Loss Prevention Alerts

ALERT 30:  The problems with indemnities

This loss prevention alert has been produced by the Loss Prevention Working Group (LPWG) of the AGS. It highlights issues that the LPWG considers may be of relevance to members. It is not intended to provide a definitive response to any issues and before taking action members should consider carefully whether they need to seek independent legal advice.

The problems with indemnities Recently, the AGS Loss Prevention Working Group has considered a number of issues relating to indemnities sought by clients employing both contractors and consultants. It may well be that a number of AGS members are executing contracts containing indemnities without a full understanding of the implications. The purpose of this note is to set out some of the issues that arise when indemnities appear in appointments or collateral warranties, some of the ways clients and their agents seek to persuade members to sign up to indemnities and the arguments that might be adopted to resist any pressure brought to bear during negotiations. 

The first point to note is that indemnities are contract terms and therefore much depends on how they are worded. Some indemnities are less onerous than others, but in the vast majority of cases even the least onerous indemnities are included to give the party seeking to be indemnified some protection over and above that which he would normally have under the normal rules of recovery for breach of contract. 

For example, in one contract we have recently seen an indemnity that provides as follows: 

"At all times the Applicant must indemnify the Authority against liability for claims, losses or damages, including claims by the Applicant, whether arising as a result of any failure by the Applicant or the Applicant's contractors to comply with the requirements of this contract, or as a result of any act, failure, inadequacy, omission, negligence or default by the Applicant or the Applicant's contractors in designing or carrying out the work." 

The first worrying point to note about an indemnity is that its operation is effectively unlimited in time. It does not matter when the claim, loss or damages arises; whenever a loss arises that is covered by the indemnity any person with the benefit of the indemnity can claim under it. The limitation issue only arises because, should the person obliged to indemnify fail to pay, the person claiming will then have six years (12 years if the contract is executed as a deed) to sue for breach of contract. Accordingly, indemnities breach one of the basic principles of good risk management; that a party to a contract should attempt to limit the period in which claims against him can be brought for breach of contract. 

Under the general rules of contract, a party in breach can only be liable for the damage which he could reasonably have contemplated at the time he entered into the contract that the other party would suffer as a result of that breach. In practice, this operates as an important limitation on the damages that can be claimed. It prevents a party from claiming damages which quite unusually and perhaps unforeseeably flow from the other party's breach of contract. However, an indemnity, depending on how it is drafted, will often subvert this basic principle so that, provided the claim, loss or damage arises as a result of the matters identified in the indemnity, the indemnity will trigger to the full extent regardless of whether the person indemnifying could reasonably have foreseen that his breach would give rise to the damage complained of. 

The example indemnity set out above subverts another basic principle of risk management; that consultants and contractors should avoid wherever possible agreeing strict, fitness for purpose obligations but should see to it that they can only be liable on proof of their negligence. Under the indemnity above, the obligation to indemnify arises not just upon the party indemnifying's negligence or inadequacy but also as a result of any act or omission of theirs and it might well be possible that the courts would construe this as entitling a party to be indemnified even though they did not commit a negligent act.

From discussions with AGS members, particularly with those who raise queries via the AGS hotline, it seems that many are misunderstanding the reasons for including an indemnity in the contract. A client or client's agent will often say that without an indemnity the client will have no right of recourse in the event the client suffers loss as a result of some negligence or other breach of contract by the consultant. This is simply not true. A contract is, by definition, an agreement the courts will enforce by making an order that any party to it who suffers loss as a result of a breach committed by another will be entitled to make a claim. No indemnity clause is needed for the contractor or consultant to bear financial responsibility for their failures or other breaches of contract. 

Further, it must be said that consultants and contractors often undermine their own position by seeking to require their clients to indemnify them under their own standard terms of appointment. In such a case, it is difficult to refuse a request by a client to incorporate a counter-indemnity. 

Although there are occasions where the inclusion of indemnities is entirely appropriate in the vast majority of cases both client and consultant/contractor would be better advised to rely on the ordinary rules of contract which entitle an innocent party to claim as damages any loss he has suffered which flows reasonably from the other's breach of contract. Indemnities can create intolerable risks by subverting the principles of foreseeability, limitation and, in certain cases, by incorporating within them concealed fitness for purpose obligations.

Prepared for the AGS by Steven Francis, DLA

Date of Issue: 10 January 2005