An indemnity is a promise by one party to compensate another for the loss suffered as a consequence of a specific event called the ‘trigger event’ – the trigger event can be anything defined by the parties including, a breach of contract, a party’s fault or negligence, or a specific action.
An indemnity clause therefore is a clause within a contract, for example vendor agreements, business contracts or service contracts between two parties doing business together which promises to compensate the party at the receiving end in the event that they suffer a loss due to a defined trigger event.
Suppose therefore, ‘A’ who is a manufacturer sells products to ‘B’ a retailer, ‘B’ might be worried that, if the products are defective, they will be exposed to product liability claims by consumer. ‘B’ the retailer will usually seek an indemnity from ‘A’ the manufacturer against those claims, in order to be compensated if such claims arise. This is basically what Indemnity agreement or clause covers.
It operates as transfer of risks between the parties and changes what they would otherwise be liable for or entitled to under a normal damage claim. They are particularly useful when the actions of one party are likely to create a risk which the other party would otherwise have to bear. The major significance of an indemnity clause is to protect the indemnified party against third party law suits.
Commercial contracts typically include an indemnity clause among other standard terms. Words such as ‘hold harmless’, ‘defend’, ‘make good’ or ‘compensate’ etc, often indicate that the clause is, in effect, an indemnity clause.
There are no hard and fast rules when it comes to indemnities. It depends mostly on the circumstances of the contract, the parties’ willingness to do so and their relative bargaining positions. It may be useful to seek an indemnity when:
- One of the parties is likely to suffer a loss from a commercial transaction and/or
- The remedies available with a pure damage claim would not be sufficient to compensate the loss suffered.
Examples of losses that cannot be indemnified are:
- Losses caused by the receiving party’s deliberate acts
- Losses caused by the receiving party’s own fraud or crime.
The presence of an indemnity clause in an agreement can both be a sword and a shield, depending on who is using it. It is not advisable to provide an indemnity if it is going to unnecessarily open you to risks you may have absolutely no control over. You should therefore first negotiate its removal entirely if you are unsure of the avoidability of said risk. If the other party however, insists on the clause, you should ensure it is narrow, so you are less exposed to risk. If you are the party seeking indemnity, reasonableness must be your watchword.
If you need a lawyer to review or draft an indemnity clause for you, please click here.
(ALUKO ADEYEMI AND ASSOCIATES)
