Commercial and construction contracts will commonly contain terms such as warranties and indemnities. In the article below we outline the difference between these, and why parties should take extra care before they give an indemnity.
What is an Indemnity?
An indemnity in is a contractual promise by one party (the indemnifier) to another party (the indemnified) to:
- protect, ‘defend’ against or ‘hold harmless’ the indemnified against loss or damage arising from or in connection with a particular event, or
- to compensate the indemnified or ‘make good’ any losses or damage incurred by the indemnified arising from or in connection with a particular event.
By providing an indemnity, the indemnifier accepts the risk of liability or loss of the indemnified arising from a particular event. Some examples of indemnities may include:
- Bare indemnity – Party A indemnifies Party B against all liabilities or loss caused by a particular event.
- Party/party indemnity – Party A indemnifies Party B for losses caused by Party A.
- ‘Proportionate liability’ indemnity – Party A indemnifies Party B except to the extent caused by an act or omission of Party B.
- ‘Third party’ indemnity – Party A indemnifies Party B against claims brought by a third party.
- ‘Reflexive’ or ‘reverse’ indemnity – Party A indemnifies Party B against claims caused by Party B.
To be enforceable, an indemnity must:
- not be prohibited by law;
- comply with public policy; and
- be written clearly and with certainty in their language.
The High Court has held:
- indemnities must be interpreted strictly according to their terms; and
- any ambiguities must be resolved in favour of the indemnifier.
- What is a Warranty?
A warranty is a contractual statement of fact, or an assurance made by one party (the warrantor) to another party (the warrantee). It is a term of contract.
By giving a warranty, the warrantor assumes responsibility for the damages if that warranty is found to be untrue. A breach of warranty is a breach of contract, therefore, the warrantee can sue the warrantor to claim damages.
What are the differences between a warranty and an indemnity?
| Warranty | Indemnity | |
| Proof of breach | The party that has suffered loss must establish the other party has breached the contract in order to sue for damages. | The indemnifier is liable if a particular event occurs.
They need not be in breach of contract to be liable for an indemnity.
The scope of the indemnity may exceed the scope of the contract, and may expose the indemnifier to liability for matters beyond the contractor’s control. |
| Remoteness, causation and proof of loss | The party must establish its damages suffered were caused by the other party’s breach of contract.
| The indemnity itself will establish the test for causation.
The indemnified only needs to show it has suffered an actual loss due to the occurrence of the particular event. It doesn’t necessarily need to be caused by the other party.
An indemnity can be for a specific sum and is not subject to the principles of remoteness or general damages arguments. |
| Foreseeability | Loss must be foreseeable | Loss doesn’t need to be foreseeable. Provided the loss falls within the scope of the indemnity it is claimable. |
| Duty to mitigate/minimise loss | The party that has suffered loss must prove that they have attempted to minimise their loss arising from the other party’s breach. | The indemnified has no duty to minimise their loss unless explicitly stated in the contract. |
| Proportionate Liability | A warranty is subject to any proportionate liability legislation.
In NSW the parties can contract out of proportionate liability. | An indemnity may in some cases remove proportionate liability.
In NSW the parties can contract out of proportionate liability. |
| Limitation Period | Cause of action arises when breach occurs. Limitation period within which a claim can be brought is subject to the legislation and common law. | Cause of action arises when the indemnity is triggered. In some instances, an indemnity can extend the limitation period. |
| Knowledge of a Breach | If a party entered the contract with prior knowledge of a breach of a warranty provided by the other party, they may not be able to sue for breach of warranty. | An indemnity may be claimable even if the indemnified knew of the occurrence of that particular event prior to entering into the contract. |
| Disclosure | A warranty may be qualified by the disclosure of other information. | An indemnity may not necessarily be qualified by the disclosure of other information. |
An indemnity offers significant advantages over a warranty, which is why parties often insist on an indemnity and not just a warranty.
Before asking for, or agreeing to an indemnity, it is important to assess:
- the scope and nature of the contract itself;
- the reasons for giving an indemnity over a warranty;
- is appropriate compensation being given to the indemnifier for the risk they are taking on;
- the scope of the indemnity- consider potential areas of exposure and the types of claims that may arise and the nature and significance of any potential loss or damage;
- who would ordinarily assume the risk for that particular event, i.e. should the indemnified ought to give the indemnity;
- should the scope of the indemnity be limited or qualified. For example, should it only apply for a certain period of time, should it exclude any events covered by insurance, should it exclude significant, unquantifiable liabilities or require the indemnified to mitigate its losses, including those traditionally not recoverable under contract law;
- if the scope of an indemnity is to be limited, does the wording:
- Define liability terms clearly;
- Specify the types of claims or situations covered;
- Outline the types of loss and damage the supplier will cover;
- is it clearly written; and
- is it prohibited by law (e.g. would it considered ‘unfair’ under the Australian Consumer Law).