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What Is The Point Of An Indemnity In A Contract and Can We Effectively Limit Our Exposure?

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Indemnities are becoming more prevalent in Customer contracts. The very wording surrounding an indemnity is enough to cause a lawyer to sweat it out over the very core of its meaning in our legal system let alone how Supplier’s might try to tackle this great unknown on their own. What are they, why have one, how are they used and how do you limit them effectively.

What and Why

Indemnities, simply put, is a promise to pay money on the happening of a specified event. Indemnities are given by the party responsible for a loss, or in a position to prevent it, to the party who will suffer the loss if it occurs.

There is no rule about when to give an indemnity, it is very much up to the negotiation powers of the parties as to when to include it and when to exclude it. That being said, if the Supplier is in a position where the Customer requires it to conform to internal requirements (such as indemnities given for data protection, confidentiality, breach of third party intellectual property rights) then the Supplier needs to be aware about how to minimise the impact of the indemnity to effectively get the parties to a reasonable and fair conclusion.

The current problem is that there are few cases which set out the meaning of what it is to give/receive an indemnity then lawyers will have believe.

How are they used

Below is an indemnity recently received by one of my Supplier clients:

“The Supplier shall indemnify and hold the Customer harmless from all claims and all direct, indirect or consequential liabilities (including loss of profits, loss of business, depletion of goodwill and similar losses), costs, proceedings, damages and expenses (including legal and other professional fees and expenses) awarded against, or incurred or paid by, the Customer as a result of or in connection with any alleged or actual infringement, whether or not under English law, of any third party’s Intellectual Property Rights or other rights arising out of the use or supply of the products of the Services (including the Deliverables)”

As the Supplier there are many issues with the above clause. Let’s take each part in turn:

“Hold the Customer harmless from”….

Garner’s Dictionary of Legal Usage concludes that ‘hold harmless’ and ‘save harmless’ both mean ‘indemnify’ therefore ask the question why the Customer wishes to use the additional words ‘hold the Customer harmless from…’ What is the purpose of this additional wording? Most lawyers may not understand why this is added given the circulation of pre worded templates. In English law, there is no established separate meaning for ‘hold harmless.’ I also ask the question, if the Customer doesn’t understand the additional insertion here, how am I supposed to convince my client’s stakeholders to accept these terms?

‘direct, indirect or consequential liabilities (including loss of profits, loss of business, depletion of goodwill and similar losses), costs, proceedings, damages and expenses (including legal and other professional fees and expenses)”

As the Supplier, you must be careful what your indemnities try to capture. Why is it that the Customer requires indirect or consequential loss? If this is not a direct action of the Supplier (which will naturally include the Supplier’s subcontractors and third parties) why should the Supplier be on the hook for this? Indirect action could come from something the Customer has inadvertently done. There is just not enough understanding of what indirect action really means to enable or convince a Supplier to accept this. If the Customer has a very good understanding of what indirect action could look like, then it’s important to define and agree the parameters around this. The other point here is to ensure we ONLY ever indemnify against direct losses and costs. This must be explicitly stated with a carve out that we also exclude indirect action. In terms of including legal and other professional fees and expenses along with the indemnity, again, I would attempt to negotiate these out on the basis that the Customer might be able to bring in a separate claim for this if it needs to and to let the Court decide if that is fair and reasonable at the time of the claim.

“any alleged or actual infringement”

What I advise my Supplier clients is to only ever accept actual infringement rather than any ‘alleged’ infringement. The purpose of the indemnity is to offer protection in the event something has gone wrong, not that it might go wrong or that someone has said it has. It must have proof and it must be directly caused by the Supplier.

“whether or not under English law”

We must be cautious here as to accepting other issues falling outside of our laws and jurisdiction. Other laws can offer contradictory settlements and cause confusion to the matter at heart. I would advise my Supplier clients to avoid accepting anything other than under English law.

Another point here which, though not shown in my example above, is included in many indemnity wording, is the use of holding harmless the Customer and its officers, directors, affiliates, third parties etc. I would question why is it that these categories of people need to be included in an indemnity when they are not party to the agreement itself. It’s a good way of limiting the Supplier’s exposure to an all-encompassing and wider reaching indemnity.

How to Limit your Indemnity Effectively

It is possible to limit a liability in one of two ways: (1) a limit on the indemnity itself; or (2) a general limit on liability under the contract. There is no general rule on whether a clause limiting liability applies to indemnities, it comes down to interpretation each and every time. An example of this is when limitations on ‘all claims arising under the contract’ could affect an indemnity claim since an indemnity is a contractual obligation to pay money. A limitation on ‘damages’ on the other hand, might incite controversy as to whether that indemnity created a liability to pay damages.

If parties want to achieve an unlimited indemnity plus a limited liability for other claims, the indemnity and cap need careful drafting to achieve this goal. For example, if a contract limits each party’s total liability to £5 million and also contains an unlimited indemnity against claims arising from events before the transaction, the receiving party recovers £7 million of losses under the unlimited indemnity. A claim then arises for damages for another breach. The new claim fails because the cap on liability has been used up.

What should have been made clear is that there should have been an unlimited indemnity and a total cap of up to £5 million for all other claims.

If you are going to seek a cap against indemnities, my advice is to ensure the cap is fair and reasonable against the type of damages a Customer might suffer as a result of any Supplier direct action. Simply putting a limitation of liability close to the agreed contract value might not adequately protect you in case of a claim and the courts might throw it out as a low balled amount. I normally advise my clients to cap such indemnities, relating to breaches of data protection, confidentiality, breach of third party intellectual property etc. close to their insurance amounts to ensure more enforceability.

Get in touch with one of the Law 365 team today to find out where your organisation stands in this new age of data protection laws.

“Law 365’s service engagement model is very flexible; essentially allowing the business to engage their legal services in a very cost effective manner and as needs dictate.”

– Jason Moody, Owner and COO at Convergent Network Solutions Limited

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