Template:Indemnity description

Indemnities are generally viewed as onerous obligations. A request for one will usually be met with a sharp intake of breath, particularly from the legal department.

Indemnities are nothing more than a contractual promises to pay an ascertainable amount of money should a defined circumstance arise, but boy do people get bent out of shape about them. There is much misapprehension. Much Fear. Much Loathing. Much ignorance.

An indemnity isn't better than a contractual right of suit. It isn't quicker. It doesn't have different accounting or capital consequences. It isn't, of itself, more severe. Nor is it inherently more broad or of less determinate scope. The sky won't fall in if you give an indemnity. It won't fall in if you don't get one from your counterparty either.

At its extremity you can only enforce an indemnity by taking legal action for breach of contract: namely the failure to pay under an indemnity claim.

Why all the anxiety?

Unlike most contractual promises, an indemnity addresses a contingency that neither party wants: An unexpected financial loss; an adverse change in tax treatment; the commencement of legal action by a third party against one or other party to the contract as a result of its performance. It allocates these unwanted, potentially unquantifiable, "third party" risks away from the person on whom they would naturally fall.

The questions in your mind should always be:

• Why shouldn't this loss fall on the party who would, under settled legal principles, ordinary bear it? If it should, and it would, you don't need an indemnity.
• How open-ended is the loss likely to be? The more open ended the loss, the harder a job you will have persuading the other guy to wear it. (and for that matter, the court to grant it to you in any case).

Example:

A enters a derivative contract with B. To hedge itself B, buys security X. B's investment in X is subject to an unexpected tax charge. A has indemnified B against all tax liabilities arising on its hedging activities.

• A did not breach the contract
• B does not need to (and indeed cannot) claim breach of contract,
• B can call on the indemnity to require A to make a payment equal to the tax charge under the indemnity.
• If A neglects to make the indemnity payment, B has an action in breach of contract.

Claiming under an indemnity

For these reasons, an indemnified party does not need to prove the indemnifying party committed a breach of contract: it need only show that the undesirable "third party" contingency has befallen it, and that it has correctly ascertained amount which the indemnifying party has indemnified it as a result.

Liability under an indemnity

Since it isn't necessarily triggered by a breach of contract, nor is the value of indemnity necessarily constrained by ordinary contract law principles for ascertaining damages. (That is not to say you don't have to prove loss, though: beware indemnities that look like penalty clauses.)

Now we have already established that you want to reallocate this risk away from the party who would naturally bear it. That person will ask itself, as should you, could my agreeing to this indemnity, in the immortal words of Cardozo J in Ultramares Corporation v. Touche open the floodgates leading to "liability in an indeterminate amount for an indeterminate time to an indeterminate class"?

Actually a little side bar here: The more open-ended the wording of your indemnity, the more prone the courts are to analogise its extent back to ordinary contractual principals of remoteness of damage - see Total Transport Corporation v Arcadia Petroleum Ltd (The Eurus) Good note that from Olswang, by the way.

The Court of Appeal, interpreting the contract as a whole, held that the obligation to pay "any time, costs, delays or loss" caused by a party's breach only covered losses flowing directly from the breach or that were in the contemplation of the parties when they made the contract.

Indemnities and Guarantees

An indemnity is nonetheless a useful back-up to a guarantee because:

• The Statute of Frauds does not apply to an indemnity.
• The invalidity of an underlying obligation does not invalidate an indemnity.
• Variation of the terms of an underlying obligation will not discharge an indemnity whereas it might a guarantee (unless you have a good waiver of defences clause)