“Indemnity” is not a word that comes up in normal conversation. However,  if you’ve ever read a commercial contract, you’ve probably seen an indemnity clause.

The indemnity clause is often one of the most important clauses in a contractual negotiation. 

So, let’s explore what it means and why lawyers care about it so much.

What Is An Indemnity Clause And How Does It Work?

An indemnity clause is all about allocating risk. It’s a guarantee to compensate for any losses caused by one party to another during the performance of the contract. 

If there is any damage arising from a contract, the parties would generally want to know:

  • What is the compensation for the damage?
  • Who has to compensate who?

In effect, an indemnity clause transfers the risk from one party to another. It’s like saying, “If this event happens, I’ll cover you for it”.

Indemnity clauses are often the source of heavy negotiation between contracting parties because the consequences that flow from a business risk could be dramatic. It could lead to things such as financial loss, legal proceedings and even a bad reputation. Therefore, you want to make sure an indemnity clause is working for you, not against you. 

What Is A Good Indemnity Clause?

A good indemnity clause protects your business as much as possible within the limitations of the law.

Commercial contracts are complex by nature, so it’s important to make sure your indemnity clause is drafted properly in light of the rest of the contract. This is the best way to save you from headaches and complications later on. 

It’s always best to seek a legal professional’s help when drafting an indemnity clause as these are always open for interpretation. 

How Will That Impact Me? 

Even if your indemnity clause seems right, the court may interpret it as ambiguous or different to your intentions. An ambiguous indemnity clause is a big red flag to the courts, and could lead to an adverse finding against your business. 

The wording is extremely important and must be catered precisely to the context of the contract. 

What Else Should I Be Looking Out For? 

Caps

It’s also important to keep an eye out for any caps that the other party may have placed on their liability. If the other party has capped their liability at a certain amount, the indemnity may not be sufficient to cover the whole loss and you may be out of pocket for any amounts above the cap.

Pour over the details because you don’t want to end up paying for someone else’s mistakes. 

Scope

Another thing to look out for is the scope of the indemnity clause – you want to avoid taking responsibility for risks that are beyond your business’ control. Indemnity clauses aren’t just there to protect you from getting damages, it’s also there to protect you in case something happens that you could not have prevented. 

If you do end up being liable for compensation to the other party, it’s important to make sure you only pay what you owe them and aren’t responsible for matters that were reasonably unforeseeable. 

Having an experienced lawyer draft your commercial contracts is the easiest way to ensure you’re getting a good deal for your business. If you’re worried about an indemnity clause and need help drafting or reviewing a contract you can talk to our contract experts at Sprintlaw.

When Is An Indemnity Clause Used?

An indemnity clause is commonly used in contracts for:

  • Supply of goods
  • Terms and conditions of services
  • Leases
  • Sale of property

This is not an exhaustive list – indemnity clauses are used in most commercial contracts!

What Can An Indemnity Clause Cover?

Since an indemnity clause is all about one contracting party paying compensation for the loss or harm of a third party, there are a range of areas to cover.

Some common areas are:

  • Negligence of a contracting party
  • Injury or death of a person related to the contract
  • Damage to property
  • Intellectual property rights
  • Legal costs and disbursements

Types of Indemnity Clauses

As mentioned above, each indemnity clause should be catered to the provisions of the contract it serves. Nonetheless, there are still certain types of indemnity clauses that are used widely in contracts. 

Proportionate Indemnities 

This occurs where one contractor covers the loss that has occurred as a result of their own actions when performing the contract. Their indemnification will be limited to the extent to which they contributed to the loss.

Example
Alyssa has agreed to paint Ben and Joan’s home. They have a contractual agreement that mentions time, pay, duties and an indemnity clause. 

While painting, Alyssa tries carrying the ladder towards an area to reach something. In doing so, she chips a wall with the ladder. 

Joan comes out to inspect it, and tries to do it instead. As she tries to adjust the ladder, she chips it even more, and causes serious scratches to the ladder, too. 

The proportionate indemnities clause in their contract limits Alyssa’s liability to the damage she caused, which is only the initial chip in the wall. Since the additional damage to the ladder was Joan’s doing, Alyssa is not liable to pay for that damage. 

Bare Indemnities

Bare indemnities will cover losses for particular circumstances. This is usually not limited to certain activities, but rather, covers the event that caused the loss as a whole.

Example
Mila pays Austin to drive a truck full of her potatoes across town to her customer. As he was driving her truck, Jack had an accident crossing the bridge. The potatoes didn’t fall into the water (thankfully), but the truck was slightly scratched. 

Mila tells Jack that he needs to pay damages for the scratch on the car. He argues that his liability should have only been limited to the potatoes (which turned out to be fine), but Mila reminds him that in the contract he signed, there was a bare indemnity clause. 

This is a blanket clause meaning that liability is not limited, but covers the set of damages or circumstances that occurred. As such, Austin is liable to pay for all the damages incurred to the truck as well. 

Hold Harmless Vs Make Good 

As you may have noticed, the indemnity clauses can fall into either one of two categories. 

Hold harmless essentially means once a loss or damage occurs that has been considered in the contract, the indemnifying party is in breach of the contract. 

Make good, on the other hand, is exactly what the term means.  The party that has caused the loss will need to rectify it as if the loss had never occurred. 

What to Take Away…

The scope and extent of an indemnity clause will always depend on the nature of your commercial contract and the risks involved.

Indemnity clauses shouldn’t be drafted or agreed to lightly. You should always seek legal advice before signing a contract to make sure you fully understand the effect of the terms.

If you would like a consultation on your options going forward, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.

About Sprintlaw

Sprintlaw is a new type of law firm that operates completely online and on a fixed-fee basis. We’re on a mission to make quality legal services faster, simpler and more affordable for small business owners and entrepreneurs.

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