UK: Indemnities – Beware The Consequences Of "Reasonableness"

The provision of indemnities, particularly those provided to corporate trustees and agents, is an important feature of an effectively functioning structured finance market.  It enables the parties involved to allocate the risks of unforeseen expenditure to those parties with the ultimate economic interest in the transaction and allows trustees and agents to keep their fees at a reasonable level.

Whilst the need for indemnities is generally accepted, the terms on which they are provided can be an area of robust negotiation.

A recent case in the Commercial Court has highlighted the importance of carefully drafted indemnities, in a ruling which focused on the consequences of limiting attorney fees for which a party may recover under an indemnity to "reasonable attorney fees".

In the case, the Claimant, Euro-Asian Oil SA, contended that, as it had a letter of indemnity in place with the Defendant, Credit Suisse AG, it should be entitled to recover its legal costs in connection with a dispute, on an indemnity basis.  The Commercial Court however held that the Claimant could only recover its costs on the standard basis, as the letter of indemnity included a limitation as to the recovery of "reasonable attorney fees".

Specifically, the letter of indemnity provided that the Defendant would "protect, indemnify and to hold you [the Claimant] harmless from and against any and all damages, costs and expenses (including reasonable attorney fees) which you [the Claimant] may suffer by reason of the shipping documents...".  Claimant's counsel argued that the court should give effect to the parties' contractual agreement regarding attorney's fees and that the word 'including' was expansive and non-restrictive, meaning that, taking this into account with the provision for payment of 'any and all cost and expenses', the indemnity should be construed as a contractual basis for indemnity costs to be awarded.

Cranston J. disagreed, first distinguishing this case from the authority relied upon by the Claimant as the indemnity in that case did not include a limitation to "reasonable attorney fees", and, secondly, concluding that the result of the inclusion of the phrase "reasonable attorney fees" resulted in the contract not providing for indemnity costs "because they would not be reasonable". Consequently, the Claimant's contractual right to costs was confined to costs on a standard basis.

To grasp the import of this, a brief refresher on costs may be helpful.

In general, there are three ways such costs can be recovered.  First, following a clear contractual agreement (e.g. indemnity) the indemnifying party shall simply pay fees pursuant to the contract. However, if there is no such agreement or if such an agreement is unclear or the amount is disputed, separate legal proceedings will be required to determine how the costs of the dispute are to be borne. Where costs proceedings are initiated, the court will make its costs order on either the standard basis or on the indemnity basis.

When dealing with costs awarded in litigation, there is a presumption that costs will be assessed on the standard basis (the most common approach used by the Courts) and under it a judge will only allow the recovery of costs where they are proportionate, and either reasonably incurred or reasonable in amount. If there is any doubt about either the reasonableness or proportionality, the judge will give the paying party the benefit of that doubt.

However, in circumstances where, for example, a party's conduct during the proceedings is found to have been egregious, the other party may request that the court makes its order for costs using the "indemnity basis".  If the court agrees to make a costs order on this basis, there is no requirement that the costs incurred are proportionate and costs will only not be recoverable if the paying party is able to show that they have been unreasonably incurred or are unreasonable in amount.

In deciding any dispute as to the amount of costs payable pursuant to a contractual indemnity, the starting point will usually be that the costs payable under those contractual terms will be presumed to be reasonably incurred and reasonable in amount.  This is akin to an award of costs on the indemnity basis and might well result in the indemnified party recovering in full.  However, as the decision in the Euro-Asian Oil case emphasises, this is not guaranteed and the precise wording of the indemnity will be important.  In the Euro-Asian Oil case, for example, as explained above, the judge found that it would not be appropriate to award indemnity costs pursuant to a contractual indemnity for "reasonable attorney's fees" because indemnity costs are not "reasonable".  Therefore, the judge decided that the award would be for costs on a standard basis.

So, the result of the indemnity including the phrase "(including reasonable attorney fees)" can have significant consequences on the recoverability of costs.  If there is a dispute over the amount payable pursuant to an indemnity for "reasonable fees", the indemnified party might be put to the test of proving that the costs claimed are reasonable and proportionate.  This may result in a far smaller recovery than would have been the case if the word "reasonable" had not been in the indemnity.

This serves as a reminder of the importance of focussing on the terms of any transaction indemnity and explains indemnified parties' resistance to the inclusion of reasonableness qualifiers in their indemnities.

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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