02/01/2017, 10:41:AM

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What is an indemnity clause in a contract?

What is an indemnity clause in a contract?

 

An indemnity is a promise to keep another person free from harm or to ensure that the person suffers no loss arising out of a particular circumstance. As example, an indemnity given in connection with a loan is a promise to ensure that the creditor suffers no loss arising out of the transaction with the debtor. 

 

An indemnity clause on the other hand is releasing and satisfying liabilities. There are two types of indemnity clauses contained in most contracts with four types of indemnity. One type of indemnity clause operates to release the liability of the indemnified party to the indemnifying party. The purpose of this type of clause is to prevent the contracting party from becoming liable for loss which they may cause to the other contracting party. The second type of indemnity clause is a promise by the promisor to keep the promisee harmless against the loss as a result of entering into the transaction with a third party. This type of clause is designed to satisfy a liability owed by someone other than the guarantor or indemnifier to a third person. The four types of indemnity include: bare indemnity, reverse or reflective indemnity, proportionate or limited indemnity, and third party indemnity. 

 

While parties are free to allocate risk of loss in a contract as they consider fit, relying on a standard indemnity boilerplate clause is not practical, as such clause should be carefully drafted for the specific requirements of the parties. A practical issue with such clauses is that the indemnifier needs to be able to indemnify if the indemnity is called upon. Indemnity clauses which are framed in general terms can later lead to arguments as to the limits and extent of liability of the indemnifying party. The core issue with indemnity clauses is the drafting and whether it purports to save harmless a party from potential liability, or to compensate that party from loss already suffered.

 

In Darlington Futures Ltd v Delco Australia Pty Ltd (1986) the court held that an exempting indemnity clause should be construed, according to its natural and ordinary meaning, read in light of the contract as a whole thereby giving weight too the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity. Contra proferentem means, that the indemnity clause in a contract that appears to be ambiguous, should be interpreted against the person who insisted that the clause be included in the agreement. 

 

In Andar Transport Pty Ltd v Brambles Ltd (2004) the court described indemnity clauses in the following manner: 

 

Indemnity clauses are provisions that purport to exempt one party from civil liability which the law would otherwise impose upon it, They are provisions that shift to another party the civil liability otherwise attached by law to the first party. Self evidently this is a serious thing to do or attempt to do. Where such indemnities are said to arise out of contracts which are ambiguous or unclear, it is not unreasonable that their provisions should be construed so that any uncertainty is resolved favourably to the party thereby burdened by legal obligations which would otherwise attach to it. In every case judges struggle with the language of the contract. They must not use mechanical formulae. Nor do rules of interpretation provide easy answers to the judicial task. However, it is sometimes useful to remember, and apply, time honoured approaches. A feature that makes doing so specially appropriate is that the propounded interpretation would shift legal liability from that which the law would otherwise provide. 

 

In Andar Transport Pty Ltd v Brambles Ltd (2004), Brambles tried to rely on an indemnity clause in the contract between the parties to avoid liability. However, the court held that Brambles could not rely on the indemnity clause in respect to its own negligence. 

 

An indemnity clause may not be enforceable because it is contrary to public policy or statute, but it will be subject to the contract and facts of the dispute. If fraud is involved an indemnity clause will not be enforceable on the party seeking relief who has committed the fraud. An indemnity clause may be open for challenge because it is found to be a penalty clause and unenforceable. In Citicorp Australia Ltd v Hendry (1985) the court held that to recover a penalty through an indemnity is inconsistent with public policy. 

 

In the absence of an indemnity clause in a contract, it will result in a limited recourse by which a party might have right of protection. 

 

There are numerous considerations that should be taken into account with the indemnity clause in the contract concerning the party that is the indemnifier. The indemnity clause should be specific to what is being indemnified to avoid the clause being construed in favour of the party in giving the indemnity when a dispute arises.   

 

The more specific and clearly drafted the indemnity clause, including expressed exclusions, the more efficient the process of making claims. Contracts are complex documents and taking the short cut using a standard precedent agreement that has not been tailored to the specific needs of the parties is thwart with risks. The prudent step before you sign that contract is to get that legal advice to protect your legal rights and interests. 

 

The comments in the aforementioned do not constitute legal advice and are general in nature, and if legal advice is required please contact: John Melis at Legal AU Pty Ltd (03) 9999 7799 www.legalau.com 

 

Legal AU Pty Ltd Lawyers are “Liability limited by a Scheme approved under Professional Standards Legislation.”
 

What is an indemnity clause in a contract?
John Melis Jan 02, 2017 10:41 AM