A recent costs decision of the Employment Court, George v Auckland Council, looked at the employer's obligation to reimburse an employee her legal costs and expenses under a contractual indemnity clause in the employment agreement.

Former employee Laura George took the Auckland City Council to task and received $70,000 more than she might ordinarily have been entitled because of the indemnity clause in her contract which was so broad it covered a situation where it legitimately (albeit unsuccessfully) made a claim against its employee for breach of her employment agreement.

Ms George was a senior council employee who was dismissed in 2010 for breaching the Council's recruitment policy and then lying about it during the disciplinary process. She raised various personal grievances arising from the dismissal but was unsuccessful. As part of that litigation, the Council counterclaimed that Ms George had breached her employment agreement by failing to implement external tax compliance advice. This exposed the Council to significant risk of being penalised and/or prosecuted by IRD.

The Council was equally unsuccessful with its claim and the parties each made a claim for costs against the other.

Protracted litigation ensued with several interim applications and decisions issued before the substantive matters (Ms George's personal grievances and the Council's counterclaim) even went to trial. By the time the matter reached the Employment Court on the issue of costs, the Council had spent over $400,000 in legal costs on both claims and Ms George had incurred close to $200,000 in legal costs and expenses (over half of which had been incurred defending the counterclaim).

The primary principle of costs awards in any litigation is that costs follow the event. Basically, if you win you can recover some (not all) of the costs and expenses reasonably incurred in bringing or defending the claim in court. As a rule of thumb, in the Employment Court you might expect to recover two thirds of your actual and reasonable costs if you win. This is subject to the discretion to adjust costs where warranted. It is very rare that a successful party would be able to recover all the costs and expenses (indemnity costs) from the unsuccessful party.

This case was not one where either party was entitled to indemnity costs. However, as far as the Council's unsuccessful counterclaim was concerned, Ms George relied on a contractual indemnity contained in her employment agreement with the Council. She argued that the Council was contractually obliged to indemnify her for all the costs and expenses she incurred in having to defend the counterclaim. The indemnity clause provided:

"The [Council] shall indemnify the employee from and against all actions, claims, proceedings, costs and damages incurred or awarded in respect of or arising out of any act or omission or statement by the employee in the course of employment, provided that the indemnity shall not be available for wilful loss, or damage caused by the employee or where the loss or damage is as a result of misconduct or unlawful activity"

The Council accepted that Ms George was entitled to a contribution to her costs, having successfully defended its claim against her. However, it did not accept that she was entitled to an award on an indemnity basis under the terms of her employment agreement.

The Court took a different view. The Judge acknowledged that the parties are entitled to contract in this way and had done so when entering into the employment relationship. The counterclaim arose out of alleged acts or omissions by Ms George during the course of her employment with the Council. It was not established at trial that Ms George had acted wilfully or unlawfully so that the contractual indemnity did not apply. The Court held that, in those circumstances, the clause was effective and the Council was contractually bound to indemnify Ms George for any reasonable costs and expenses incurred by her in defending the counterclaim.

Having determined the indemnity applied, the Court assessed the extent to which Ms George's actual costs and expenses were reasonably incurred. It held that the vast majority of costs and expenses were reasonably incurred and ordered the Council pay Ms George $134,000 toward the costs and expenses she incurred defending the counterclaim.

Contractual indemnities in employment agreements are not uncommon. They are usually activated when an employee incurs costs in defending a claim made by a third party arising during his/her employment. In the absence of a contractual term, the common law implies a term into all employment agreements that an employee is entitled to be indemnified by their employer for liabilities and expenses when acting in the reasonable performance of his or her duties. However, this would only apply to claims made against the employee and/or the employer by a third party and not to claims made by the employer against the employee arising out of the employment relationship.

It was certainly not the Council's intention to indemnify Ms George in circumstances where it was making a claim against her, nor did the Council plan to cover any costs and expenses associated with such claim. However, that was the practical effect of the clause in Ms George's employment agreement. The contractual term went further than what might otherwise be implied at common law. Most notably it did not limit the scope or application of the indemnity to exclude certain types of claims and expenses.

Conclusion: Employers who provide an express contractual indemnity in favour of employees should consider the scope and the circumstances in which the indemnity is intended to apply.

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.