Construction contracts are often encyclopaedic, imposing extensive obligations upon contractors. Typically, several indemnity clauses are also included, occasionally with at least one party labouring under a misapprehension that these types of clauses are endowed with unique and magical qualities.
However, as is the case for any other contractual clause, the meaning and effect of any indemnity clause turns on the specific words used. Indemnity clauses do not attract unique or unusual rules of interpretation and unusual meanings will not be implied (absent remarkable circumstances).
While it is often the case that indemnity clauses have severe consequences, the effect of any indemnity ought to be clear from the words used in that clause.
That is, the effect of any indemnity clause on a contractor’s risk profile turns on:
Baseline: what if there is no indemnity?
It is helpful to consider the parties’ rights and obligations under contracts with no indemnity clauses in order to identify the pros and cons of including indemnities in any deal.
Parties to contracts are obliged to honour the contract’s terms irrespective of whether the contract includes indemnity clauses.
While other remedies might also be available, when one party breaches a contract’s terms causing the innocent party to suffer loss, the innocent party may recover that loss as ‘damages’ from the defaulting party.
The courts’ approach to valuing these ‘vanilla’ flavoured damages is discussed here.
However, the amount recoverable can be quite different if an indemnity clause is included in a contract.
What is an Indemnity?
Indemnities come in many different flavours, including:
Also, an indemnity clause might not include the words ‘indemnity’ or ‘indemnify’. Instead, ‘hold harmless’, ‘defend and hold harmless’, ‘reimburse’, ‘be liable for’, ‘pay’ or ‘make good’ potentially have the same effect as ‘indemnify’.
The natural and ordinary meaning of words[1] included in any particular indemnity clause are important, and should be considered within the context of the contract as a whole.[2]
Potentially, the effect of indemnity clauses can include that:
Recovery of indirect, unreasonable and unforeseeable costs under an indemnity requires clear drafting. However, if the court is satisfied that this was the agreement struck between the parties, then the court ought to apply the indemnity clause with that effect.[3]
Similarly, the words included in a particular indemnity clause can also increase the term of a contracting party’s potential liability.
This is because claims for damages for breach of contract must be made within:
If the relevant agreement was made in the form of a deed, then claims must be made within:
Breaches of construction contracts (or deeds) rarely occur later than the date of final completion: meaning the limitation period usually commences no later than the date of final completion.
Similarly, if an indemnity clause requires that an indemnifier ‘hold harmless’ an indemnified party, the indemnifier will be in breach as soon as the indemnified party suffers any loss or damage: the breach being failing to ‘hold harmless’. That is, the limitation period will start running immediately from the date of the breach.
However, if an indemnity clause requires that an indemnifier ‘make good’, then the indemnity will only be breached if the indemnifier fails to ‘make good’. That is, the indemnifier will only be in breach of contract when (and the statutory limitation period will not commence until) the indemnified party takes steps to recover loss or damage suffered and the indemnifier wrongly refuses to honour the indemnity. As the breach of the indemnity clause might occur much later than, say, final completion of the contract, this type of indemnity clause has potential to substantially extend the period within which claims might be made under a construction contract.
Issues to Consider when Negotiating Indemnity Clauses
If an indemnity is either required or requested from another party, care must be taken to ensure that the terms of the indemnity reflect the parties’ agreement.
When considering the scope of any indemnity that might be required, or ought reasonably be given, parties ought to consider:
Parties ought to use boilerplate indemnity clauses with caution. Just because a particular indemnity clause worked for one deal does not mean it is automatically suitable for your next deal.
Also, there is very little value in a broad indemnity given by an insolvent company. If the indemnified party requires an entitlement to potentially recover a significant amount under an indemnity clause, consideration ought to be give to whether:
The indemnifier must also carefully identify and value its potential exposure under any indemnity before signing on the dotted line. For example, an indemnity ‘against any loss or claim suffered or incurred by the Principal directly or indirectly arising from or otherwise in connection with the project as a whole’ potentially exposes the indemnifier to liability for matters:
As well as ensuring the indemnity clause is clearly drafted and correctly aligned with the scope of the agreed indemnity, a prudent potential indemnifier ought to:
[1] If the indemnity clause is unclear or ambiguous, then it will be construed in accordance with the usual principles applied by courts to resolve ambiguity – being a topic for another day.
[2] Erect Safe Scaffolding (Aust) Pty Ltd v Sutton (2008) 72 NSWLR 1 per Giles JA at [5]
[3] See Total Transport Corporation v Arcadia Petroleum Ltd, (“the Eurus”) [1998] Lloyds Rep 351 and Church Commissioners v Ibrahim [1997] 1 EGLR 13
[4] Also, in Queensland, parties can not contract out of the Civil Liability Act 2003 (Qld): meaning that indemnity clauses do not reduce the extent to which a party is proportionately liable for another party’s loss where claims are made for property damage or pure economic loss.