Australia: The dreaded indemnity clause

The indemnity clause is usually the most contested clause in any contract negotiation including in property transactions.

This is understandable.

After all, the ultimate effect of an indemnity clause is either to reaffirm or to alter the common law or statutory position in relation to the recovery of damages. This can be seen in various situations including leases and licences, transactions involving contaminated land and terms regarding incidents arising from the use of easements.

What is the basic premise of an indemnity clause?

Although it is often a point of contention, the basic premise of negotiating an indemnity clause is to determine which party is best placed to bear the risks associated with the matter at hand.

Most parties seem to forget this when they arrive at the negotiating table.

The importance of understanding the common law and statutory rights of recovery

In order to negotiate effectively in relation to an indemnity clause, it is imperative to understand the common law and statutory rights of recovery that apply to the situation in question.

This knowledge will allow you to negotiate effectively if you need to displace the risks and liabilities that the common law or statute place on either party.

For example, if the damages that you wish the other party to bear are too remote, then they may not be recoverable at common law so you may wish to provide for them explicitly in an indemnity clause.

Key issues to consider when drafting an indemnity clause

Types of losses

When drafting the indemnity clause, you need to consider what types of losses may arise in the context of your transaction.

Common areas that you may want an indemnity clause to cover may include:

  • Negligence
  • Injury or death
  • Infringement of intellectual property rights
  • Destruction or damage to property
  • Environmental issues such as contamination
  • Liability to a government department or authority
  • Legal costs.

Damages that are not foreseeable

One area of recovery that you may wish to include in an indemnity clause is for damages that would ordinarily be excluded due to the concept of remoteness.

Ordinarily, if the loss or damage wasn't contemplated by the parties at the time of contracting or is too remote, it may not be recoverable at common law (see: Hadley v Baxendale [1854] EWHC J70).

Nevertheless, an effective indemnity clause can extend the damages to include those that may be considered 'remote' or that were not contemplated by the parties at the time of the contract's formation.

Basically, you should consider what would be reasonable in the circumstances, so as not to prolong the negotiations.

Should the indemnity clause be 'absolute' or 'proportional'?

One issue you should always bear in mind when considering the scope of an indemnity clause is whether it should be 'absolute' or 'proportional'.

'Absolute' means that the party providing the indemnity bears all liability in relation to the matter at hand.

'Proportional' means that the risk is shared, depending on the circumstances.

A common proportional indemnity provision is one where the party provides an indemnity, but that indemnity is reduced proportionally to the extent that the indemnified party caused or contributed to the loss. This is common in contracts regarding property transactions. It could be drafted as follows:

The indemnity under this clause is reduced proportionally to the extent that the acts, defaults or omissions of the [indemnified party], its employees, contractors or agents caused or contributed to the loss of life, personal injury or damage to property.

In contrast, absolute liability in an indemnity clause would not include the carve-out above, which reduces the liability on a proportional basis. This means that the party providing the indemnity does so in an absolute way.

So, you have an indemnity clause, but can the other party deliver?

While an effective indemnity clause is often crucial to the transaction, it is also important to establish whether the party providing the indemnity is able to comply with the indemnity from a financial perspective.

An insurance policy may provide some comfort to the indemnified party, but you still need to analyse the terms of the insurance policy in order to determine whether there are any gaps that create potential exposure.

For example, in a lease, if you are the party being indemnified (this would be the landlord), you will want to know if there are gaps in the lessee's insurance policy and, if so, you would want to ensure that they have recourse to other funds should the indemnity be triggered (and the gaps are realised).

In short, the provisions of the insurance clauses in your contract are just as important as the indemnity clauses.

If you are the party providing the indemnity (in a lease this would be the lessee), you should show your insurer the clause in question to confirm and provide you comfort in knowing that your cover extends to all potential liabilities provided for in the clause.

If gaps are identified, it may be an appropriate time to extend your insurance cover either to minimise them or to eliminate them completely.

Knowledge of the parameters and limitations of your policy will assist you in your negotiations. It is possible that a point of contention in the indemnity clause is something for which you already have insurance coverage. Don't waste time arguing over something that doesn't even need to be an issue.

Finally, and most importantly, be aware that most insurance policies don't provide cover to a party that offers an absolute indemnity. In other words, to offer absolute indemnity is to put your insurance cover at risk.

How to approach negotiations

There are two steps you should take when approaching negotiations over an indemnity clause.

Step 1: Identify risks, liabilities or damages

Identify the real risks that may arise during the term of your contract, as well as the liabilities or damages that may occur. This may include risks that may be deemed remote at common law but which one party may have specified as being crucial to the deal.

Step 2: Determine the party best placed to wear those risks and liabilities

Determine which party is best placed to bear those risks and liabilities.

Every transaction may require different drafting, depending on the circumstances of the matter. For example, a short term lease over a small premises for a negligible rental will have different considerations to a lease over a large area, for a longer term or for a higher rental.

A few final words

If you are involved in negotiations over a contract that includes an indemnity clause, it will likely be the source of a great deal of discussion (and even frustration).

As a result, you should seek legal advice from the outset to assist you to identify the risks and liabilities, as well as to determine the most appropriate way to apportion them.

Finally, refer back to the fundamental question and ask: which party is best placed to bear the risks associated with the matter in question?

Would you like to find out more?

At Bartier Perry, our property team has extensive experience in contract negotiations and, more specifically, indemnity clauses. If you need assistance in this area, please don't hesitate to get in touch.

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