Why are there so many contracts in circulation that include indemnities?
The short answer may be that the drafter thinks they are expected, and doesn’t want to be criticised for omitting them.
But too often the wording seems misconceived, as if the drafter doesn’t really understand the principles behind them, or just has a vague idea that they somehow provide greater protection than a contract that merely has warranties and other obligations.
The classic way of looking at indemnities is to say that they provide stronger protection to the beneficiary of the indemnity than a contractual obligation on the other party. For example, being entitled to an indemnity against third party claims for IP infringement may provide greater protection than being the recipient of a warranty that no third party IP is infringed. This argument assumes that the indemnity provides, in effect, a “blank cheque” for the amount of any damages or settlement payment to the third party IP owner. By contrast, if there is merely a warranty, the recipient of the warranty can only recover if the “holy trinity” of contract claims are satisfied, namely:
- Causation. The loss suffered must have been caused by the breach of warranty.
- Remoteness. The loss must not be too remote from the breach.
- Mitigation. The recipient of the warranty must take reasonable steps to mitigate, or minimise, the loss.
There is some case law that suggests that mitigation, at least, may be required, even in the case of an indemnity. But, in general, drafters feel that an indemnity of this kind may provide stronger protection than a warranty, and in some types of negotiation a possible advantage is enough to justify including a clause, even if the precise extent of that advantage in an individual case is not clear.
While this argument is understandable using the above examples, there are many other examples, seen in practice, where the argument is much less clear. Sometimes, an indemnity is given against breach of warranty. Adapting the previous examples, a party warrants that no third party IP is infringed, and indemnifies the other party against its breach of warranty.
In this example, it is much less clear that the indemnifier is giving a blank cheque to the other party. The party asking for the indemnity is, no doubt, hoping that the indemnity will provide greater protection than the warranty, otherwise what is the point of the indemnity? But are they clear in their mind what that greater protection is? Are they expecting that the court will say that, because an indemnity against breach of contract is given, the party in breach no longer has the protection of causation, remoteness and mitigation?
In IP Draughts’ view, the case law on this point is far from clear. See further Wayne Courtney’s excellent book, Contractual Indemnities, for a discussion of the case law.
Even if it might be possible to persuade a court that an indemnity against breach strips away the protection of causation, remoteness and mitigation, why would the party in breach want to agree to removing their rights under contract law, which arguably provide a reasonable balance between the interests of the parties?
This type of indemnity, which has gradually crept into many English contract templates from overseas, notably from the USA, is arguably misconceived and should be avoided. Of course, the counter-argument is that it depends on which party you are acting for, but we shouldn’t just put stuff in contracts because others do, and where the rationale is not clear.
Once you start including this type of indemnity, the next question and area of confusion is whether liability under the indemnity should be limited. If the indemnity is viewed as a bolster or flying buttress for a breach of contract claim, then yes, liability probably should be limited in the same way that the contract typically limits liability for breach of warranty. But if the indemnity is designed for a different purpose, namely to allocate responsibility for third party claims (as in the first example given above) then different considerations apply. Some of this confusion can be avoided if the indemnity is drafted not as an indemnity against breach of contract, but as an indemnity against a third party claim.
Or the contract might not need any indemnities. In IP Draughts’ view, the contract drafter should start from the assumption that no indemnities are needed, then add them if there is a good reason to do so, rather than the other way around.