Indemnity Clause in the Contract

An indemnity clause plays a vital role in the managing the risks which are associated with the commercial transactions which protects against the effects of the contractual default or negligence by the other party. Basically, the general approach is to seek an indemnity which will protect a party to the maximum possible extent against the liabilities which arise from the actions of the other party. While drafting the contract, the indemnity clause must be carefully examined by the parties because the interpretation of the indemnity and the manner in which operated may be very different to which the parties thought of agreeing to the contract.

There are six types of indemnity clauses which provide the scope and operation, including:

  1. Bare Indemnities
    In such type of contract, the Party A indemnifies Party B for all the liabilities or losses which are incurred in connection with the specified events or circumstances, but without specifying the limitations. Such indemnities will remain silent as to whether the party indemnifies the losses arising out of Party B’s own acts or omissions and can be interpreted in a way to have the effect of a reverse indemnity.
  2. Reverse or Reflexive Indemnities
    Party A indemnifies Party B against the losses incurred as a result of its own acts and omissions because of Part B’s negligence.
  3. Proportionate or Limited Indemnities
    These indemnities are considered to be the opposite of Reverse Indemnities. The Party A indemnifies Party B against losses except those which are incurred of Party B’s own acts and/ or omissions.
  4. Third Party Indemnities
    Party A indemnifies Party B against liabilities to or claims by Party C.
  5. Financing Indemnities
    Party A indemnifies Party B against losses incurred in case the Party C fails to honour the financial obligation (i.e. the primary obligation) to Party B (most often these are fixed with a guarantee),
  6. Party/ Party Indemnities
    Each party to a contract indemnifies the other(s) for losses occasioned by the indemnifier’s breach of the contract.

Scope of Indemnity

Generally the indemnity clauses are drafted too widely seeking to cover third parties and circumstances beyond the ordinary breach circumstances actionable under the common law. In some circumstances, the indemnity clauses also seek to apply even when there is no breach of contract by the party. the very god example of indemnity is the guarantee in which one party indemnifies another party for the act, default or breach of a third party. Indemnities in these circumstances can therefore extend into unintended onerous obligations which the common law would not otherwise impose.

It is not uncommon for a party with the most commercial influence and bargaining strength in respect of a project, particularly where the project is large or risky, to insist on indemnities from other participants. Such indemnity clauses are often drafted in the broadest possible terms. The adoption of broad-ranging indemnities is not always, however, the best tool for achieving risk apportionment.

Ambiguity in the drafting of an indemnity clause presents a risk that the indemnity will not be held to cover losses, which they expected it to cover. Ambiguity is also a risk to the indemnifier that it will be held to cover losses that were not within their contemplation.

It is important to take care in commercial negotiations to confine and document the intended scope of the indemnity being negotiated and to identify precisely what is sought to be achieved economically.

Duration of Liability

Another significant issue surrounding the utility of an indemnity clause is the extended time for which it may remain available for enforcement compared to a claim for breach of contract. Statutes of Limitation exist in all states and territories of Australia that limit the time by which a claim must be brought for breach of contract. Normally, the period is 6 years for an ordinary agreement, commencing from the date of the breach.

It is critical to understand that the limitation period in relation to an indemnity clause starts from the date on which the indemnifier refuses to honour the indemnity. The indemnified party would then have a further 6 years from that date within which to bring legal proceedings to enforce the indemnity. Consequently, an action on the indemnity to seek recovery of its loss may be brought many years after the right to bring damages for breach of contract has expired. In most instances, parties granting indemnities are not adequately advised of this potential impact and the extended period of risk they are assuming as part of their indemnity obligations.

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