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.
In this article, we consider how to mitigate risk through indemnity clauses and the importance of drafting good indemnities clauses so that they are beneficial and enforceable. Indemnity clauses allocate risk as one party agrees to cover particular loss and damage suffered by another. They often deal with issues such as negligence by a party, non-performance, environmental risk, litigation and product liability.
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. Typically, the dominant company 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.
Benefits
Indemnity clauses are beneficial because they can be used to recover damages beyond common law losses. A well-drafted indemnity clause can provide the indemnified party with significant advantages, including:
- No obligation to mitigate loss: An indemnity provision may remove the requirement for the innocent party to mitigate loss resulting from a breach of contract, subject to all the other terms of the agreement. This means that the indemnity compensates the party for all losses suffered without the indemnified party needing to take any reasonable steps to reduce their loss.
- Statutory limitation period: Indemnity clauses can be drafted so that the six year limitation period to bring a claim forward starts from the date on which loss was incurred, rather than the date the contract was breached. This means the limitation period of an indemnity can extend beyond the expiry of the contractual limitation period.
- Remoteness of damage: An indemnity clause may permit the aggrieved party to recover damages that the common law would regard as too remote. The requirement to prove causation for relevant losses can be excluded by an indemnity clause that indemnifies one party for all losses, rather than loss suffered in connection with the contract.
Enforceability
Indemnity clauses can be an effective risk allocation tool but their effectiveness will depend on how well they are drafted. Indemnities can be altered in many ways, such as ensuring that certain types of losses are claimable (such as direct losses or loss of profits) or that an innocent party has a specific obligation to mitigate losses.
Indemnities will be enforceable in the absence of uncertainty, statutory prohibition or public policy considerations. One example of statutory exclusion is section 23 of the Schedule 1 of the Competition and Consumer Act 2010 (Cth) which incorporates the new amendments to the unfair contract terms for small business. The effect of this section is that if an indemnity clause is deemed to be ‘unfair’ it will be void in standard form contracts entered into by small businesses that employ fewer than 20 persons. This will apply to contracts with an upfront price payable of $300,000 (or $1 million for contract lasting more than 12 months).
Tips
To properly minimise risk through indemnity clauses, businesses may take these preliminary commercial steps:
- when drafting a contract, consider whether an indemnity is the best method of allocating risk and whether it is commercially necessary;
- assess whether the risks are manageable and whether the benefits outweigh the risks;
- explore the availability of insurance coverage for the risk likely to be covered by the clause if you are the party providing the indemnity;
- understand that indemnities should be treated as more than just a ‘boilerplate provision’; and
- indemnity clauses can be carefully and creatively drafted to ensure that they are enforceable to the extent that the law permits.
