Mistaken Indemnity

An indemnity is a contractual promise by one party to make good

a specific loss suffered by another. The indemnity entitles the

indemnified party to a payment if the anticipated event does indeed

take place. Simple enough? Yes and no.

A customer licenses software from a supplier. If the software

should turn out to have been copied from a third party, the

customer's use of the software will infringe the rights of that

third party and the customer could end up being sued for damages.

So the supplier provides the customer with an indemnity, protecting

it by agreeing to cover any loss that might arise as a consequence

of the uncertain copyright position. Problem solved.

When used correctly an indemnity can provide a simple remedy to

a situation in which one party should not reasonably be expected to

bear the burden of a particular loss from a specified event. But

there are a number of popular misconceptions about indemnities

which ensure that they are often misused.

Warranty vs. indemnity

One common confusion is the difference between an indemnity and

a warranty. Both provide important contractual protections, but it

is important to be aware of the differences.

A warranty is a contractual undertaking that a particular state

of affairs exists. For example, one party to a contract warrants

that it has taken all necessary action to authorise the execution

and performance of its obligations under the agreement. Should that

warranty turn out to be untrue, the other party has a claim for

breach of warranty and might be able to recover damages for that

breach. However to do so, it must show that (a) it has suffered a

loss, and (b) the damage suffered is not too 'remote'. In

other words:

the loss was a natural consequence of the breach, the type and

extent of which a reasonable person would accept in the

circumstances; or

at the time the contract was entered into, the loss was fairly

and reasonably contemplated by both parties as the probable result

of the breach (this would cover an unusual type of loss due to

special circumstances known to the parties from the start).

Furthermore, under a claim for breach of warranty the injured

party is under a duty to mitigate by taking reasonable steps to

minimise the loss and not taking unreasonable steps to increase

it.

An indemnity, on the other hand, is a promise to reimburse the

other party in respect of a particular type of liability, should it

arise. Unlike breach of warranty claims, a party does not...