20th August 2018

Indemnities – Are they essential?

Indemnities are contractual promises to reimburse another party, on a pound for pound basis, in respect of a specific type of liability, should that liability arise. They are used in contracts as a way of allocating certain types of risk between the parties. Think of them as ‘sit up and take notice’ provisions – whether you are considering giving an indemnity or looking to receive the benefit of one, their inclusion in a contract requires your particular focus and attention.

Indemnities are contractual promises to reimburse another party, on a pound for pound basis, in respect of a specific type of liability, should that liability arise. They are used in contracts as a way of allocating certain types of risk between the parties. Think of them as ‘sit up and take notice’ provisions – whether you are considering giving an indemnity or looking to receive the benefit of one, their inclusion in a contract requires your particular focus and attention.

Receiving an indemnity

Being in receipt of an indemnity is a strong measure to protect you from a specific liability caused by another party’s actions, whether from a breach of contract, fault, negligence or another specified action.

For example, imagine you engage a software developer to work on new software for your business. You may be concerned that, if the developer uses software that infringes another party’s IP rights, you will be exposed to claims from the owner of those rights. By including an IP rights indemnity in the software development agreement, you can seek compensation on a pound for pound basis should you face such a claim.

Indemnities are used in a wide variety of contexts and are not limited to commercial contracts. For example, in a share purchase agreement, the buyer might seek indemnities relating to the particular risks of purchasing that specific company, often in relation to tax liabilities. In property transactions, a landlord might identify certain risks posed by a specific tenant and ask to be indemnified against those risks. If your business outsources key functions, such as payroll or HR, you might wish to seek an indemnity in relation to losses resulting from any data protection breach regarding the personal data of your staff. An indemnity might also be sought to cover losses arising from a breach of confidentiality provisions which result in the disclosure of sensitive and valuable information.

How effective are indemnities as a way of managing risk?

Although indemnities are useful tools to have in your favour, they are not a magic solution to every risk.

The effectiveness of an indemnity depends on the party you receive it from. It is sensible to undertake due diligence on any party you are considering contracting with, from both a financial and reputational perspective.

Continuing with the example above, if the software developer would not be able to compensate you from a financial perspective should the worst happen, you would look to include a clause in the development agreement ensuring that the developer has appropriate insurance, and that your specific interest is named on their insurance policy. It is also possible – though potentially costly – to take out your own insurance against such risks.

It is a matter of weighing up the risks and potential cost to your business if faced with a claim, against the cost of guarding against that risk as far as possible. Ensuring the relevant indemnities are included in the contracts your company enters into is a vital aspect of protecting the financial health of your business.

Giving an indemnity

If you are being asked to give an indemnity, take expert legal advice before agreeing, as you can be exposed to considerable financial risk. There are no general rules about whether or not to give an indemnity. It will depend largely on the nature of the contract and the contracting parties’ relative bargaining power. In general, a party who is in a stronger negotiating position is more likely to ask for an indemnity from the other party.

Consider whether it is reasonable to give the indemnity at all. For example, is it within your company’s control to protect against the risk in question, or are you likely to fall foul of circumstances you have no influence over? There are no hard and fast rules, but Thrings’ experienced team can review your particular circumstances and offer advice tailored to your business’ specific situation.

Limitations

Indemnities are often unlimited in nature, and often fall outside the usual contractual limitations of liability. Most contracting parties will not be in a financial position to give an uncapped indemnity. Negotiation is necessary, dependent on the particular nature of the risk in question, to enable both parties to agree whether an indemnity might be capped or otherwise restricted.

When looking to include an indemnity clause in a contract, ask the following questions:

  • What is the loss that a party might suffer?
  • What action would trigger the indemnity against that loss?
  • To what extent should the indemnity cover the loss suffered?

Appropriate indemnity insurance is a common method to manage contractual risk against indemnity claims, however you should always check both with your lawyer and insurance provider whether your cover is suitable for the risks in question.

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