Remedies for Breach, Stand Alone Contractual Obligations, or Both?
Contracts are the glue holding business relationships together—and indemnities are often the hidden duct tape keeping everything from falling apart, particularly if a third-party could get harmed. Yet, for many business executives, indemnities are shrouded in legal mystique. Are they remedies for breach? Are they standalone contractual obligations? Or are they something in between? Let's unravel this legal puzzle and see how indemnities play out in the real world of business.
So, What Exactly Is an Indemnity?
Think of an indemnity as a safety net in a contract. It's a promise by one party to compensate the other for specific losses or damages—whether those arise from third-party claims, breaches, or unforeseen events. Indemnities may be thought of the contractual equivalent of insurance (if a certain event happens, then someone else steps in to help protect you). You hope you never need to use them, but when disaster strikes, you're glad they're there.
Remedy or Obligation: The Great Debate
This is where things get tricky. Is an indemnity a remedy for a breach (like a refund or damages), or is it a standalone obligation, more like the duty to perform services or deliver goods? The answer, as with many legal questions, is: it depends.
Indemnities as Remedies
When indemnities are tied to breaches of contract or
non-compliance, they can look a lot like remedies. For example, if
Party A breaches its contract with Party B, causing Party B to face
a lawsuit from a third party. Party B can invoke the indemnity
clause to recover its legal costs.
Let's say Wile E. Coyote (Party A) breaches its contract with
Acme Corporation when attempting to use Acme's jet powered
roller skates to carry Bugs Bunny off a cliff. Because Acme's
contract has a clear prohibition on using its products to inflict
intentional harm, Wile E. Coyote is in breach. So, when Bugs sues
Acme Corporation, Wile E. Coyote must indemnify Acme.
In this scenario, the indemnity functions as a remedy for the harm caused by the breach. However, because it is tied to the breach, it may be subject to the same limitations as other remedies, such as liability caps or exclusions in the contract.
In our example, Wile E. Coyote's indemnity obligation to Acme may not fully protect Acme from all of its damages if the contract's limitation of liability provision caps the parties' respective liability to something less than the damages Acme incurred due to Bugs' lawsuit.
Indemnities as Contractual Obligations
Now, consider the scenario where Party A agrees to indemnify Party B against all claims arising from Party A's use of Party B's products—regardless of any fault or even misuse.
In this case, it doesn't matter if Wile E. Coyote's use of the rocket powered roller skates breaches the contract. Even if Wile E. Coyote's use of the skates is fully within the bounds of the contract, and he just happens to collide with Bugs while skating, without any fault on behalf of Wile E. Coyote, then if Bugs sues Acme, Wile E. must indemnify Acme.
Since the indemnity is a standalone obligation and is not triggered by a breach, it is now a simple issue of fulfilling a contractual promise, similar to delivering goods or performing services. Typically, this type of indemnity is not subject to limitations on liability, unless explicitly stated in the contract.
Poor Wile E. Coyote, who, this time, could arguably be required to fully indemnify Acme against all damages.
Why Does This Matter?
For business executives, understanding how indemnities are treated can mean the difference between managing risk effectively and walking into a legal minefield (and crippling costs and damages). Here are some key points to consider:
- Limitation of Liability: If the indemnity is treated as a remedy, it may be subject to the contract's liability caps, which may not be the intention of the parties. Alternatively, if it's a standalone obligation, those caps might not apply, even if the parties want them to —leaving the indemnifying party exposed to unlimited liability.
- Drafting Clarity: Ambiguity is the enemy of good contracts. It is important to clearly define whether the indemnity is a remedy or an obligation, and spell out how it interacts with other provisions, like limitation of liability.
- Negotiation Strategy: When negotiating contracts, the scope of indemnities deserves attention. Overly broad clauses can create significant financial exposure, while overly narrow indemnities may not provide sufficient protection. The key is to establish indemnity terms that can protect both parties without overburdening them.
Making It Relatable
Imagine you're a bakery owner, and your supply contract
includes an indemnity clause. If your flour supplier's product
turns out to be tainted, leading to customer complaints and
lawsuits, the indemnity may be your safety net, protecting you
against major costs and damages.
But, whether that net catches all the costs or just some of them
will depend on several factors, including how the clause was
drafted. If it's treated as a remedy for breach or negligence,
your recovery might be limited to any limitations in the contract.
If drafted as a standalone obligation, you could potentially be
fully protected against all costs, assuming, of course, the
supplier hasn't baked in exclusions!
Ultimately, the protection afforded by indemnity will depend on clear drafting capturing the intent of the parties, the applicable terms of the contract, and even applicable law which can impact the scope of indemnity obligations based on the jurisdiction, the facts leading to the indemnity, and the damages incurred.
So, in summary
Indemnities are powerful tools for managing risk, but their effectiveness depends on how they're drafted and interpreted, the facts and circumstances giving rise to the indemnity obligation and the applicable law. Are they remedies? Obligations? Both? The answer lies, at least in part, in the contract's wording and the parties' intentions. For businesses, the key is to work with a lawyer who understands not just the law but also your industry, strategy, and risk tolerance.
Because at the end of the day, a well-crafted indemnity is like a good umbrella: it may not be necessary when it's sunny outside, but keeps you covered when the storm hits — and nobody likes getting soaked.
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.
