Risk minimisation is necessary for any successful business.
Indemnity clauses, liquidated damages, warranties, exclusions and
limitation of liability clauses are all mechanisms of risk
allocation in a contract that require careful drafting to be
effective and enforceable.
In this article, we consider how to mitigate risk through
indemnity clauses and the importance of drafting good indemnities
clauses so that they are beneficial and enforceable. Indemnity
clauses allocate risk as one party agrees to cover particular loss
and damage suffered by another. They often deal with issues such as
negligence by a party, non-performance, environmental risk,
litigation and product liability.
Indemnities are one of the most negotiated risk allocation
clauses during contract negotiations. Parties will negotiate and
agree on a range of indemnities depending on the commercial context
of the transaction and their respective bargaining positions.
Typically, the dominant company will attempt to enforce broad
'boilerplate' indemnity clauses to provide wide protection,
whilst the non-dominant party in a weaker bargaining position will
need to undertake vigorous risk assessment management procedures
and negotiate where possible, a more reasonable position.
Indemnity clauses are beneficial because they can be used to
recover damages beyond common law losses. A well-drafted indemnity
clause can provide the indemnified party with significant
No obligation to mitigate loss: An indemnity
provision may remove the requirement for the innocent party to
mitigate loss resulting from a breach of contract, subject to all
the other terms of the agreement. This means that the indemnity
compensates the party for all losses suffered without the
indemnified party needing to take any reasonable steps to reduce
Statutory limitation period: Indemnity clauses
can be drafted so that the six year limitation period to bring a
claim forward starts from the date on which loss was incurred,
rather than the date the contract was breached. This means the
limitation period of an indemnity can extend beyond the expiry of
the contractual limitation period.
Remoteness of damage: An indemnity clause may
permit the aggrieved party to recover damages that the common law
would regard as too remote. The requirement to prove causation for
relevant losses can be excluded by an indemnity clause that
indemnifies one party for all losses, rather than loss suffered in
connection with the contract.
Indemnity clauses can be an effective risk allocation tool but
their effectiveness will depend on how well they are drafted.
Indemnities can be altered in many ways, such as ensuring that
certain types of losses are claimable (such as direct losses or
loss of profits) or that an innocent party has a specific
obligation to mitigate losses.
Indemnities will be enforceable in the absence of uncertainty,
statutory prohibition or public policy considerations. One example
of statutory exclusion is section 23 of the Schedule 1 of the
Competition and Consumer Act 2010 (Cth) which incorporates the new
amendments to the unfair contract terms for small business. The
effect of this section is that if an indemnity clause is deemed to
be 'unfair' it will be void in standard form contracts
entered into by small businesses that employ fewer than 20 persons.
This will apply to contracts with an upfront price payable of
$300,000 (or $1 million for contract lasting more than 12
To properly minimise risk through indemnity clauses, businesses
may take these preliminary commercial steps:
when drafting a contract, consider whether an indemnity is the
best method of allocating risk and whether it is commercially
assess whether the risks are manageable and whether the
benefits outweigh the risks;
explore the availability of insurance coverage for the risk
likely to be covered by the clause if you are the party providing
understand that indemnities should be treated as more than just
a 'boilerplate provision'; and
indemnity clauses can be carefully and creatively drafted to
ensure that they are enforceable to the extent that the law
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Do not depart from the contract terms, or encourage the other party to do so, unless you plan to alter the contract.
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