First, we need to distinguish between two types of indemnity. Take the example of a contract between A and B, under which A is engaged to manufacture a pharmaceutical drug for B, to B’s specification, which B will use in human clinical trials.
A third party indemnity allocates responsibility between A and B for dealing with third party claims or liability. In the present example, a patient might be injured by the drug. The manufacturing contract may provide that, if a patient brings a claim in respect of that injury:
(a) if the injury arose because the drug was inherently toxic or harmful, B will indemnify A against the patient’s claim; or
(b) if the injury arose because A introduced some contaminent into the drug during the manufacturing process, or otherwise failed to make the drug to B’s specification, A will indemnify B against the patient’s claim.
Third party indemnities can be contrasted with an inter-party indemnity, e.g. where A indemnifies B against any loss or damage suffered by B, if A fails to perform its obligations under the agreement or is in breach of a contractual warranty. In the present example, if A fails to deliver the drug by the contractual delivery date, B may have a claim against A for any losses suffered by B arising from that breach. The contract may provide that A will indemnify B against such losses.
IP Draughts is happy to see third-party indemnities in contracts such as the manufacturing contract described above. Our concern relates to the over-use of inter-party indemnities.
In the past, a conventional response among English lawyers would have been to query the need for inter-party indemnities. If A is in breach of contract, B will have remedies under the general law of contract. There is no need for an indemnity as well.
From A’s perspective, an indemnity in this situation is unattractive. Depending on how the indemnity is worded, it may remove some of the protections given by general contract law to the party in breach. Under general contract law principles, B would have to demonstrate that the loss suffered is not too remote from the breach, and B would have to mitigate his loss. These protections may be swept away by the indemnity (although there is some case law to suggest that mitigation of loss may still be required).
If B’s objective is simply to maximise its legal position, then an indemnity may be attractive. However, if parties are negotiating on the basis of trying to reach a “reasonable” position, an indemnity may be considered rather one-sided.
IP Draughts believes that the trend towards increasing use of inter-party indemnities has come from the US, where different legal rules operate. US lawyers have told us that, if a winning party in contract litigation is to recover its legal costs, an indemnity is required. This is because the courts in the US do not generally award a winning party its legal costs. English law in this area is very different; usually the winning party is awarded some or all of its legal costs.
If there is a good reason to include an inter-party indemnity in a contract, then it should be included. However, we have negotiated contracts prepared by the other party, where it appeared that an indemnity was included merely because it formed part of the template agreement on which the draft contract was based, and where the other party had no convincing reason for including the provision.
Our general approach is: if there is no clear reason for including an indemnity, it probably shouldn’t be there.