The Dangers of Broad Indemnity Clauses

What is an Indemnity Clause?‍

An indemnity clause is a provision in a contract where one party (the indemnifying party) agrees to compensate the other party (the indemnified party) for certain losses, damages or liabilities that may arise during the course of the agreement.

It is effectively a legal promise to protect.

The indemnifying party is basically saying to the indemnified party that “If something goes wrong and you suffer a loss because of it, I’ll cover those costs”.

What are examples of things that could go wrong?

• Legal claims from third parties
• Damage to property
• Personal injury
• Breach of contract

Why are indemnity clauses important?

Indemnity clauses are used to:

• Allocate risk between parties
• Protect against third-party claims
• Cover legal costs, damages, or penalties
• Sometimes go above and beyond what the law would normally require

What are some common types of indemnity clauses?

• Bare Indemnity: Covers all losses regardless of fault.
• Proportionate Indemnity: Limits liability to the indemnifier's share of fault.
• Third-Party Indemnity: Covers claims made by external third parties (e.g. customers, subcontractors)

What should I watch out for?

• Broad wording like "any and all claims" which can expose you to unlimited liability.
• Uninsurable risks if the clause goes above and beyond what your insurance policy covers.
• Ambiguous terms which lead to costly disputes.

Let's take a look at an example of a broad indemnity clause:

What are the dangers of this indemnity clause?‍

A broad indemnity clause like the above can pose serious risks to the Consultant, both legally and financially.

Here is a breakdown of the key dangers:

1. Expansive Liability Exposure
   

This clause covers all claims for personal injury, death, and property damage, including those made by third parties like workers compensation insurers. This means the Consultant could be liable for events beyond their control, even if they were not directly at fault.‍

2. Vicarious Liability for  Personnel

The clause renders the Consultant responsible for the actions of their employees or subcontractors, even if those individuals act negligently or in breach of the contract.

3. Insurance Incompatibility

Most professional indemnity and public liability policies exclude cover for contractual indemnities. If the clause extends liability beyond what the Consultant would normally face under common law (e.g. negligence), the insurer is entitled to decline cover.

4. Limited Proportionate Liability Protection

While the clause includes a carve-out for proportionate liability, it is qualified and might not fully protect the Consultant. Courts may interpret this narrowly, especially if the indemnity overrides proportionate liability legislation (which can happen in NSW under the Civil Liability Act).

5. Ambiguity

The phrases “associated with” or “in connection with” are broad and vague. This can lead to disputes over what types of claims are covered. Such disputes can potentially become costly litigated proceedings.

6. Mitigation Obligations

The Indemnity clause requires the Client to use “reasonable endeavours” to mitigate liability, but what “reasonable endeavours” are is open to interpretation; it is subjective and difficult to enforce. If the Client fails to mitigate, the Consultant may still be held liable unless they can prove that the Client was negligent in its failure to mitigate.

What can I do to minimise risk to my business with respect to Indemnity clauses?

To reduce risk, you can:

• Narrow the scope of the Indemnity clause to cover only losses caused by the Consultant’s own negligence or breach.
• ‍Exclude third-party claims unless directly tied to the Consultant’s conduct.‍
• Insurance compatibility: Ensure the Indemnity clause is compatible with your insurance coverage. Review with your broker to ensure indemnities are insurable.‍
• Avoid ambiguity: Define terms clearly and avoid vague language like “associated with” or “in connection with”.‍
• Mutuality: A mutual Indemnity clause can reduce any imbalance between the parties.
• Carve-outs: Losses caused by or contributed to by the indemnified party should be excluded from the indemnity. This ensures the indemnifying party is not unfairly burdened and encourages both parties to act diligently.
• Clear mitigation obligations: Ensure the indemnified party has a clear duty to mitigate their losses to ensure that they cannot claim compensation for losses that they could have reasonably avoided.‍
• Back-to-back Indemnity clause: Where there are various contracting parties involved, incorporate a back-to-back Indemnity clause so that indemnities are passed down the chain of contracting parties. This ensures that each party in the contractual chain bears the specific risks associated with its position, helping to manage liability and clarify insurance requirements. For example, a builder (principal) might have a contract with a tradesperson (contractor) who in turn has a contract with a subcontractor. A back-to-back Indemnity clause would ensure that the subcontractor indemnifies the contractor for their own negligent actions, and the contractor then indemnifies the principal in turn for the same or a related liability.

What if the broad Indemnity clause is in my favour? Why would I want to amend it if I can pass all claims and other losses to the indemnifying party?

At first glance, a broad Indemnity clause in your favour might sound fantastic.

However, a broad indemnity clause has the potential to be unfair. In ACCC v JJ Richards & Sons Pty Ltd [2017] FCA 1224, the ACCC found that a broad one-way indemnity was unfair because it did not require fault on the part of the indemnifying party and it covered losses that could have been avoided or mitigated by the indemnified party.

Australia’s Unfair Contract Terms (UCT) regime, under the Australian Consumer Law (ACL) took effect from 10 November 2023, making it illegal to include, propose or rely on unfair terms in standard form contracts with consumers and small businesses. The reforms impose hefty penalties for non-compliance, which were not previously in place. The regime presently applies to standard form contracts for small businesses with fewer than 100 employees or an annual turnover of less than $10 million. A court can declare an unfair term void and impose penalties such as financial penalties, injunctions, or orders to compensate affected parties.

How would you suggest re-drafting the above indemnity clause to reduce risk?

The above re-draft consists of the following key improvements:

• Limits indemnity to fault-based events (negligence or breach).
• Removes blanket liability for third-party claims unless caused by the Consultant.
• Is compatible with most insurance policies which cover negligence but not contractual indemnities.
• Preserves proportionate liability and thus avoiding full liability for shared faults.

Example of a claim in which the Contractual Liability exclusion in the policy was applied by the insurer:

In a recent claim, the Policyholder had a contract in place with the Principal Contractor (a property manager) to perform services as required in accordance with the Principal Contract.

On this occasion, the Policyholder had subcontracted on an informal basis with a Technician to perform works on the Policyholder’s behalf under the Principal Contract. Unfortunately, the Technician made an error during the works which caused damage to the property managed by the Principal Contractor.

The Principal Contractor pursued the Policyholder for damages pursuant to the contract.

The Policyholder submitted the claim to its Liability Insurer. For relationship reasons, the Policyholder did not pursue the Technician for the damage.

The Insurer, having reviewed the claim, deemed the Technician to be 30% liable and the Policyholder 70% liable for the damage.

However, based on a broad indemnity clause written into the contract in favour of the Principal, the Insurer applied the Contractual Liability exclusion against the Policyholder which had the effect of the Policyholder having to bear 30% of the claim. That 30% was deemed to be the Technician’s liability. The Insurer paid 70% of the quantum of the claim, which represented the Policyholder’s negligence, leaving the Policyholder 30% out-of-pocket due to the Contractual Liability exclusion. This is an example of how an indemnity clause that is incompatible with the insurance policy can leave a policyholder exposed to an uninsured loss.  

If you have any concerns with your contracts, we recommend consulting your legal adviser to tailor them to your needs.

Start the conversation today. Reach out to us to check that your contracts are compatible with your insurance policies.