UK: Mistaken Indemnity

Common Misconceptions In Contractual Promises
Last Updated: 24 October 2008
Article by Tom Coulson

An indemnity is a contractual promise by one party to make good a specific loss suffered by another. The indemnity entitles the indemnified party to a payment if the anticipated event does indeed take place. Simple enough? Yes and no.

A customer licenses software from a supplier. If the software should turn out to have been copied from a third party, the customer's use of the software will infringe the rights of that third party and the customer could end up being sued for damages. So the supplier provides the customer with an indemnity, protecting it by agreeing to cover any loss that might arise as a consequence of the uncertain copyright position. Problem solved.

When used correctly an indemnity can provide a simple remedy to a situation in which one party should not reasonably be expected to bear the burden of a particular loss from a specified event. But there are a number of popular misconceptions about indemnities which ensure that they are often misused.

Warranty vs. indemnity

One common confusion is the difference between an indemnity and a warranty. Both provide important contractual protections, but it is important to be aware of the differences.

A warranty is a contractual undertaking that a particular state of affairs exists. For example, one party to a contract warrants that it has taken all necessary action to authorise the execution and performance of its obligations under the agreement. Should that warranty turn out to be untrue, the other party has a claim for breach of warranty and might be able to recover damages for that breach. However to do so, it must show that (a) it has suffered a loss, and (b) the damage suffered is not too 'remote'. In other words:

  • the loss was a natural consequence of the breach, the type and extent of which a reasonable person would accept in the circumstances; or
  • at the time the contract was entered into, the loss was fairly and reasonably contemplated by both parties as the probable result of the breach (this would cover an unusual type of loss due to special circumstances known to the parties from the start).

Furthermore, under a claim for breach of warranty the injured party is under a duty to mitigate by taking reasonable steps to minimise the loss and not taking unreasonable steps to increase it.

An indemnity, on the other hand, is a promise to reimburse the other party in respect of a particular type of liability, should it arise. Unlike breach of warranty claims, a party does not usually need to show that the loss passes the 'remoteness' test, and nor does it have a duty to mitigate the loss. Thus an indemnity has clear advantages over a damages claim because it provides a 'guaranteed' remedy, on a pound-for-pound basis, for a defined loss.

Unfortunately parties frequently make the mistake of simply relying on the word 'indemnity' without clearly setting out what it means. This is done in the mistaken belief that because a provision contains the word 'indemnity' it will successfully protect against all losses that might flow from the indemnified event. The wise man reads on ...

Cap on liability

Is an indemnity by its very nature unlimited, so that it covers all losses that the injured party might suffer? No. It depends on the wording of the indemnity as well as on what the rest of the contract says. For example, the contract may well contain a separate limitation of liability clause which provides for specific caps on liability, which might look a bit like this: "Party X shall in no circumstances be liable to Party Y for any indirect or consequential loss or damages, and in any event, the liability of Party X to Party Y shall be limited to £1 million." Then, if a claim under the indemnity arises, unless the contract says to the contrary, the indemnity will be subject to these limitations both as to the scope and amount of the liability. If it is intended that no such limits will be placed on the amount or scope of the claim under the indemnity, then the remainder of the contract must be carefully reviewed and any conflicts or inconsistencies between the indemnity and the remaining provisions of the contract (including limitations of liability and exclusion clauses) must be resolved.

Sole remedy?

Is an indemnity the sole remedy available for the indemnified event? What happens where the parties have agreed a cap on the liability under the indemnity? For example, "Party X will indemnify Party Y against Party X's breach of contract up to £1 million."

An indemnity in relation to a breach of contract is actually an additional right to a common law breach of contract claim. So, in the above example, Party X's liability for breach of contract is not limited to £1 million; that limit applies only to claims under the indemnity. Instead of bringing a claim under the indemnity, Party Y could bring a claim for damages, which would not be subject to the cap. So the better approach from Party X's perspective would have been to include a provision along the following lines: 'Party X's total liability in contract, tort (including negligence or breach of statutory duty), misrepresentation, restitution or otherwise, howsoever arising, for any breach of contract, including under any indemnities, shall be limited to £1 million."

Indemnity for general breach of contract

Do the rules relating to remoteness of loss apply to indemnities, and is mitigation relevant? It is true that for many indemnities these restrictions do not apply, but care must be taken in relation to indemnities against general breaches of contract.

One of the most common indemnities seen in commercial agreements is as follows: 'Party X will indemnify Party Y for any loss caused to Party Y as a result of Party X's breach of this agreement.' The result being that should X breach the agreement, Y can ask X to cover the losses it has suffered.

There are few cases specifically on this issue, but those that there are suggest that the courts will not automatically assume that by including a provision in these terms the parties have indicated their wish to exclude the rules against mitigation and remoteness. So, where a contract provides an indemnity against losses arising from an ordinary breach of contract, it is unlikely that the courts will automatically hold that the indemnity covers all conceivable losses, and it is also likely that the party with the benefit of the indemnity will be required to mitigate its loss. It is certainly possible for an indemnity against breach to cover all conceivable loss, but if this is the intention the contract should say so expressly, perhaps like this: "Party X shall indemnify Party Y (who shall have no duty to mitigate) for all losses, damages, costs, claims or expenses of whatsoever nature and howsoever caused (including any indirect or consequential loss) arising out of or in connection with a breach by Party X". Obviously Party X should be very wary of agreeing to any such indemnity!

Indemnity for express obligation to make a specific payment

So far our discussion has focused on indemnities against breaches of contract. The position is different in respect of a breach of an express obligation to make a payment. Such indemnities are characterised as claims in debt. Consider the following indemnity: 'Party X shall indemnify Party Y from and against any losses suffered or incurred by Party Y arising out of or resulting from any regulatory fine, award, or penalty levied on Party Y.' The courts have held that an indemnity such as this is a debt claim and so the mitigation rules do not apply. Similarly, since what is claimed is a quantified debt rather than damages, the rules relating to remoteness of loss do not apply either.

Conclusion

So what are the key "takeaway" points?

  • Firstly, an indemnity for a specific sum due on the happening of an event is not a claim in damages, so mitigation and other principles relating to the assessment of damages do not apply.
  • Secondly, where the indemnity is for a general breach of contract by the indemnifier, the default position is that rules relating to remoteness of loss and an obligation to mitigate will apply. If the parties intend to include unforeseen losses, and to exclude the duty to mitigate, they need to expressly say so in the contract.

And finally, remember: the word 'indemnity' is not possessed of magical' properties. To work properly it is important that any indemnity is drafted in the context of the rest of the agreement.

www.lg-legal.com

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.