The Use (And Misuse) Of Indemnities In Construction Contracts

Meeting agendas often give good notice of the topics that will get negotiations heated. Watch out for: limitations on liability, rights to terminate for convenience, exclusions of loss of profit, time bar clauses to claims, and, not to be forgotten, liability for Brexit. Frequently, indemnities fall within this category.

Having watched indemnities bounce backwards and forwards in contract negotiations, Edward Colclough has often wondered if parties are fully aware of the implications that the much sought after "indemnity" brings with it.

Aside from securing the trophy of an "indemnity" in your construction contract, what extra does an indemnity get you and is it worth the fight?

Back to basics

Why are indemnities so desired? In short, they are a promise to pay money on the occurrence of a specified event.

Properly used, an indemnity allows the parties to a contract to allocate the risk of an event occurring and the losses that flow from it (which can be a fixed sum or an amount of damages to be determined). The indemnified event may be triggered by Party A (the indemnitor) either:

breaching a term of the contract (e.g. a confidentiality undertaking); or taking on responsibility for a specified event occurring (e.g. a change in VAT law). The trigger event can therefore be either "fault based" or neutral. If, however, Party A would already be responsible at law for a fault-based breach of the contract, what additional reward does the indemnity get Party B (as the indemnitee)?

Advantages of indemnities?

Full recovery of loss. The true intent behind an indemnity is normally that Party B wants 100% recovery from Party A for any losses it incurs as a result of the trigger event occurring. The aim is to fully apportion the risk of the trigger event onto Party A.

Party B will argue that any losses it incurs as a result must be covered by Party A, and should not be subject to the usual legal hurdles of remoteness, foreseeability or reasonableness which can whittle down what it can recover. The goal is for Party A, as the indemnitor, to pick up the tab for whatever losses arise. This is seldom the case. Lord Justice Staughton1 identifies two classes an indemnity can fall within in a contract:

"The word 'indemnity' is ... used in two senses. It may mean simply damages awarded for tort or breach of contract. ... Alternatively the word 'indemnity' may refer to all loss suffered which is attributable to a specified cause, whether or not it was in the reasonable contemplation of the parties. There is precious little authority to support such a meaning, but I do not doubt that the word is often used in that sense."

As can be seen, the courts are cautious to depart from the well-established approach of not awarding unforeseeable or not properly mitigated losses, especially in the context of a breach of...