Indemni what

A look at indemnities, warranties and breach of contract claims.

Indemnities in particular are the domain of lawyers, but even they struggle to explain the full significance of these obligations in a clear and simple manner to their clients. After having attempted numerous times myself, with varied success, here comes another attempt.

1. Let’s Start with what we know: Warranties.
“Is it still under warranty?” No, the warranty expired yesterday.

Most of us are familiar with the idea of a warranty. It is an understood principle that if you buy a product, use it as intended, and that product breaks within a specified period, (usually 12 months), you can return that item to the seller or manufacturer and receive a shiny new product in return.

This is because the manufacturer has made a promise to the buyer that the product will not break within that specified period. This specific promise is known as a ‘warranty’.

Strictly speaking, a warranty claim is a claim for damages (i.e. compensation for the loss suffered as a result of product failure). However, often the option to replace the affected product is expressly agreed between the parties.

Warranties can be given in a variety of contexts, not just when buying consumer goods. For example: a warranty can ensure that the information provided is accurate or that a company is permitted to enter into a contract.

2. Comparing breach of contract claims and warranty claims
Under a breach of contract claim, the party seeking the remedy (the claimant) must demonstrate the following: (1) there was a duty on the defendant; (2) the defendant was in breach of this duty; (3) as a result of the breach the claimant suffered loss; and (4) the claimant mitigated this loss as far as reasonably possible.

A breach of warranty claim is the same in relation to conditions (1), (3) and (4). However, the difference is that under (2) there is no need for the claimant to show how the defendant breached their duty. The approach here is more akin to strict liability i.e. the product stopped working, but the reasons why are irrelevant.

Of course limitations (if any) on the particular warranty would need to be considered. For example: most manufacturers will expressly say that the product warranty will be invalidated if the product is not used for its intended purpose.

Warranties and warranty periods are important to understand as they directly impact issues such as price and insurance cover. Many jurisdictions imply into consumer contracts warranties and minimum warranty periods (for example: the Sale of Goods Act 1979 in England and Wales). In a business context, parties usually have more leeway to exclude implied obligations and can negotiate bespoke warranties and warranty periods.

For example: the parties must agree whether the warranty period is to be fixed, (regardless of whether any replacement product is provided during that period) or whether the replacement product will be subject to its own warranty period, as though it were a new product (known as a ‘revolving warranty’).

3. Indemnities
An indemnity is an obligation to pay a beneficiary on the occurrence of a specific event.

An indemnity is either a claim: (i) for damages; or (ii) for a debt. The difference is important. Where the indemnity is a claim for damages, the claimant will be expected to mitigate the loss and will only then be able to claim foreseeable loss. If the indemnity is a claim for a debt then, depending on the wording of the indemnity, the rules on remoteness and the duty to mitigate do not apply.

Is the particular indemnity a claim for (i) damages or (ii) for a debt?
Indemnities tend to be ‘event-based, and can therefore create a strict liability scenario. For example: “In the event that I am fined or suffer any loss due to the product breaking, you will indemnify me.” It is therefore important to know how the indemnifying event can occur before committing to indemnify someone.

An indemnity for a specific sum means it is more likely to be held as a claim for a debt rather than a claim for damages. However, the courts have also stated that the decision is, in part, a question of fact and determined on the basis of the drafting. ¹

In White and Carter (Councils) Ltd v McGregor [1962], the court held that an indemnity from the defendant to pay the full contract sum if any payment was late was enforceable and because this was a debt claim, it would not be subject to mitigation. ²

If, therefore, an indemnity is specific e.g. “in the event delivery is late you will indemnify me £20,000”, it will be treated as a claim for a debt, and therefore the sum of £20,000 will not be subject to mitigation. The fact that, for example, no loss has been suffered at all, is irrelevant as to the application of the indemnity.

A party can, therefore, be liable under an indemnity despite not having been responsible for the indemnifying event occurring and despite the claimant having suffered no loss.

Indemnity event arises due to claimant conduct
As part of public policy, courts have applied the rule of ex turpi causa, which prevents someone from recovering damage as a result of their own illegal conduct.

In Askey v Golden Wine Company and others [1948], Denning J (as he was then) set out the general principle in relation to indemnities for criminal liability:

“It is, I think, a principle of our law that the punishment inflicted by a criminal court is personal to the offender, and that the civil courts will not entertain an action by the offender to recover an indemnity against the consequences of that punishment.”

However, in Osman v J Ralph Moss [1970], the court held that a party could be indemnified for a fine or penalty for a strict liability offence (in this case driving without valid insurance), provided that there was no degree of intention or culpable negligence.

Similarly, in Drake v Morgan (1978), it was held that a union could indemnify its members for fines imposed for criminal offences, provided the indemnity was for fines after the offence had been committed. This was further confirmed in Transport for London v Griffin, Addison Lee and others [2012], where it was held that an indemnity to pay for traffic fines was lawful if the indemnity was to pay the fines after their occurrence.

Courts interpret indemnities strictly in accordance with the contra proferentem principle.;While an indemnity for the consequence of any illegal conduct is not permitted, it is possible to be indemnified for any fine from a criminal offence after that fine has been imposed.

Statutory limitation
Although parties are free to negotiate indemnities, it is possible for express legislation to hold certain indemnities and to be void and therefore unenforceable. For example: Section 232 of the Companies Act 2006 holds that indemnities for directors liability for negligence, or breach of trust are generally void.

Who must be indemnified?
In the case Durley House Ltd v Firmdale Hotels Plc [2014], the defendant had provided the claimant with an indemnity to pay the claimant’s rent and other operating expenses. The claimant failed to pay the rent and then sought a sum of money equal to the outstanding rent from the defendant. The defendant argued that the indemnity was specific to the claimant and since the claimant had not suffered any loss (i.e. the claimant should first pay the rent before being indemnified for that loss) there was no requirement to pay out.

The court held that the claimant was entitled to be indemnified the unpaid rent sum from the defendant. Note that the court did not order or require the claimant to use the recovered sum for the payment of the outstanding rent.

The case highlights the importance of drafting indemnity clauses to make sure it is clear (i) who will be indemnified, (ii) what specific matter the indemnity is for and (iii) whether there are any preconditions to payment.

For example: if the intent had been to ensure the property rent remained paid to avoid the property becoming subject to repossession, the indemnity should have been worded to clarify that it was the landlord who would be indemnified for the claimant’s rental costs. If, on the other hand, the indemnity was for the benefit of the claimant for their rental costs, then the indemnity should have been specific that it would be conditional on proof that the rent had been paid.

Whilst it is clear under most indemnities that an obligation to pay is owed on the occurrence of an event, it is important to clarify the mechanics of who gets paid, in what circumstances and subject to which preconditions.

Indemnities for 3^rd party claims
One specific indemnity, which is widely accepted as market standard, is the third party intellectual property claim indemnity. What exactly does this mean? If you purchased a special piece of software to simplify your company’s payroll processing, you would expect the seller to warrant that they own the intellectual property rights ‘IPR’ in the software. The seller should also indemnify you in the event that someone brings a claim against you for using the software in breach of their (alleged) IPR right.

It is important that the party providing the third party indemnity ensures it will retain control over the handling of the claim and any settlement thereof (even if it is not a party to the claim). Generally speaking, the right to indemnity should also be limited to reasonable legal costs. Without a clear ‘conduct of claims’ clause, there is a real risk of a disconnect between the indemnifying and the indemnified party. For example: the indemnified party could settle the claim and engage expensive lawyers and the indemnifying party would be responsible for these costs.

Is there nothing to stop these indemnities?
It is best for a contracting party not to have to provide any indemnities and simply rely on contractual breach as a remedy. If a party must provide indemnities, it should consider the following clarifications to limit exposure:
• make the indemnity or indemnities subject to an overall or a specific cap on liability
• specify that the indemnity is for a defined category of loss (e.g. direct loss), which has actually been incurred by the party seeking to rely on the indemnity
• Consider the purpose of the indemnity and to whom the payment obligation should be owed
• require that all loss, including under an indemnity, is mitigated as far as reasonably possible
• include a clear conduct of claims clause under which the indemnifying party has control over the litigation/settlement and will only pay legal costs on a reasonable basis
• include disqualifiers which prevent an indemnity from being relied upon – for example: where the acts/omissions of the party seeking to rely on the indemnity caused the event to arise

4. Conclusion
Whilst indemnities are complicated, they are very rarely subject to litigation. This is, I believe, because the dispute is not one about culpability, but about an acceptable amount of damages. It is ultimately in both parties’ interest to agree a settlement amount to be paid by the indemnifying party. However, the lack of litigation should not diminish the importance of trying to avoid indemnities all together, or to ensure the mechanics around them are clearly set out.

In an indemnity case, it is important to define whether it should be treated as a damages claim or as a debt claim. An indemnity for a prescribed amount or a fine (as opposed to a generic claim for ‘losses’) is more likely to be treated as a debt claim.

Indemnities and their application do arise in other jurisdictions and it is therefore advisable to beware of specific statutory or other rules that may apply to indemnities.

––––––––

1 See Total Transport Corp. v Arcadia Petroleum Ltd (The Eurus) [1998]
2 See also Scottish Midland Guarantee Trust v Woolley [1964] and Royscott Commercial Leasing Ltd v Ismail [1993]