Spotlight On Contractual Indemnities

11/27/23, 11:36 AM Spotlight on contractual indemnities - Osborne Clarke
Commercial
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Spotlight on contractual indemnities

Published on 1st Mar 2019
Indemnities are an essential part of any contract lawyer's toolkit, and are often a hotly
contested aspect of a contract negotiation. The law around indemnities is complex and, in
many cases, far from settled. Ensuring that you have a solid understanding of the
principles, and knowing where the potential pitfalls lie, can help you to spot the
contractual risks and, where possible, mitigate them from the outset.
Key messages
Indemnities are commercially significant in many transactions and hotly negotiated.
It is by no means clear that a contractual indemnity excludes the common law rules
of remoteness and mitigation that apply to damages claims: keep an eye on
developing case law!
The extent of liability will ultimately depend on the terms of the contract of which it
is a part: express drafting recommended!
If you give an indemnity, seek safeguards.
https://www.osborneclarke.com/insights/spotlight-on-contractual-indemnities 4/17
If you receive an indemnity, check for restrictions and carve-outs which may claw-
back the benefits which youEN think your client has received.
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Back to basics
What is an indemnity?
An indemnity is a promise, usually made in a contract, to pay money on the happening of

a specified event. Indemnities protect one party from a contract from suffering financial
loss in relation to certain eventualities – usually those that would arise from the conduct
of the other contracting party, or over which the other contracting party has control.
In other words, an indemnity is a contractual mechanism for allocating risk, in a similar

way to a warranty in a typical M&A contract, or a guarantee in a finance contract.
Why are businesses keen on including indemnities in contracts?
An indemnity is a primary obligation; it does not depend on having to prove a breach of a

contractual obligation. This offers a number of advantages over bringing a damages claim
for a breach of contract:
An indemnity will typically be triggered by losses being incurred, without the need to
prove any "fault". This can also avoid rules around causation and mitigation, which
can otherwise make recovery more problematic.
If the scope of the indemnity is wide, it can allow fuller recovery of losses such as
legal and other related costs than would be possible for a breach of contract claim;
the parties can also choose to quantify prospective losses upfront to give greater
certainty.
The ability to pursue losses as a crystallised debt can also make recovery more
straightforward in practice: indemnity claims are seen as more difficult to resist and
payments are more likely to be made by an indemnifying party under an indemnity
without the need for legal proceedings to be initiated.
Why are indemnities such a challenging topic?
Being creatures of contract, indemnities are highly flexible, according to how they are
drafted. But this can also be a challenge. Compared to mechanisms like guarantees,
indemnities are subject to few fixed rules. There is no settled "law of indemnities". As a
result, the questions of whether concepts like causation and mitigation apply, and what is
needed to prove the amount being claimed, are all dependent on how the indemnity is
drafted.
In focus | Drafting the trigger
It is crucial that there is absolute certainty in relation to the relevant factual event that
triggers the indemnity. A prime example of this issue arose in the recent Supreme Court
case of Wood v Capita Insurance Services. The case turned on the interpretation of an
indemnity in a share purchase ENagreement, which read as follows:
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"The Sellers undertake to pay to the Buyer an amount equal to the amount which would
be required to indemnify the Buyer against (1) all actions … losses, claims, damages …
expenses and liabilities suffered or incurred, and (2) all fines, compensation or remedial
action or payments imposed on … the Company (A) following and arising out of claims or
complaints registered with the FSA … against the Company … (B) and which relate to
the period prior to the Completion Date pertaining to any mis-selling or suspected mis-
selling of any … insurance related product ..."
The numbers and letters in bold were not included in the original text, but the court
inserted them to help in the construction of the clause. The question was whether the
indemnifying party (Mr Wood as the seller) was required to indemnify Capita (as the
purchaser) where there had been a loss "pertaining to … mis-selling or suspected mis-
selling of … insurance products" but the claim being made did not arise out of "claims or
complaints registered with the FSA" but arose as the result of an internal investigation.
The critical distinction between the constructions presented by the two parties was
whether:
(A) qualified both (1) and (2), in which case the indemnity would only apply if the loss
arose from a FSA claim or complaint; or
(A) qualified part (2) only, in which case the indemnity would apply whether or not
the loss arose from an FSA claim.
The Supreme Court preferred the first interpretation: the words in (A) qualified both (1)
and (2), and (1) could not be read as an independent trigger. Given that no claims or
complaints had been registered with the FSA, the indemnity therefore did not apply.
Drafting point:
The action for those drafting indemnities is clear: we must check for any
ambiguities in the drafting of indemnity clauses, particularly when that clause
grows in the course of negotiations.
It is common that an issue arises during the course of negotiations that the original
draft of the agreement did not contemplate: use sub-clauses and renumber
clauses as appropriate so that the specific trigger or triggers can always be
identified with ease.
In focus | Causation is within your control
How close is the connection?
One of the restrictions on the recovery of damages in a breach of contract claim is the
rule on legal causation. The loss must have been caused by the breach (in the sense that
the loss would not have been caused absent the breach), but a new intervening act will
break that chain of causation.
But the causal connection required in relation to an indemnity depends on the wording of
the indemnity itself and its interpretation.
EN For indemnities that relate to the performance by
one party of its obligations, it is  
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therefore possible   causal
wider or a narrower
link. Campbell v Conoco suggests that there is an escalating scale of connecting links.
The indemnity in that case read as follows:
"The Contractor hereby agrees to indemnify and hold harmless the Operator against …
all claims arising in respect of any injury, death, sickness or ill health caused to or suffered
by the Contractor and any Personnel as a result of or arising out of or in connection with
the performance or non-performance of the Contract ..."
The Court of Appeal found that the connecting links in this indemnity were of increasing
breadth, ending with the words "in connection with", which are as wide a connecting link
as one will commonly come across. The degree of causal connection required is
therefore within our control and will be determined by the words used in the drafting of
the indemnity.
How remote is the loss?
In Capita v RFIB Group, the Court of Appeal held that using the causal words "directly or
indirectly" within a contractual indemnity imported the Hadley v Baxendale test of
remoteness into the clause. The indemnity was worded as follows:
"The Seller undertakes to indemnify … the Buyer … from any liabilities costs claims
demands or expenses which [it] may suffer or incur arising directly or indirectly from …
any services or products supplied … prior to the Transfer Date".
The court ruled that including the words "or indirectly" made it clear that the indemnity
provided the widest link allowed by law in establishing liability for the relevant conduct. It
held that the wording covered liability for losses within the second limb of Hadley v
Baxendale, but that it could not cover liability for losses which are more remote than the
second limb.
Drafting point
Avoiding using the words "directly or indirectly" but relying on causative words
such as "arising out of or in connection with" will have a broader interpretation that
may go beyond the two limbs of Hadley v Baxendale and include all losses
suffered, without importing the principle of remoteness.
In focus | Are indemnities against fines or penalties

enforceable?
With both the level and instance of regulatory fines on the rise, a question of increasing
importance is whether a party can be indemnified against such fines or penalties.
Our view is that, where it is commercially feasible to do so, a party that could have fines
or penalties imposed on it as a result of the actions or inactions of its counterparty to a
commercial contract should consider seeking an indemnity to cover those potential fines
and penalties from that counterparty.
However, if you are seeking such an indemnity, be aware that it may not necessarily be
EN will be precluded (under the doctrine of "ex turpi
enforceable. For example, a party
causa") from recovering for damage
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its own illegal
act. By
extension, this would prevent a party from enforcing an indemnity for the penalties it has
to pay as a result of that act.
Thus, an indemnity against criminal liability is generally unenforceable. Where the offence
is one of strict liability and the party commits the offence innocently, however, it seems
that an indemnity may be enforceable.
In relation to regulatory breaches, one of the key cases is called Safeway Stores v
Twigger. Safeway was a chain of supermarkets; Twigger and others was a group of
former directors and employees who engaged in repeated exchanges of commercially
sensitive pricing information. Following an enquiry by the OFT (as it was then), Safeway
admitted breaching the Competition Act 1998 and the OFT imposed a fine. Safeway
then sought to be compensated by the wrongdoers under an indemnity, but Twigger
argued that ex turpi causa applied and that any recovery under the indemnity would be
contrary to that maxim.
The directors were successful, and the maxim defeated the indemnity. The Court
considered that the contraventions of the Competition Act 1998 were sufficiently illegal
or unlawful or serious to engage the maxim; and, additionally, that the Competition Act
1998 did not impose any liability on directors and employees, only on undertakings.
Safeway was therefore not vicariously liable (i.e. liable because of the actions of another)
but was personally liable. If a company is personally liable, the defence can apply, and the
fine may not be recoverable under an indemnity. Conversely, if the company's liability can
be vicarious, i.e. liability can be imposed on the company, its directors, (or its processors,
in a data processing context), then the maxim may not apply and the fine may be
recoverable under an indemnity. The ex turpi causa principle is one of law but it is worth
noting that its application will vary with the circumstances.
The policy driver should also be considered. It is clear that if a party can transfer a penalty
to a third party, there is less deterrent to commit that offence again. (This is why an
insurance policy will not generally provide cover for a regulatory fine imposed on the
insured – to do so would be against public policy – but may provide cover for a
regulatory fine which is imposed on a counterparty of an insured (and which that
counterparty seeks to recover from the insured under an indemnity) because that claim
could be regarded as a compensatory claim.) But if the contractual indemnity transfers
the penalty to the party which could have ensured compliance, public policy may not be
defeated, and enforcing an indemnity may not offend such public policy.
Drafting point
In an industry where seeking an indemnity against a regulatory fine may not be

market practice, it is worth remembering that it may still be possible to seek an
indemnity in relation to the costs of dealing with the regulator action, and other
related losses, if not for the fine itself.
Drafting FAQs
What do the words "keep indemnified" add to an indemnity?
There is surprisingly little case law on this point. There is an argument that including the
wording may help to ensure that ENthe indemnified party is not required to combine all
claims it may have during the term 
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 of the relevant agreement into one single claim. There
is a second argument that including the wording may help to ensure that the indemnity
survives termination of the agreement. But if that is the intention, best practice must be to
include reference to the indemnity in the survival clause of the agreement.
In most instances, the words are probably superfluous.
What does it mean to say: "the indemnifying party shall indemnify and
defend the other party"?
In Codemasters it was argued that including the word "defend" in an indemnity required
the indemnified party to allow the indemnifying to run the defence. This was rejected. At
best, it was held, the word may give the indemnified party the right to request the
indemnifying party to take over the defence. The court also identified the challenging
overlap between the word "defend" and the conduct of claims clause.
Best practice is to avoid using the word "defend" in indemnities and ensure all conduct of
proceedings issues are dealt with in one place, namely in the "conduct of claims" clause.
What do the words "on demand" add to an indemnity?
The trigger for a claim under an indemnity will be the suffering of loss that is covered by
the indemnity. It is for this reason that the limitation period for an indemnity claim will not
start to run until the date that the indemnified loss is established.
There is very little consistent case law on this point. There is an argument that including
the words "on demand" in an indemnity may lengthen the limitation period, in that the
indemnified party may have a cause of action from when a demand is made by it, not from
when the indemnifying party fails to prevent the indemnified party from suffering a loss.
Alternatively, inclusion of the words "on demand" may mean that the indemnified party can
argue that its claim under the indemnity should be paid as soon as the claim has been
made (or at least as soon as the amount has been agreed between the parties). However,
this wording would not prevent a party from disputing whether a particular sum is covered
by the indemnity. That ultimately can only be settled by litigation or other dispute
resolution procedure in which case any payment will only be due and payable in
accordance with any resulting court order or equivalent and not "on demand" from the
indemnified party.
There are further arguments: perhaps including the words "on demand" is relevant where
the agreement includes a "late payments" clause which states that interest is payable
from the date of demand. Or alternatively, including such words may protect an
indemnifying party from a claim being brought against it under the indemnity before being
served by a demand. There is scant case law to provide a definitive view on the precise
consequence that including "on demand" will have on an indemnity. We can only
conclude that given the case-law is unclear on what the consequence are of adding the
words "on demand" into an indemnity, the words are omitted and the parties draft
expressly to provide for any of the above consequences, as required by the parties.
Are indemnities subject to contractual limitations of liability (including caps)?
There is no general rule as to whether a clause limiting liability applies to indemnities
contained within the agreement. ENIt will therefore be a question of construction. It seems
most likely that the wording "liability 
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 under this Agreement" would in fact cover   indemnity
claims. However, it could be argued, for example, that the indemnity claim is a claim in
debt, and that a debt is a promise to pay, not a liability. Far better, therefore, to draft
expressly and make it clear (either in the indemnity clause, or the limitation of liability
clause) whether or not the agreement cap limits the indemnity.
You should also consider whether any sums paid under a specific indemnity count
towards or "use up" the agreement liability cap. Considering the issue up-front and
drafting expressly to deal with the concern will help avoid later disputes. Wording such as
the following may be helpful: "no amounts awarded or agreed to be paid under the
indemnity in clause X shall count towards the financial cap on liability in clause Y".
As mentioned below, consideration must also be given to whether or not any exclusion of
indirect losses applies in the event of a claim being brought under any indemnity.
What do the words "hold harmless" add to an indemnity provision?
The meaning of the phrase "hold harmless" has been discussed in a number of cases
notably in the Supreme Court in Farstad Supply v Enviroco, in a case between the same
parties in a lower Scottish Court, and in Deepak Fertilisers v (1) Davy McKee and (2) ICI
Chemicals.
The result of these cases is that, in some ordinary contexts, the words "indemnify" and
"hold harmless" can have the same meaning. The likely consequence of this is that
including only the words "hold harmless" in a contractual provision is that it could be
deemed to be an indemnity provision.
However, it seems clear that including the words "hold harmless" in an express obligation
to indemnify will add something, and takes the clause beyond an obligation to reimburse.
In Deepak, the Court held that a promise to hold harmless is wholly incompatible with a
right to sue. It held that "an agreement to indemnify and hold harmless contains within it
by necessary implication an implied term not to sue".
Thus, if party A agrees to indemnify and hold harmless party B in respect of any loss or
damage suffered by party B for the breach of a third party’s intellectual property rights,
party A must indemnify party B for those losses, but, in addition to that, these cases also
suggest that party A cannot bring an action against party B were party A to consider that
party B had caused or contributed to the loss suffered (whether through its negligence or
contractual breach). Party B would have a defence to party A’s claim because its liability
to party A is excluded by the words "hold harmless".
Without the words "and hold harmless", an indemnity may not protect an indemnified
party against claims by the indemnifying party. However, in most circumstances, an
indemnifying party is likely to resist the inclusion of these words as it would not want to
rule out the possibility of bringing an action against the indemnified party where that party
is partly responsible for the loss.
In Durley House v Firmdale Hotels, in considering whether the requirement of prior

payment was a condition precedent to the right to be indemnified, the judge explained
that one view is that where the clause requires the indemnifying party to "hold harmless"
the indemnified party, the true obligation of the indemnifying party is to prevent the
indemnified party from sustaining any loss or expense in the first place, rather than merely
to reimburse the indemnified party only once the latter has paid or lost. However, it was
not necessary to resolve this particular debate on the facts of the case, so this point
remains unsettled. EN
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Should the indemnity cover related parties?
It is quite common to see a long list of indemnified parties in a contractual indemnity. You
may be familiar with wording such as the following: "The Supplier shall at all times during
and after the term of this Agreement indemnify and keep indemnified the Customer, its
Group Companies, the Service Recipients and their respective contractors, employees
and suppliers".
As the indemnifying party, you should seek to expressly limit any indemnity to the other
contracting party only, not its subsidiaries, agents, sub-contractors, directors, etc.
Adopting this position will oblige the indemnified entity under the agreement to seek to
put in place a contractual mechanism for recovery by it of the losses suffered by and on
behalf of those other entities. You will also need to consider the "rights of third parties"
clause. Commonly, the indemnifying party will want to seek to avoid a direct right of
enforcement of rights by third parties.
What effect does it have to limit recovery of legal costs in an indemnity

clause to "reasonable legal costs"?
It is quite common to see the phrase "costs (including reasonable legal costs)" within the
list of losses that can be recovered in an indemnity clause. Following the recent case of
Euro-Asian Oil v Credit Suisse, it seems that the wording "reasonable legal costs" will
have a specific meaning in the context of any ensuing litigation.
In Euro-Asian Oil, after judgment was given in Euro-Asian's favour, it sought to rely on an
indemnity as entitling it to a more favourable recovery of its litigation costs. The indemnity
read as follows: "To protect, indemnify and to hold you [Euro-Asian Oil] harmless from
and against any and all damages, costs and expenses (including reasonable attorney
fees) which you [Euro-Asian Oil] may suffer".
Euro-Asian Oil argued that the words "any and all … costs" meant that the legal fees
should be assessed on an indemnity basis, which is the basis that generally provides for a
higher recovery, given that the costs don't have to be proportionate to the sums in issue,
or to the complexity of the litigation, and any doubt is resolved in favour of the receiving
party. Credit Suisse disagreed and argued that the costs should be recoverable on a
standard basis.
The court found in favour of Credit Suisse, that the costs were to be awarded on the
standard basis. This meant that the costs recovered had to be proportionate (for example,
proportionate to the sums in issue), and if there was any doubt as to whether the costs
were incurred reasonably, that doubt would be resolved in favour of the indemnifying
party, not the indemnified party.
Should indemnities be accompanied by a conduct of claims clause?
A conduct of claims clause offers significant and practical protection to an indemnified

party. There are many permutations of such a clause, and the practical requirements of
each particular clause will need to be considered carefully. Such a clause may require the
indemnified party to:
give prompt notice in writing of events alleged to trigger an indemnity;

allow the indemnifying party to conduct negotiations and proceedings; and
EN
provide all reasonable assistance to the
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other party
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data or
records – and not do anything which might prejudice the litigation or any settlement
negotiations.
The clause may also require that the indemnifying party conducts the claim so as not to
bring the reputation of indemnified party into disrepute. If litigation is conducted in the
name of the indemnified party, it may want a right to appoint a co-counsel.
As a drafting point, seek to make compliance with the claims procedure a condition of
making a claim. In the recent case of Heritage Oil v Tullow Uganda the indemnifying party
argued that there was a condition precedent of giving notice before a certain indemnity
kicked in, which had not been complied with. But it lost its argument on the basis that
elsewhere in the contract was a condition precedent for an indemnity that had been
clearly drafted as such. (It stated that that indemnity "shall not apply unless...".) In
comparison to such clear drafting, the court did not accept that the clause in question
was intended to operate as a condition precedent.
If you intend compliance with the claims procedure to be a condition of making a claim, it
could deprive the indemnified party of the benefit of the indemnity even if it commits a
trivial breach of the claims procedure (which may in fact cause no loss or have no
prejudicial effect). As such, you need to ensure that the effect of the clause is clearly
drafted (particularly if there are any conditions precedent elsewhere in the contract).
Drafting tips
If you are the indemnifying party
Where you are giving an indemnity, the concern is that any resulting claim would give rise
to a claim in debt (such that the principles of mitigation and remoteness would not apply)
and therefore you should seek to draft expressly such that mitigation and remoteness do
apply!
First, you should consider providing for an express duty to mitigate. This could be
achieved by way of a boilerplate clause in the agreement which applies on a mutual basis
to all indemnities in the relevant agreement. For example: "Each party shall use
reasonable endeavours to mitigate its losses under this agreement, including any losses
under any indemnities set out in this agreement". Or it could be drafted to apply to a
specific indemnity only: "The Indemnified Party shall not be entitled to an indemnity under
clause [x] to the extent that it fails to take reasonable steps to mitigate its losses."
You should also consider the issue of remoteness. Consider any clause in the relevant
agreement which excludes indirect losses, and the interplay between that clause and the
indemnity clause in question. Can indirect losses be claimed under the indemnity? You
can consider drafting expressly so that remoteness will in essence apply: "provided such
losses are reasonably foreseeable". Including such wording might provoke the
indemnified party to exclaim: "hey, this indemnity is now no more than a breach of
warranty claim!". If that is the case, it is much better to have these discussions at the
point of negotiation so that both parties can be clear on what they expect to be able to
recover in the event that any claim is made.
If you are the indemnified party
Where you are receiving the benefit of an indemnity, your aim is likely to be ensure that
the claim will be treated as a debt
EN claim, or in the same way as a debt claim would be
treated. We would therefore advise 
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
 that you draft the indemnity narrowly so that the loss
is quantified in the contract, or is easily quantifiable, or there is perhaps a mechanism
within the contract which can be used to quantify the liquidated loss.
You should consider drafting expressly so that remoteness will not apply to any resulting
claim. You could include wording such as "whether or not foreseeable" in the relevant
clause.
You should also consider drafting expressly so that a duty to mitigate does not apply.
Mutual wording could be included in a boilerplate provision, such as: "Neither party's
recovery under any indemnity set out in this Agreement shall be subject to a duty to
mitigate the losses suffered." Or perhaps you could include wording in the specific
indemnity clause itself: "…shall indemnify party B (which shall have no duty to mitigate its
losses)…".
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* This article is current as of the date of its publication and does not necessarily
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11/27/23, 11:36 AM Spotlight on contractual indemnities - Osborne Clarke

Indemnities are commercially significant in many transactions and hotly negotiated.

If you give an indemnity, seek safeguards.

An indemnity is a promise, usually made in a contract, to pay money on the happening of

In other words, an indemnity is a contractual mechanism for allocating risk, in a similar

Why are businesses keen on including indemnities in contracts?

An indemnity is a primary obligation; it does not depend on having to prove a breach of a

Why are indemnities such a challenging topic?

In focus | Drafting the trigger

In focus | Causation is within your control

How close is the connection?

How remote is the loss?

In focus | Are indemnities against fines or penalties

In an industry where seeking an indemnity against a regulatory fine may not be

What do the words "keep indemnified" add to an indemnity?

In most instances, the words are probably superfluous.

What do the words "on demand" add to an indemnity?

Are indemnities subject to contractual limitations of liability (including caps)?

What do the words "hold harmless" add to an indemnity provision?

In Durley House v Firmdale Hotels, in considering whether the requirement of prior

Should the indemnity cover related parties?

What effect does it have to limit recovery of legal costs in an indemnity

Should indemnities be accompanied by a conduct of claims clause?

A conduct of claims clause offers significant and practical protection to an indemnified

give prompt notice in writing of events alleged to trigger an indemnity;

If you are the indemnifying party

If you are the indemnified party

Interested in hearing more from Osborne Clarke?

Connect with one of our experts

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