Indemnities are clauses in a contract where one party (the indemnifier) promises to protect another party (the indemnified) in the case of loss caused by a specific event. This can include claims brought by a third-party for damages. Indemnity clauses are a common feature of many commercial contracts. They are means of managing and shifting the risk. They also alter the common law and statutory rights and obligations of the parties. In construction contracts, for example, an indemnity clause works to protect the owner of the property from claims of injury brought on the construction site. The indemnity clause transfers the risk from the owner to the contractor.
The indemnity clause may take the form of a ‘hold harmless’ clause or a ‘make good’ clause. Under a ‘hold harmless’ indemnity clause, the indemnifier promises to protect the indemnified party from incurring a loss. As soon as a loss occurs, the indemnifier is in breach of the indemnity clause. The ‘make good’ indemnity clause creates an obligation for the indemnifier to compensate the indemnified party after suffering a loss. A loss is indemnified only when the indemnified party makes a claim for indemnification.
Indemnities vs Insurances and Warranties
Indemnity and insurance both allocate risk, however, they differ in the manner they shift the risk. While an indemnifier voluntary accepts the transfer of risk, an insurer receives a premium for the acceptance of risk. More information about the difference between indemnity and insurance is available in our guide here. Warranties are also different from indemnities. A warranty is an assurance in a contract relating to the condition of the asset or the business. If a person suffers loss because the quality of the goods is not as expected, they may seek compensation from the court for a breach of warranty. Warranties protect a party from an unknown risk while an indemnity allocates risk to a known party. Please refer to our comprehensive guide on warranties for more information about their implications.
Negotiating Indemnities
Indemnities are an important part of a contract and may become the focus of long negotiations between the parties. They play such an important role because they can create significant problems for the indemnifier. An indemnified party can demand that an indemnifier be covered by an insurance or a guarantor. This ensures that the indemnified party is able to receive an indemnification in case they suffer loss. Many insurance providers require a substantially high premium to insure indemnity liability’s. This is especially true for professional indemnity policies. If the loss is not covered, the indemnifier will have to pay themselves. This can create problems because the indemnifier may not have the financial capacity to indemnify. The indemnifier should ensure that they do not accept too great or broad risk and that indemnity clause is within their capacity to fulfill.
Types of Indemnities
There are many types of indemnity clauses. The phrasing of the clause determines the amount or level of risk involved.
1. Bare Indemnity
An indemnity clause may be so broad that it covers all liabilities arising out of the contracts, without any qualification. This is known as a bare indemnity and the clause can apply even where the sole cause of fault is the party being indemnified. For example, even if the owner of a property is at fault for a third-party claim, under a broadly construed indemnity clause, the owner may be able to recover the losses from the contractor. Often, a party with a greater bargaining power can insist on a bare indemnity. However, an indemnifier must try and ensure that the indemnity liability is reasonable.
2. Proportionate Indemnities
An indemnity clause may be more limited by restricting indemnification to losses solely caused by the indemnifier. In this example, the contractor will only be liable for the loss caused by him and no more. If the claim is for $100,000 and the contractor was 10% responsible for the damage, then the contractor must only indemnify $10,000 to the owner.
3. Party/Party Indemnity
In a party/party indemnity, both the indemnifier and the indemnified agree to indemnify each other for loss caused by the indemnifiers breach of contract.
4. Third Party Indemnity
A third party indemnity is an indemnity that specifically protects the indemnifier in cases of third party claims.
