Indemnity provisions are an essential tool in the allocation of risk in commercial agreements. Often, indemnity provisions can be overlooked or misunderstood which can belay the effect of any intended risk allocation and also give rise to unintended consequences or, in the event of a dispute, inconsistent interpretations by courts and arbitrators. This blog post aims to provide a basic overview of the nature of indemnity provisions and the considerations that should be taken into account when reviewing your business’s commercial agreements.
All types of commercial agreements contain indemnities, from agreements for the purchase and sale of goods and services, supplier-distributor agreements, leasing of personal property to major transaction documents in the sale of an entire business. In its simplest form, an indemnity provision is an undertaking by one party to pay another party for certain costs and expenses upon the occurrence of specific events. The determination of which party will indemnify is dependant on the risk exposure and negotiating positions of the parties.
In the absence of an indemnity, if Party A breaches its contractual obligations by making an incorrect statement of fact or failing to perform an obligation, Party B will have a claim for damages under certain common law causes of action in tort and contract. With an indemnity provision, both Party A and Party B can address explicitly in the contract how certain claims can be handled in specific circumstances, and if there is to be any limitation on those claims that may expand or narrow the remedies available at common law. Often a contractual indemnity may be an exclusive remedy for the parties or may be in addition to, or in substitution of, a cause of action at common law.
Sometimes an indemnity provision can substantially broaden who is entitled to be indemnified. Often the indemnity can come with a laundry list of potential indemnified third parties, including directors, officers, employees, volunteers, customers of the actual party to the commercial contract. When providing an indemnity, it is essential to understand the risks associated with agreeing to indemnify a broad swath of potential third parties. Often as an indemnifying party, depending on the specific risks involved, it is best practice to limit the indemnity obligation to the parties to the commercial contract itself.
The specific wording of an indemnity provision will dictate how and what risks are apportioned to which party. Indemnity provisions can be:
Bare: For example, a supplier indemnifies a customer for all liabilities or losses incurred in connection with specified events or circumstances, without setting out any specific limitation;
Limited: For example, a vendor indemnifies a purchaser against all losses, except those incurred as a result of a purchaser’s acts or omission;
Third Party Indemnities: For example, a licensor indemnifies a licensee against liabilities to, or claims by, a third party; or
Party/Party Indemnities: For example, each party to a contract indemnifies the other parties for losses in specified circumstances.
The above represents a small subset of the basic form of indemnities that are commonly seen in commercial agreements, and each type can be drafted to the particular circumstances of each party, with nearly infinite variation, expansion or limitation.
The Language of Contractual Indemnities
The language in indemnity provisions has been parsed and dissected by courts in Canada, and standard language that is often seen in many agreements can be interpreted by courts in ways in which the parties to the contract may never have intended.
It is commonplace for draftspersons to use the jargon “indemnify and hold harmless” (or save harmless). At least one Canadian court (Stewart Title Guarantee Co. v. Zeppieri 94 O.R. (3d) 196 ) has found “indemnify” and “hold harmless” have distinct meanings, being that the contractual obligation to “hold harmless”, is broader than that of “indemnify”, in that someone having the benefit of a hold harmless provisions, should “never have to put their hand in pocket with respect to a claim”. In other words, to “hold harmless” is to protect against the ongoing costs and expenses associated with a claim as they arise, rather than the reimbursement of losses and liabilities resulting from the claim.
Other Canadian and American case law has found that there is no distinction and the terms are effectively redundant synonyms. In any case, the astute contract drafter will ensure that wording of any indemnity provision reflects the commercial intention of the parties. The term “hold harmless” can often be excluded so as not to run the risk of the ambiguous term being interpreted by the courts in a manner inconstant with the parties’ intentions.
Duty to Defend
Similar the duty to “hold harmless”, often embedded within an indemnity provision of commercial contracts is a “duty to defend”. A duty to defend can be a broader obligation than to indemnify because it often applies even if a claim does not have a reasonable prospect of being successful. A standard duty to defend, like to “hold harmless” will cause the indemnifying party to cover costs and expenses paid as part of defence costs, the result of the resolution of the dispute, as well as to advance payment for any unpaid costs and expenses comprised of defence costs. Often the duty to defend will also come with the option (and sometimes the obligation) to assume control of the defence of a claim.
Your Commercial Agreements
As quickly becomes apparent, indemnity provisions can lead to costly and significant consequences that can increase complexity should a dispute ever arise under a commercial agreement. The impact of the specific language of any indemnity provision and its application to your circumstances is a crucial step in assessing the risk profile of any commercial agreement.
The business lawyers at Mills & Mills LLP have extensive experience with all manners of commercial agreements and seek to help clients obtain practical and positive outcomes as they navigate the legal landscape of complex business arrangements. To benefit from the individual, customized service and the superior business law knowledge that Mills & Mills LLP offers, please contact us at 416-863-0125 or send us an email.