General

We like to call indemnity clauses contractually created damage (although professionals and academics distinguish damage from indemnity).  It allows a party (an indemnified party or indemnitee) to claim compensation for loss that may not otherwise be available to the party under “normal” damages (such as expectation damage).  While the legal literature is not all too clear (at leas to us), we believe these are some of loss (or damage) for which indemnity may be useful:

(a)   Certain indirect loss and those that would not normally meet the requirements for causation (i.e., that damage must be caused by the breaching party), foreseeability and certainty,

(b)   Loss that is not caused by another party’s breach – in other words, an indemnified party sustains loss, but that loss is not due to a breach by the other party.  Good example of this would be claims relating to intellectual property.  A licensee may be sued by a third party for breach of IPs licensed from the licensor.  A licensee typically seeks an indemnification, whereby a licensor would compensate for the licensee’s damages and costs in connection with defending against the claim, irrespective of whether the third party’s claim is successful or not.

(c)    Loss that would typically not be recoverable under law (common law or statutory), despite meeting all criteria for damages (see para (a) above).  Good example of that is attorney’s fees, which may meet all criteria in para (a), but would still not recoverable, unless otherwise stated in the contract.

(d)  We would specifically note tort claims.  For instance, misrepresentation gives rise to damages in tort and typically, the measure of damage is “reliance” – i.e., put the parties back where they were before they made the contract.  That can leave out some type of loss.     

In short, indemnification clause can be used to secure a party from or cover the kind of loss (or “damage”, if the word is used in generic sense) that may not be recoverable or fully recoverable under normal damage.   An indemnity clause transfers the risks of a party associated with certain types losses to another party, which makes an indemnification clause a “risk apportionment” tool. 

Types of Loss:  Indirect Loss

In the context of indemnity clause it is useful to distinguish direct loss and indirect loss.  A good example of indirect loss is a third party claim:

Fact pattern: Say, there is a party purchasing cleaning services – we will call him the “Principal”.  The service is performed by the “Service Provider”, who must clean the Principal’s premise.  When doing cleaning work, the Service Provider’s equipment causes (i) personal injury to employee of the Service Provider, and (c) damage to a property of a third party (we will call the employee and the third party, “Third Parties”. 

The Third Parties sue the Principal.   Let’s say the Principal sustains two types of damages: 1)  litigation interferes with the Principal’s business and it loses some money, and 2)  litigation costs, including attorney’s fees, despite that the Service Provider takes over the litigation (institutes itself a party to the litigation).  

Direct Loss

An example of direct loss in the context of indemnification is a clause along the lines of: “Party A shall indemnify Party B against a loss arising from Party A’s breach of contract”.  In other words, simple breach of contract for which there is an indemnity. 

The question is why have indemnity for the type of loss that is recoverable under a “normal” damage.  It appears there could be few reasons: 1) some breaches may not give rise to damages, either because they fail to meet the requirements, such as causation, foreseability or some other reason, 2) it is easier to bring claim under indemnity – the claimant would need to show few major connections, including connection between the breach and loss, and 3) some damages may not be fully recoverable under expectation damages.  

Drafting and Negotiating Indemnity Clause

Theoretically, an indemnity could be along the following lines:

“Party A shall indemnify Party B and its directors, officers, employees, agents, representatives, contractors and subcontracts against any loss, damage, cost, expense, action, claim, infringement and other liability, arising from or connectied with acts or omissions of Party A”.  

This is, however, quite broad.  For instance, it does not state whether the loss, damage, cost, etc must somehow relate to the agreement between the parties.  Further, “acts or omission” is too broad – it would be unfair to hold a party liable for all of its actions or omissions under all circumstances.

Example Clause and General Comments

See this Example. 

Few things need to be discussed before going into each section. 

Firstly, the indemnification clause tends to contain number of “in connection with”, “related to” and similar expressions.  Depeding on how a clause is drafted, this may be because the clause attempts to capture connection between several elements:

(a)    Indemnitee should be connected to a loss (or vice versa) – a loss should be the Indemnitee’s loss, not just anyone’s (or anything),

(b)   A loss should be connected to a certain event or act.  The part of the first paragraphs a Loss “arises from or relates to”, such as misrepresentation, violation of law etc. sets the connection of a loss with a certain event or act. 

(c)    connecting the event to the agreement or party’s obligations under it.  For instance, “failure to comply with applicable law”.  It can be that the obligation to indemnify arises from failure to comply with applicable law generally – i.e., does not matter whether that law or failure relates to the agreement.  But some drafters (especially, from Indemnifying party’s perspective) would want to limit events or acts to the agreement in which the indemnity clause appears.  In our example, we have identified that connection in each bullet point – e.g., “representations… contained in this Agreement” (not just any representation).

Secondly, acts that entitle the Indemnitee to claim damages (or compensation for other loss) could be linked to a party only, or to a party and its related persons, such as affiliates, directors, officers and employees.  In the example of failure to comply with Applicable Laws – the trigger event could be failure by the party only, or by the party or any of its directors, agents, contractors, subcontractors and so on (see the definition of “Related Person”).  A party that is a body corporate is generally vicariously liable for acts of its employees, however, the list of related persons could be extended.  For instance, generally a company is not responsible for acts of its “Affiliates”, unless provided so in the agreement.

Breakdown of Indemnity Clause

See here for the breakdown of the Indemnity Clause.

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