commercial sense and in
accordance with commercial reality.
• Give the wo...
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Indemnity clauses - what they are, how they work and how to make them for you

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Indemnity clauses - what they are, how they work and how to make them for you

  1. 1. Indemnity Clauses – what they are, how they work and how to make them work for you
  2. 2. Introduction • Effective risk transfer technique so apply the ISO 31000 framework before the contract is signed • They are subject to the Insurance Contracts Act (1984) because of the operation of s10(2) so be mindful of duty of utmost good faith in s13 • The risk transfer effected by the clause is a essential characteristic of an insurance arrangement (see Bayswater Car Rental Pty Ltd v Hannell (1999) WASCA 34 where the Court held that an indemnity clause in a car hire agreement was a ‘provision of insurance’ for the purpose of s10(2) of the ICA)
  3. 3. Risk Identification and Allocation • Critical part of pre-contractual negotiation • The party with the greatest capacity to control the risk should be responsible for it • Different transactions – different industries – different risks so one size does not fit all • Map the identified risks in a matrix, evaluate and analyse their importance, understand their priority and then allocate responsibility for the risks to the party with the greatest capacity to mitigate the risk.
  4. 4. How are contractual risks allocated? • A party should bear the risk where: – It lies within their control – It is economically beneficial to transfer the risk – It is efficient – It is not practical or necessary to assume the expense and uncertainty of a transfer option
  5. 5. Definition – what is an indemnity clause • A promise – ‘I (the indemnifier) promise to protect you (the beneficiary) in the event that you suffer a loss or damage’ • ‘I have a contractual obligation to make good any loss that you suffer or to compensate you if you suffer loss as a result of a described and pre-agreed event’ • Can also be called a ‘hold harmless’ clause meaning one party will not or cannot sue the other party for losses (usually bodily injury, property damage or consequential loss) irrespective of the fault of the other party • No need to use the words ‘hold harmless’- that phrase just emphasises the indemnity
  6. 6. Different to a guarantee and a right to claim damages • With a guarantee – I (as guarantor) agree to answer for a debt or default that you (as beneficiary) might incur. I promise to take over and perform the obligation imposed on you in the event that you fail to perform it • With a right to claim damages – I (as plaintiff) have a legal right to demand compensation for a legal injury suffered at the hands of another • In contrast, a right to indemnity can exist – even if the indemnifier has caused no injury to the beneficiary or – where the loss or damage was caused by a third party completely unrelated to the indemnifier and the beneficiary
  7. 7. The common law position in relation to consequential loss • At common law, if one party to a contract when carrying out the venture governed by that contract, performs the venture poorly causing loss to the other party, that injured party had a right to recover damages for those losses which were (i) a natural consequence of the breach (measured objectively using the reasonable person test) and (ii) those which were within the reasonable contemplation of the parties at the time of making the contract – in other words, the parties knew these losses were possible (measured subjectively) • Recovery of damages was subject to a test of what losses were foreseeable at the time of the contract and the extent to which the other party could have reasonably mitigated the loss. (see Hadley v Blaxendale (1854) 156 ER 145) • BUT the second limb in Blaxendale has been reconsidered
  8. 8. The Australian position on consequential loss • The second limb in Hedley v Blaxendale has been reconsidered in Australia as a result of recent cases such as Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) VSCA 26 and Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7)(2012) SASC 49 • In the Peerless case, the Victorian Court of Appeal held that consequential loss means ‘anything beyond the normal measure, such as lost profits and expenses incurred through the breach’. • In Yokogawa, the Supreme Court of South Australia referred to the definition of ‘consequential’ in the Oxford dictionary and noted that consequential loss extends to all damages suffered as a consequence of a breach. They held that to limit the meaning of consequential loss to those losses arising under the second limb in Hadley’s case was unduly restrictive. It is now settled law that in Australia, consequential loss will extend beyond reasonable contemplation to those items that are a consequence of the breach.
  9. 9. Types of indemnity clauses • Third party indemnity –where the indemnifier (party A) agrees to compensate or hold harmless, the beneficiary from loss or damage arising from a claim made by a third party. • Party to party indemnity – where the indemnifier (party A) holds the beneficiary harmless against specific losses suffered by the beneficiary such as loss arising from a breach of contract. • Bare indemnity – Party A indemnifies Party B for all liabilities or losses events and circumstances but without imposing any specific limitations.
  10. 10. Three more for the sake of completeness! • Reverse indemnity - Party A indemnifies Party B against losses incurred as a result of Party B’s own acts and/ or omissions (mostly Party B’s own negligence) • Proportionate or limited indemnities - Party A indemnifies Party B against losses except those incurred as a result of Party B’s own acts and/ or omissions • Financing indemnities - Party A indemnifies Party B against losses incurred if Party C fails to honour the financial obligation (ie the primary obligation) to Party B (most often these are coupled with a guarantee
  11. 11. Why are indemnity clauses important • When they are properly used, indemnities are an effective risk management tool. If they are improperly used, they can be expensive and difficult to manage. Heed the warning given by Giles J in Erect Scaffolding and DON’T rely on a precedent: • ‘the operation of any contractual liability must be found in the application of the facts of the relevant clause, construed as part of the contract as a whole. Decisions on the operation of contractual indemnities in different words in different contracts are likely to be of limited assistance’ (see Erect Safe Scaffolding (Australia) Pty Limited v. Sutton (2008) 72 NSWLR 1) •
  12. 12. What to think about when constructing or negotiating an indemnity clauseUnderstand what the parties are contracting about – - what is the scope of their agreement, - what is the form of the agreement, - who will be protected and - how much will be paid in the event that loss or damage is suffered by the beneficiary. - what insurance provisions will be inserted, - who will bear the legal costs, - will there be any limits or caps on the amount of compensation to be paid, - what are the conditions on which that will occur, - what will trigger the operation of the indemnity clause? - what happens after the contract has come to an end?
  13. 13. Approach of the Courts • Interpretation based on commercial sense and in accordance with commercial reality. • Give the words used, their ordinary meaning. • Avoid using overly technical methods of interpretation. • Apply an objective test – in other words, look at what the reasonable person in the position of the indemnified party would have understood them to mean. • In the event of ambiguity or uncertainty – apply Strictissmi Juris principle. Similar to contra preferentum but in the case of indemnity clauses, the courts will construe the ambiguous clause in favour of the indemnifier (see Andar Transport v Brambles Ltd (2004) 217 CLR 424

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