Indemnifying the damnified

contractual indemnitiesContractual Indemnities (by Wayne Courtney, Hart Publishing 2014) is an excellent book. It draws upon the PhD thesis of its author, who is a former practising lawyer and is now a Senior Lecturer and Associate Dean of the Law Faculty at the University of Sydney.

Regular readers of this blog will be familiar with the frustration that IP Draughts feels about the typical drafting of indemnities – a frustration that is shared by others whom IP Draughts respects, including contract drafting guru Ken Adams. See some of his commentaries on indemnities here.

Indemnities are often drafted with complex wording and long sentences, so that it is difficult to glean their precise meaning. The reasons for this complexity are various and include:

  1. Broad in scope. Indemnities are typically drafted so as to be broad in scope, and the lawyer sees their task as one of trying to be comprehensive and avoiding loopholes. In some market sectors, eg M&A, there are no prizes for simplifying indemnity wording, only potential claims against the lawyer’s professional indemnity policy if the lawyer’s original drafting fails to achieve the financial result desired by the client.
  2. Difficult issues. It is difficult, even for lawyers, to think through all the legal and practical implications of an indemnification obligation. In the heat of urgent negotiations, it is tempting to use wording that one has seen before, and that seems to cover all the bases.
  3. dryTheoretical. Indemnities are concerned with risk allocation, rather than operational issues such as price and performance obligations. The subject matter can seem very dry and theoretical and, frankly, boring. This combination of theoretical and legal subject-matter tends to make commercial clients run a mile, and leave the drafting and negotiation to their lawyers. As a result, there is less pressure to make the drafting straightforward and understandable.
  4. Case law. There is an extensive body of case law on the interpretation of indemnities. Unfortunately, the case law has not made the drafter’s job any easier; rather it has served to illustrate the many issues of interpretation that are thrown up by indemnity language and the different ways that judges can “jump” when presented with a set of facts about a commercial relationship.

In passing, IP Draughts considers that one of the problems with judges interpreting indemnities is that they often lack experience of drafting and negotiating them. In the UK and, one suspects, many other countries, judges are drawn from the ranks of courtroom advocates, who tend to be a different group from those who draft and negotiate commercial contracts. Increasingly, IP Draughts wonders whether the courts – even highly-respected commercial courts such as those in England and Wales – are the best place to decide matters of interpretation.

Be that as it may, Wayne Courtney has done a very good job of distilling centuries of English and Commonwealth case law on indemnities into a narrative that sets out the main principles of interpretation. His experiences as a practising lawyer and as an academic have undoubtedly contributed to making this a useful work.

aqua vitaeIP Draughts has only two significant criticisms of the text. First, that he would have liked even more distillation of the messy, impure fluid of authorities. He feels it should be possible to keep reducing the liquid down over time, into an aqua vitae of principles that are simple to apply when drafting indemnities. Perhaps this will be Wayne’s life’s work and, by the time of the third edition of this estimable book, the main text will be 150-200 pages, rather than the 302 pages it currently takes to cover the subject.

For example, there is a discussion (at section 7-7) of whether the indemnifier has an obligation to defend an action that is brought against the indemnified party, and is within the scope of the indemnity. It seems to IP Draughts that this question is intimately linked to the questions of whether the indemnity is preventive, and whether it covers claims as well as ultimately liability. These questions are discussed in other chapters. It seems to IP Draughts that these various points, which are each discussed in a useful and authoritative way but in isolation from one another, could be combined and distilled into a master-scheme of analysis.

IP Draughts’ second criticism is that Wayne doesn’t offer any indemnity language to address the main points that he has discussed in the text.

Highlighting a few of those points:

  1. damnifyIndemnities can be interpreted as “preventive” (requiring the indemnifier to ensure that the indemnified person does not suffer a loss) or “compensatory” (requiring the indemnifier to make good any loss that the indemnified person has suffered – referred to in the text as “damnification” – a wonderful word). Often, the courts will adopt a preventive interpretation. This does not seem to depend on using words such as “hold harmless” although, having read the book, IP Draughts suspects that the lawyers’ practice of using this phrase may have its roots in a desire to make the indemnity preventive in scope. There are better ways, in IP Draughts’ view, of making this point clear, than using a formulaic and unclear phrase such as “hold harmless”. (Incidentally, Wayne discusses and dismisses the idea that a preventive interpretation was to be found in the courts of equity, while a compensatory interpretation was to be found in the courts of law, prior to the merger of those courts under the Judicature Acts of 1875.)
  2. It is not always clear, from the wording of the indemnity, whether it applies to all or just some of the following: (a) third party claims against the indemnified party, (b) losses suffered by the indemnified party as a result of the indemnifier’s breach of contract, and (c) claims that might otherwise by brought by the indemnifer against the indemnified party, eg for breach of contract – this type of indemnity is effectively an exclusion clause.
  3. Whether the wrongdoing of the indemnified party cancels or qualifies the indemnity, eg if they are negligent.
  4. Whether claims that have not yet resulted in a liabilty are in some way covered by the indemnity.
  5. Whether costs are recoverable.
  6. Whether an indemnity that covers the same ground as a liability for breach of contract (eg where the contract includes an indemnity against breach of a warranty) can be broader in scope than the underlying breach of contract claim, or is subject to the same limitations and qualifications (eg as to causation, remoteness and mitigation). Wayne discusses the different viewpoints on this subject, eg that an indemnity provides an “agreed damages” mechanism that overrides the usual contract law rules (similar in effect to liquidated damages), but concludes that there are relatively few clear cases that support this analysis of the effect of indemnities, and that each clause must be construed individually. IP Draughts is reassured to hear this conclusion. He has encountered this “agreed damages” approach in the world of M&A and has long wondered where it came from.  More generally, IP Draughts has encountered commonly-held assumptions about the legal effect of contract terms in the world of M&A that are not always obvious to those whose contract experience has been in another market sector, and he wonders whether an element of “group think” has developed in that closed world.

IP Draughts may attempt some drafting of indemnities from first principles and with these points in mind, in a later blog posting. Most of these points are familiar, but some of them, eg the distinction between preventive and compensatory indemnities, have been brought into sharper relief by the book’s analysis.



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Filed under Book review, Contract drafting

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