Indemnity Clause – What Does it Mean?

Author: Ian Aldridge, Progressive Legal

In a commercial setting, indemnities are a point of significant contractual negotiation. If the contract you are about to sign contains an indemnity clause, read it carefully and consider contacting a lawyer to avoid unintended consequences. Indemnities can come with high legal risk when signing a contract.  

This article outlines some key issues in relation to indemnities and will deal with: 

1. What is an indemnity clause? 
2. Who indemnifies in what situations? 
3. Types of indemnities; and 
4. Tips for drafting indemnities.  

What is an indemnity clause?  

Put simply, an indemnity refers to where one party promises to compensate another in the event the latter suffers loss and/or damage during the performance of the contract. The purpose, therefore, is to address, transfer and allocate risk. This is in addition to ensuring that a party is duly compensated for loss arising out of, or in connection to the contract. 

Indemnities are used in the majority of commercial contracts such as (and not limited to) leases, terms and conditions, supply of goods, construction contracts, manufacturing agreements, and the sale of property.  

Who indemnifies in what situations? 

Ultimately, it will depend on the nature of the contract.  

However, common indemnities will relate to: 

1. property damage;  
2. death or injury of a specified person; 
3. negligence; or  
4. legal costs.  

Generally speaking, the person who provides the indemnity is known as the “indemnifier”. Conversely, the person compensated is the “indemnity holder”, or “indemnified party”. If you have been provided with a contract to execute, it is unlikely the indemnity will be in your favour and you should seek legal advice before signing it. 

Indemnity Clause Types  

Bare indemnities  

Bare indemnities may provide protection against any and all liabilities which occur in certain situations or circumstances. This is in contrast to indemnities which have a specific, narrow focus such as personal injury or loss to property. As a result of its broad construction, bare indemnities are notoriously problematic in practice as there is uncertainty attached to their ambiguous meaning; this is especially true where a Court is involved in its interpretation. 

Further, bare indemnities do not indicate whether the indemnity holder will still receive an indemnity for its own actions or omissions which result in loss.  

Proportionate Indemnities 

Proportionate indemnities relate to situations where the indemnifier agrees to indemnify, but does not agree to indemnify for losses arising out of the indemnity holders acts or omissions. As such, the indemnity provided is limited to the extent the indemnity holder has contributed to their own loss.  

Third Party indemnities  

As the name suggests, third parties’ indemnities relate to where an indemnity is provided for a claim against a third party which is related to the contract. 

Reverse indemnities  

Reverse indemnities are the opposite of proportionate indemnities, and the indemnifier agrees to indemnify for the indemnity holders own acts or omissions, even if negligent.  

Tips for Drafting an Indemnity Clause

As indemnities give rise to contingent liability, you may endeavour to limit the scope of them so as to only have them apply to certain situations. It is often the case that indemnities are drafted with too much breadth.  

Some tips for drafting such clauses include: 

1. limit how many indemnities you give; 
2. explicitly identify what types of claims are allowed; and  
3. explicitly identify the type of loss or damage that you will cover under the indemnity. 

By limiting the scope of your indemnity clauses, you are decreasing the chance of you being held responsible for losses which you are not responsible for or are otherwise out of your control. 

Further, indemnities are construed on the basis both parties intended to produce a commercial result. If a court renders an indemnity clause to be too ambiguous in terms of its construction (after the general principles of construction have been applied, see Central Coast Council v Norcross Pictorial Calendars Pty Ltd [2021] NSWCA 75 at [123], the likely result is that the clause will be interpreted in a manner which favours the indemnifier.  

Unfair Contract Terms and a One-Sided Indemnity Clause  

When drafting indemnities, it is also imperative that you are mindful of the Unfair Contract Terms (UCT) regime which is contained within the Australian Consumer Law (ACL). Considering whether an indemnity is unfair will require an application of the three-limb test outlined in s 24(1) of the ACL. Examples of an unfair indemnity clause include: 

1. where the indemnity is one sided insofar as it limits the liability of one party, but does not provide a right for the other party; or 
2. where the indemnifying party has to compensate the indemnified party for something caused by the indemnified party.  

In order to ensure that your indemnity clauses are fair in accordance with the UCT regime, you should consider the following questions: 

1. is it possible to have a mutual indemnity clause within the contract?;  
2. Is it possible to limit the indemnity to certain types of loss which are referable in the contract?;  and 
3. is the indemnity clause too broad? 

Key Takeaways  

Due to the centrality of indemnities in commercial transactions, it is vital that you have a basic understanding of their importance and operation.  

Some key points to remember are: 

1. indemnities compensate another for loss sustained;  
2. there are different types of indemnities with different consequences;  
3. the duration of indemnity liability may be of utility for parties seeking to recover loss under the contract; and  
4. limiting the scope of an indemnity is important for ensuring you do not expose yourself to unintended liability. 

If you require any assistance in relation to drafting or interpreting your commercial contracts, or have a contractual dispute, contact our team at Progressive Legal. All you have to do is fill our online contact form here, or contact our office at 1800 820 083. 

Indemnity Clause FAQs