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What’s in an indemnity anyway?

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There is a noticeable trend for the list of “indemnified” losses in IT and outsourcing contracts to be getting longer and longer. Our commercial/business colleagues and clients can see the lawyers get very hot under the collar in arguing about them, and yet it can be difficult to articulate quite why this is an issue, especially when the lawyers themselves may not have a common understanding of what an indemnity actually “means” in a contractual sense!

So is this all just a storm in a tea cup?

The answer is – of course – “maybe”.

To start, one needs to assess what the more “traditional” view may be as to the benefit that an indemnity clause may provide, as opposed to a pure damages claim. Without delving too much into the black letter law on this issue, it is that:

- with an indemnity claim, there is no need to show fault or negligence, necessarily; it suffices to show that the “trigger” for the indemnity has occurred;

- there may be an ability to recover all loss which causally flows from such trigger event, no matter how remote or indirect it may seem to have been; and

- there is no requirement for the indemnified party to show that it has mitigated or sought to reduce or minimise its loss.

Under English law at least, there is a perhaps surprising paucity of case law dealing with these issues and such cases as there have been are, in many respects, apparently contradictory, but it is at least arguable that the effects outlined above will apply. In laypersons language, therefore, the indemnity will have the effect of increasing the quantum of any potential claim.

However, that really only tells part of the story. The reality is that indemnities can either be given their intended “teeth” – or otherwise! – depending on  the detailed contract drafting contained in the final version of the Agreement in which they appear.  There are a number of core points to watch for in this regard, as follows:

  • What loss does the indemnity cover?  Eg does the clause itself fully describe (or limit) what loss can be claimed?  More generally, do the exclusions in any limitation of liability clause (including, for example, a general disclaimer of indirect/consequential loss) apply to cover loss claimed on an indemnity basis as well as damages claims?
  • Are there express carve outs?  This may not be as obvious as it seems.  For example, an IP indemnity may be expressed as applying to “all amounts paid by way of damages or in settlement to a third party claimant…” which then ignores the fact that the primary loss the indemnified party may have suffered is its own internal costs associated with having to deal with the infringement claim (which might for example include the costs of having to procure replacement services or systems).
  • Is the indemnity a “sole remedy”?  This may not initially seem to be a problem if – as may be the case with an IP indemnity – the indemnity is also expressed as sitting outside the limits of liability (i.e as an unlimited loss).  However, as the preceding bullet point amply demonstrates, it can in fact be a major problem if the indemnity itself only covers a fraction of the loss which the indemnified party may suffer as a result of the event in question (and in respect of which it may then wish to retain a right to sue for damages).
  • Do the limits of liability apply?  It is a misconception to believe that limits of liability set out in the contract automatically do not apply to loss simply because it is expressed to be recoverable on an indemnified basis; it is instead purely a matter of contract drafting as to whether the limits of liability apply to indemnified losses as well as losses claimable on any other basis.  Again, care must be taken in this regard; indemnified loss might for example be more “accidentally” excluded from the cap on liability if the cap is expressed as applying to “any and all damages payable under the Agreement…” (my emphasis added!).
  • Must the loss be mitigated?  A source of conflicting case law… but often in any event circumvented by slipping in an express obligation to mitigate all losses arising, but equally often with such obligation being “hidden away” in the boilerplate provisions so as to avoid any express linkage to the indemnity provisions!

So, the moral of the story is to tread carefully where indemnities are concerned, but to ultimately be guided primarily by what the contract says that they mean, rather than what you might otherwise have concluded!

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