An indemnity is a contract by one party to keep another harmless
against loss. It transfers risk from one party to
another to compensate for loss. Some businesses assume that
throwing in a broad, boilerplate indemnity clause into a contract
will protect them from all potential losses. This approach is
ineffective. If you intend for an indemnity clause to be
enforceable it needs to be drafted clearly and effectively.
An indemnity clause can be altered in many ways. A clause may be
drafted to ensure that specific types of losses are claimable (such
as direct losses), to provide that the innocent party has a
specific obligation to mitigate losses or to exclude or include
How specific do indemnity clauses need to
Indemnities are often drafted widely in an attempt to cover
third parties and circumstances beyond the ordinary breach
circumstances available under the common law.
If you want to exclude all losses and liabilities, you will need
to use very clear and precise language. Courts have generally
construed that 'all losses' or 'all damages' are
too wide to be enforceable. If you are the indemnified party, you
should avoid drafting clauses too widely or risk
If a party is seeking to exclude consequential loss from
application in the contract, it is necessary to be specific and
define exactly what losses are excluded. Failure to define
'consequential loss' will leave the contracting parties
open to the risk of uncertainty because the court will determine
its 'plain and ordinary meaning'. It is worth
considering whether the exclusion of consequential loss applies in
favour of one or all the parties in the contract.
What should you do?
There is no strict interpretation for popular expressions such
as 'consequential loss' and 'indirect loss' at
All businesses, when drafting an agreement, should:
use clear headings to ensure the purpose of all clauses cannot
avoid vague expressions, particularly in exclusion clauses.
state how you want the clause to apply; and
remain aware of legal decisions that may impact potential
The key to drafting an effective indemnity clause is to
understand what the underlying risks are and to be as specific as
possible. Indemnity clauses deserve to be treated as more than a
'boilerplate' provision if you want to successfully protect
your business from unwanted risks.
What should you consider?
Besides making sure that indemnity clauses are clear and
specific, you should consider some of the following questions about
the nature and implication of indemnities in the specific contract
to ensure the contract reflects your intentions:
Is the indemnity in favour of one party to the contract or are
the indemnities mutual?
Is the obligation to indemnify extended beyond the parties to
the contract? For example, the related parties of the indemnified
Are there any exemptions from liability?
Are there any limitations of liability and are those
Does the indemnified party need to incur costs and liabilities
before seeking recourse pursuant to the indemnity?
Is there a time frame for exercising any of the indemnities
(particularly in a share sale agreement)?
Does your insurance cover protect you for the risks that have
been shifted to you pursuant to the indemnity clause?
Drafting a clear and effective indemnity clause and considering
related issues may appear burdensome. However, the consequences of
a poorly drafted indemnity clause are dire, particularly if the
balance of the agreement does not level the playing field. A
well-drafted indemnity clause helps parties avoid contractual
disputes and the costs associated with interpretation by the court
of the indemnity's scope and liability.
 Yeoman Credit Ltd v Latter (1961) WLR
828  Environmental Systems Pty Ltd v Pearless Holdings
Pty Ltd  VSCA 26
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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Businesses should review their standard form contracts for unfair terms to ensure they do not fall foul of the new laws.
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