Indemnity Clauses In Contractor Agreements

Mike runs a cleaning business in Melbourne. A new commercial client sends over a contractor agreement and asks Mike to sign it that afternoon. Buried near the end is a clause saying Mike must indemnify the client for any loss connected with the services, whether or not Mike caused it.

That one sentence could make a big difference. If a staff member damages a customer's floor, an indemnity may be fair. But if the client gives Mike unsafe access to the premises and someone gets hurt, Mike shouldn't automatically carry the whole risk.

An indemnity clause in a contractor agreement doesn't have to be scary. The key is making sure it's tied to fault, backed by the right insurance, and balanced with sensible limits on liability.

What Is An Indemnity Clause In A Contractor Agreement?

An indemnity is a promise to compensate another party for certain losses if a particular risk happens.

In a contractor agreement, the client may ask the contractor to indemnify them for losses caused by the contractor's work. For example, this could cover loss arising from:

• property damage caused by the contractor
• injury caused by the contractor's negligence
• a breach of confidentiality
• infringement of someone else's intellectual property
• a data breach caused by the contractor's systems or staff
• a subcontractor's actions

Indemnities are common in services agreements and service agreements because they shift risk. They can make sense where one party is in the best position to control that risk. If your contractor controls how the work is done, brings their own equipment and supervises their own team, it's usually reasonable for them to take responsibility for losses they cause.

The problem is when the indemnity goes beyond that. A very broad indemnity can make a contractor responsible for losses they didn't cause, couldn't control, or couldn't insure against.

When Is A Contractor Indemnity Clause Reasonable?

A contractor indemnity is usually reasonable when it covers losses caused by the contractor's own breach, negligence, wilful misconduct or unlawful conduct.

For your business, the fairest starting point is this: each party should be responsible for the risks they can control.

For example, if you engage a web developer to build your online booking system, it's fair for the developer to be responsible if they copy code from a third party without permission and your business receives an intellectual property claim. The developer chose the code and controlled that part of the work.

It may also be fair for the developer to indemnify you if they mishandle customer personal information after you gave them access to your database, especially if your business has obligations under the Privacy Act 1988 or the Notifiable Data Breaches scheme.

A practical indemnity will usually be limited to losses arising from things such as:

• breach of contract: the contractor doesn't do what the agreement requires
• negligence: the contractor fails to take reasonable care
• wilful misconduct: the contractor deliberately does the wrong thing
• unlawful acts: the contractor breaches applicable laws while providing the services
• IP infringement: the contractor provides materials that infringe another person's rights
• privacy or confidentiality breaches: the contractor misuses confidential information or personal information

Good drafting will also include the words to the extent caused by. This matters because it links the indemnity to the contractor's level of responsibility.

Compare these two versions:

• Too broad: The contractor indemnifies the client for all loss arising in connection with the services.
• More balanced: The contractor indemnifies the client for loss to the extent caused by the contractor's negligent act or omission, breach of this agreement, wilful misconduct or unlawful conduct.

That small change can stop one party from carrying the full cost of a problem partly caused by the other party.

When Can An Indemnity Create Excessive Exposure?

An indemnity can create excessive exposure when it's broader than the contractor's fault, uncapped, or not matched to insurance.

If you're the business engaging a contractor, a broad indemnity might feel comforting at first. But if the clause is unfair or unrealistic, it can create problems later. The contractor may refuse to sign, price the risk into their fees, or have no real ability to pay if something goes wrong.

If you're asked to sign your customer's contractor terms, you should be especially careful with indemnities that cover:

• all losses connected with the services, even where you didn't cause the issue
• indirect, consequential or special loss without clear limits
• losses caused by the customer's own instructions, materials or site conditions
• third party claims that are outside your control
• regulatory penalties or fines where the customer also contributed to the breach
• losses that are excluded from your insurance policy

Say you run a cafe in Brisbane and engage a contractor under an IT services agreement to install new point of sale software. The contractor should be responsible if their technician negligently damages your hardware. But if your staff ignore the contractor's written instructions and delete a key database, it wouldn't be fair for the contractor to carry 100% of the loss.

Unfair Contract Terms Can Matter

Australian unfair contract terms laws can apply to standard form small business contracts under the Australian Consumer Law and the Australian Securities and Investments Commission Act 2001.

For contracts entered into, renewed or varied from 9 November 2023, the small business protections generally apply where at least one party has fewer than 100 employees or annual turnover under $10 million, and the contract is a standard form contract.

An indemnity or liability clause may be unfair if it creates a significant imbalance, isn't reasonably necessary to protect legitimate interests, and would cause detriment if relied on. For companies, penalties for proposing, using or relying on unfair terms can be significant. The ACCC and ASIC are the key regulators in this area.

This doesn't mean every one-sided indemnity is automatically unlawful. It means broad standard clauses need to be justifiable and carefully drafted, especially if you're dealing with smaller contractors or customers.

How Should A Liability Cap Work In A Contractor Contract?

A liability cap should set a clear maximum amount each party may have to pay, while carving out risks that genuinely need higher protection.

An indemnity tells you what losses are covered. A liability clause tells you how far that responsibility goes.

Common liability cap options include:

• a fixed dollar amount
• the fees paid or payable under the contract
• a multiple of the fees, such as two or three times the fees
• the fees paid in the previous 6 or 12 months for ongoing services
• the amount recoverable under the relevant insurance policy

The right cap depends on the value of the contract, the type of services, the likely loss if something goes wrong, and what insurance is available.

For a low-risk marketing retainer, a cap equal to 12 months of fees may be workable. For a contractor handling customer data, critical software or site safety risks, you may need a higher cap or specific carve-outs.

What Should Be Uncapped?

Some risks are often excluded from the liability cap because a capped amount may not be enough to protect your business.

Common carve-outs include:

• fraud
• wilful misconduct
• intentional breach of confidentiality
• intellectual property infringement
• privacy breaches and cyber incidents
• personal injury or death caused by negligence
• property damage caused by negligence
• unpaid fees or payment obligations

You don't need to make every carve-out uncapped. For example, privacy and cyber liability might be capped at the amount of cyber insurance the contractor is required to hold. The aim is to match the risk with a realistic recovery pathway.

What About Consequential Loss?

Consequential loss should be dealt with clearly because the phrase can be interpreted differently depending on the contract and circumstances.

Instead of relying on vague wording, it's usually better to say exactly what is excluded or included. For example, you might exclude loss of profit, loss of revenue and loss of opportunity, but still allow recovery of third party claims, reasonable rectification costs and direct costs of fixing the problem.

Clear wording helps both sides understand the real commercial deal.

What Insurance Should Sit Behind The Indemnity?

The insurance should match the risks the indemnity is asking the contractor to carry.

An indemnity is only useful if the party giving it can actually meet the claim. That's where insurance becomes practical.

Depending on the services, you may want the contractor to hold:

• public liability insurance: for personal injury and property damage claims
• professional indemnity insurance: for professional advice, design, consulting or errors in services
• cyber insurance: for data breaches, cyber incidents and related response costs
• product liability insurance: where goods, products or supplied materials are involved
• workers compensation insurance: where the contractor has employees, noting requirements are state and territory based
• plant, equipment or motor vehicle cover: where vehicles, tools or machinery are used

Your contract should say:

• what policies the contractor must hold
• the minimum cover required
• when they must provide certificates of currency
• how long cover must be maintained
• whether subcontractors must hold equivalent insurance
• what happens if insurance is cancelled or materially changed

Don't assume insurance covers every indemnity. Many policies exclude contractual liabilities that go beyond what the contractor would have been liable for under general law. This is a big reason to avoid indemnities that are broader than fault.

You should also remember that an indemnity doesn't remove your own legal duties. For example, under work health and safety laws, you may still have duties to workers, contractors and others at your workplace even if your contractor agrees to indemnify you. You need both good contract wording and safe systems in practice.

How Do Indemnities Work With Subcontractors?

A subcontractor indemnity should flow the right obligations down to the subcontractor without letting the main contractor off the hook entirely.

If you engage a contractor and allow them to use subcontractors, your business will usually want the main contractor to stay responsible for the subcontractor's work. Otherwise, you may be left chasing someone you didn't choose and may not have a direct contract with.

Your agreement can deal with this by saying the contractor:

• must get your consent before using subcontractors
• remains responsible for all subcontractor acts and omissions
• must make sure subcontractors comply with confidentiality, privacy, WHS and IP obligations
• must ensure subcontractors hold suitable insurance
• must indemnify you for loss caused by subcontractors to the same extent as loss caused by the contractor

If you're the head contractor hiring subcontractors, you need your subcontractor agreement to reflect your obligations to the end client. This is often called a flow-down arrangement.

For example, if your client requires you to keep customer data confidential, maintain cyber insurance and meet certain security standards, your subcontractor should have matching obligations if they will access that data.

Templates often miss these flow-down details. A subcontractor agreement works best when it's matched to the head contract, the actual services and the risks on the job.

What Else Should Your Contractor Agreement Cover?

Your contractor agreement should cover the full working relationship, not just the indemnity and liability clauses.

An indemnity is only one part of the risk picture. You should also make sure the contract clearly deals with:

• scope of work: what the contractor is doing, what is excluded, and any milestones
• fees and payment: rates, invoicing, expenses, GST wording and late payment rights
• timeframes: delivery dates, dependencies and what happens if either party delays
• standards: quality requirements, service levels and acceptance testing if relevant
• Australian Consumer Law: obligations that may apply to services supplied to consumers, including some business customers
• intellectual property: who owns new materials, who can use existing materials, and licence terms
• confidentiality: what information is protected and how it must be handled
• privacy: how personal information is collected, used, stored and reported if something goes wrong
• termination: when either party can end the agreement and what happens on exit
• contractor status: wording that supports an independent contractor relationship, where that reflects the reality of the arrangement

If you're engaging an individual contractor, consider employee or contractor advice and don't rely on labels alone. Under the Fair Work Act 2009, calling someone a contractor won't fix the arrangement if the real relationship is employment. The contract should match how the work will actually be done.

This is also where practical contract management helps. Keep certificates of insurance, signed variations, project emails and approvals in one place. If there's a disagreement later, clean records can make it much easier to work out what happened.

Common Mistakes To Avoid

The most common mistake is treating indemnity wording as standard boilerplate when it's actually one of the most risk-heavy clauses in the contract.

Before you sign or send a contractor agreement, watch out for these issues:

• Using a blanket indemnity: avoid wording that covers every loss connected with the services, regardless of fault.
• Forgetting contribution: include wording that reduces liability to the extent the other party caused or contributed to the loss.
• Ignoring insurance exclusions: check whether the indemnity goes beyond what the relevant policy will cover.
• Leaving liability uncapped by accident: if there's no cap, exposure may be open-ended.
• Capping everything: some risks, such as fraud or wilful misconduct, may need to sit outside the cap.
• Not flowing obligations down to subcontractors: make sure subcontractors carry the obligations they need to carry.
• Copying a clause from another deal: indemnities should reflect the actual services, price, risk and bargaining position.

A well-drafted indemnity shouldn't feel like a trap. It should clearly answer: who caused the problem, what loss is covered, how much can be recovered, and what insurance sits behind it.

Key Takeaways

• An indemnity clause in a contractor agreement is a promise to cover certain losses if specified risks occur.
• The fairest indemnities are usually fault-based, using wording such as to the extent caused by breach, negligence or misconduct.
• Broad, one-sided indemnities can create excessive exposure and may raise unfair contract terms issues in standard form small business contracts.
• A liability cap should match the value and risk of the services, with clear carve-outs where needed.
• Insurance should support the indemnity, but you need to check the policy actually covers the risk being accepted.
• If subcontractors are involved, your agreement should flow down confidentiality, privacy, IP, insurance and safety obligations.

If you'd like help with your contractor agreements, liability caps, indemnity wording or subcontractor terms, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.