Indemnity Clauses : Protection or Peril?

Indemnity clauses are ubiquitous in contracts of all kinds; from copier leases to multi-million (and billion) dollar deals, indemnity clauses are an integral part of a contract. No contract should be without one.

The purpose of an indemnity clause is to shift or allocate liability between the parties to a contract, and they are always, but not exclusively tied to the representations and warranties that the parties to a contract make to each other. For example, in an agreement to sell all of the assets of a business, the seller will represent to the buyer that the assets included in the sale are all of the assets “used and useful” in the operation of the business, and are all of the assets necessary to operate the business “in the manner in which it is currently operated”. If the assets are not as represented; if, for example, an essential item of equipment is not delivered, the seller would have to indemnify the buyer against its damages or losses, either with money damages, or by delivering the missing item of equipment.

Indemnity clauses protect the parties to a contract from breaches of the contract; from negligence, and from tortious conduct; conduct that is an intentional act or failure to act.

Indemnity clauses should be fair, triggered only when a breach is material. Fairness also requires that the liability of a party is proportionate to the gravity of the conduct or negligence that resulted in harm. Referring to the example above, it would not be “fair” if the seller was required to pay the cost of a new piece of equipment where the buyer could be made whole by the delivery of the missing item. An indemnity clause should be mutual. It is certainly not fair for an indemnity to run to one party only, essentially shifting all of the risk to that party.

In contracts for services, the liability of a party to the contract will often by capped at the contract price; a breach by a buyer might require the buyer to pay the entire contract price without regard to whether the seller had completed delivery of the services. Similarly, if a seller of services failed to deliver, the seller’s liability might be capped at the amount that the buyer had paid to the date of the breach.

The scope of an indemnity should always be limited only to matters that are within the control of the indemnifying party. Where an indemnifying party’s performance depends in part on a third party or conditions (such as weather) that are beyond the control of the indemnifying party, the indemnity clause should carve out an exception for those circumstances.

Depending on the type of contract and the relative bargaining power of the parties, drafting fair, mutual and balanced indemnity language can be tricky, but is well worth the effort.