Understanding indemnity clauses

Indemnity and insurance clauses are a common way to transfer risk in commercial contracts. As a contracting party, you may be asked to provide an indemnity on behalf of your agency, or you may seek an indemnity from another party.

Where there is a risk of loss or damage during the course of or in performance of a contract, the party with the most control over that risk will often provide an indemnity to the other party. An indemnity clause ultimately amounts to an assurance by a party that they will cover the cost of any loss or damage. This may include any loss or damage suffered by the other party as a result of a claim made by a third party in connection with the risk.

As Kirby J stated in Andar Transport v Brambles (2004) 217 CLR 424 at 452, an indemnity clause is a provision that purports to exempt one party from a civil liability the law would otherwise impose on it.

What should I be aware of when agreeing to provide an indemnity?

If you are asked to provide an indemnity, there are a number of key questions you should consider before committing your agency to the indemnity clause.

Do you have authority to grant an indemnity?

An indemnity is a Type 1 Financial Arrangement under the Statutory Bodies Financial Arrangement Act 2009. If you are drafting or entering into a contract on behalf of a statutory body, you will need to seek the approval of the State Treasurer prior to granting an indemnity.

Will insurance cover the indemnity?

The Queensland Government Insurance Fund (QGIF) Insurance Policy (Version 6) provides that cover is not provided under any section in respect of “loss, damage or liability for which the Agency has assumed under a contract or agreement, however QGIF will cover the Agency’s liability if it would have existed in the absence of such contract or agreement”.

This means that any indemnity that releases another party from liability, such as a liability for their own negligence, will not be covered by a QGIF insurance policy. Many commercial insurance policies also will contain similar terms.

In addition, under the QGIF Guidelines, an agency is required to notify QGIF if it provides an indemnity to another party for that party’s breach of duty or negligence. If you intend to proceed with granting the indemnity, you should consider whether your agency is willing and has the resources to meet any costs for a contractual liability not covered by the insurance policy.

How broad is the indemnity?

The terms used in an indemnity clause should be carefully considered to ensure that you are not assuming risks on behalf of your agency that are beyond the agency’s control. When construing indemnity clauses, the courts will interpret the clause according to the ordinary meaning of the words in the context of the contract as a whole (Erect Safe Scaffolding (Australia) Pty Ltd v Sutton (2008) 72 NSWLR 1 at 21; Samways v WorkCover Queensland & Ors [2010] QSC 127 at [68]).

Drafters should be careful to tailor their indemnity clause to each contract, rather than using a ‘standard form’ indemnity clause that may be interpreted differently from contract to contract, depending on the nature and context of the agreement.

Where a clause is ambiguous, it will be construed in favour of the indemnifier (Andar Transport Pty Ltd v Brambles Ltd (2004) 217 CLR 424 at [17]-[23]; Samways v WorkCover Queensland & Ors [2010] QSC 127 at [66]).

However, where the terms of the indemnity are clear and unambiguous, a court will not construe the term in favour of the indemnifier to rectify unfairness (Samways v WorkCover Queensland & Ors [2010] QSC 127 at [67]).

To avoid doubt, care should be taken to ensure that the words are not broad and general. Clauses that specifically exclude liability for negligence and contributory negligence on behalf of the other party will minimise the risk that a party will be liable for the acts of the other party.

Indemnity clauses also may be drafted to include a requirement on the other party to mitigate their loss where

What should I consider when asking another party to provide an indemnity?

Does the indemnity cover the relevant risks?

When seeking an indemnity from another party, you should consider whether the indemnity should cover all employees, agents and subcontractors of the other party.

Under the QGIF Guidelines, if you are insured by QGIF, you are required to ensure that the contracting party will indemnify you for any claims arising from that party’s breach or negligence.

Is the party able to satisfy the indemnity?

To ensure that the contracting party can meet its liabilities under the indemnity clause, you should include a clause in the contract that requires them to take out the usual insurances.

The QGIF Guidelines also require agencies insured with QGIF to include insurance clauses covering the indemnity for the party’s negligence, in addition to insurance for other risks specified in the contract.

You may wish to consider including a term that requires the insurance policies taken out by the other party to name the State or your agency as an additional insured. This will assist in the event of claim.

As discussed above, insurance won’t necessarily cover the entire indemnity. In some circumstances, your agency could ask the party for a bank guarantee to cover the indemnity. Whether this is appropriate will depend on the circumstances of the contract.

Indemnities generally

The nature and extent of the indemnity will always depend on the nature of the contract, the risks that are presented by the contract, the level of control each party has over the risks and the bargaining power each party brings to the contract negotiation phase.

The information in this publication is provided for general purposes only. It is not to be relied on as a substitute for legal advice. Crown Law and the Department of Justice and Attorney-General accept no liability for losses caused by reliance on the material in this publication. Formal legal advice should be obtained for particular matters.

Published: 11 March 2015

Author: Melinda Pugh