Indemnity Clauses in Contracts

Risk minimisation is necessary for any successful business. Indemnity clauses, liquidated damages, warranties, exclusions and limitation of liability clauses are all mechanisms of risk allocation in a contract that require careful drafting to be effective and enforceable. When drafting a contract, consideration needs to be given to whether an indemnity is the best method of allocating risk and whether it is commercially necessary.

In Sunbird Plaza Pty Ltd v Maloney[1][i], the High Court described an indemnity as “a promise by the promisor that he will keep the promisee harmless against loss as a result of entering into a transaction with a third party. In Andar Transport Pty Ltd v Brambles Ltd[2], the High Court said that indemnities are designed to satisfy a liability owed by someone other than the guarantor or indemnifier to a third person.

Indemnities are one of the most negotiated risk allocation clauses during contract negotiations. Parties will negotiate and agree on a range of indemnities depending on the commercial context of the transaction and their respective bargaining positions. 

The key to an effective indemnity clause is to understand what the underlying risks are and to be as specific as possible. Indemnity clauses deserve to be treated as more than a ‘boilerplate’ provision if you want to successfully protect your business from unwanted risks.

Typically, the dominant party will attempt to enforce broad ‘boilerplate’ indemnity clauses to provide wide protection, whilst the non-dominant party in a weaker bargaining position will need to undertake vigorous risk assessment management procedures and negotiate where possible, a more reasonable position. There is no strict interpretation for popular expressions such as ‘consequential loss’ and ‘indirect loss’ at common law.

All good indemnity clauses should:

  1. use clear headings to ensure the purpose of all clauses cannot be misinterpreted;
  2. avoid vague expressions, particularly in exclusion clauses;
  3. explore the availability of insurance coverage for the risk likely to be covered by the clause if you are the party providing the indemnity;
  4. expressly state how the parties want the clause to apply;

Each party involved in negotiating an effective indemnity clause should also remain aware of legal decisions that may impact potential liability claims.

Regardless of whether your business is big or small, it is important that you understand how an indemnity clause works, and what liabilities and risks agreeing to one poses for your business. This is true whether you are a business owner, or someone negotiating a contract on your organisations’ behalf. There are some indemnity clauses that have the ability to void insurance, meaning that you may think they are “standard”, but you could unknowingly be exposing your business to high levels of uninsurable (and unquantifiable) risk which can have devastating impacts if the indemnities are called upon.

It is worth engaging a legal professional to get right the drafting of an indemnity right, or to provide you with the right advice around what risks the indemnity can have on your business. At Interpret Contracts, we have had years of experience reviewing, drafting and negotiating indemnity clauses and providing our clients with the right advice and protection. If you have a question about a contract or what your liability is under an indemnity clause, please contact us and one of our friendly staff can assist you with your enquiry.

Disclaimer: The material contained in this publication is of general nature only and not, nor is intended to be legal advice. If you wish to take any action based on the content of this publication we recommend that you seek professional advice.

[1] Sunbird Plaza Pty Ltd v Maloney (1988) 166 CLR 245 at 254; 77 ALR 205; 62 ALJR 195; (1988) Q ConvR 54-295.
[2] Andar Transport Pty Ltd v Brambles Ltd (2004) 217 CLR 424 at 437; 206 ALR 387; [2004] HCA 28.