Indemnities are often one of the most heavily negotiated terms in a commercial agreement, but for non-lawyers their perceived advantages may not always be clear. In this short article we set out how indemnities may vary normal contractual rules, and why it is vital to draft indemnities clearly and precisely.

Firstly, what is a contractual indemnity? In simple terms it is a contractual provision under which a party promises to reimburse another party in relation to loss. There are notable advantages to include an indemnity provision in an agreement as the receiving party, however, these advantages can only be achieved by express and unambiguous drafting. This note will explore some of the key themes to consider when drafting and negotiating an indemnity.

(i) Remoteness

Ordinarily, a party cannot recover damages under a breach of contract claim for unforeseeable losses. However, an indemnity can be drafted so that a party can recover all of their losses, including losses that would be too remote to recover as damages. In practical terms, whether you are able to include such wording will depend on your bargain position under the agreement.

(ii) Causation

Although most indemnities cover losses that have been caused by a specified event, it is possible to draft an indemnity to pay out for non-causal losses too. This is in contrast to a breach of contract claim for damages where only losses that are caused by the breach can be recoverable as damages.

(iii) The duty to mitigate loss

Under common law, a party has an obligation to mitigate any loss suffered as a result of a breach of contract. However, it is possible to draft an indemnity so that a party is liable to pay for even reasonably avoidable losses. This can be achieved by express and clear drafting to incorporate liability for these losses. Again, in practical terms, whether or not you can include this provision may largely depend on the bargaining power of each party.

(iv) The extent of the loss

A particularly difficult aspect of negotiating an indemnity clause is how widely it should be drafted in terms of covering specific types of losses, for example, direct losses, indirect losses and/or consequential losses. These provisions must be clearly drafted so that there is no ambiguity as to what the indemnity does or does not cover. It is common to see parties push back on this provision and therefore discussions may be raised as to capping a party's liability in order to achieve an agreement.

(v) Contractual context of an indemnity

In the case of Wood v Capita Insurance Services [2017] UKSC 24, the Supreme Court interpreted an "opaque" indemnity clause in a Shareholders' Purchase Agreement ("SPA"). In order to do this, the court relied on other warranties in the SPA which covered much of the same ground as the indemnity provision but were more limited in the period of time and costs. It was held that the scope of the indemnity had to be considered within the context of the SPA. The court added that lawyers and judges should use textualism and contextualism as tools to interpret a contract in order to ascertain the meaning of the language within the agreement.

(vi) Summary

Indemnities, when drafted accurately, can provide a party with remedies not normally recoverable. It is evident that when drafting an indemnity provision it is crucial to get the wording right. However, it is also apparent that the entirety of the contract may be considered in order to see how well the indemnity clause matches up with the warranties provided, along with other relevant clauses. Of course, if you need any advice in drafting an indemnity we would be very happy to assist.

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.