Indemnity Clause "Red Flags"

Author: Corbin Devlin

In most construction contracts, there is nothing more tricky than the indemnity clause. Indemnities don’t come into play on most projects (but when they do, it is because something has gone badly wrong.) As a result, indemnity clauses often get short shrift in negotiations.

A blog is no place for a discussion of such a complex subject. Or is it? Determining whether or not an indemnity clause is problematic is the starting point.

With the intent of giving a complex subject a simple treatment, this is my list of “red flag” issues that call for (re)negotiation of an indemnity clause:

• Indemnity for risks out of your control: This is a basic principle. The indemnitor (the party with the burden of the indemnity clause) should ask, am I taking on any risk under this indemnity clause that I cannot control? The purpose of indemnities is (or should be) to attach a particular risk to the party best able to control that risk.
• Indemnity for risks controlled by the other party: This is worse. Unless you are in the insurance business, you should not agree to indemnify the other contracting party for something in their control.
• Indemnity for losses resulting from the other party’s own negligence: This is the absolute worst. (Fortunately, this is also a very rare animal. And the Canadian courts say that they won’t imply an obligation to indemnify the other party for a loss caused by their negligence unless the contract says so in the most clear and obvious language. I have seen such express clauses, but not many.)
• Indemnity for an uninsured (or uninsurable) risk: This is another basic principle. The indemnitor should always be asking, do I have insurance that protects me against these risks covered by the indemnity clause?
• Indemnity without limit: Is there no cap on the indemnity obligation? Remember that insurance policies have monetary caps; an indemnity without a cap is a sure sign that the indemnitor are taking on an uninsured risk (i.e. in excess of policy limits).
• Indemnity disproportionate to the contract: Is the indemintor taking on risk under the indemnity clause that is far greater than the contract value? Would the indemnity clause put the company at risk of bankruptcy if the unexpected comes to pass?
• Indemnity for consequential damages or economic loss: Indemnity clauses broad enough to include consequential damages or economic loss require very careful consideration. By definition, such indemnity clauses expose the indemnitor to liability that is broader than ordinary principles of contract law or common law would allow. (Perhaps another day I will elaborate; this is a topic that warrants an article of its’ own.)
• Indemnity for negligence or breach of contract: Now we are getting into clauses that are common, but require caution. Indemnity clauses that cover negligence or breach of contract expose the indemnitor to potential liability for unforeseeable losses. But at least such obligations require the indemnitee to prove that the indemnitor was negligent, or breached the contract. If the indemnitor has to give such an indemnity, the other “red flags” mentioned in this list become even more important; e.g. If you must agree to indemnify the other party for any loss resulting from your breach of contract, can you negotiate a monetary cap, and/or an exclusion of consequential damages or economic loss?
• Indemnity for any loss “arising from or related to” the work: Such broad indemnity obligations do not depend on proof of negligence, or breach of contract – it may be sufficient to trigger indemnity obligations if the loss is (somehow) related to the work, even without negligence or breach of contract. Therefore, such indemnities require even more caution than indemnities for negligence or breach of contract. Once again, however, such indemnity clauses may be fine – if they are otherwise subject to some reasonable limitations in scope and amount.

There are infinite permutations of project risks, indemnity provisions, and insurance programs; an indemnity clause may be unreasonable in once case but justifiable, even necessary, in another case. Be sure to consider the indemnity clause in the context of possible real world risks on the project (bodily injury, damage to existing facilities, delay in completion, environmental risk…) and the project insurance program. Just don’t ignore the indemnity clause or treat it as boilerplate. A bad indemnity clause can be a very big problem, not only when that unexpected loss occurs but also in the event of any contract dispute.