True Stories - Indemnity Clauses

TRUE STORY - Indemnity Clauses - They Cut Both Ways

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"My name is Peter Janssen and I have been a Solicitor in Australia for over 13 years. During this time I have encountered some amazing cases in the IT & E-Commerce area. In this section, I discuss some of the true stories that have come across my desk. Obviously the names and circumstances have been changed to keep parties anonymous. You'll get some valuable insights from these true stories."

The Facts

You often see an Indemnity Clause in business agreements and contracts. This can be a good or bad thing, depending on whether the indemnity is in your favour. An Indemnity Clause acts like a Guarantee, it states that the person giving the indemnity promises or guarantees to underwrite any loss or damage suffered by another party (usually the other party to the contract).

The loss may literally come out of left field or not be your fault, and indeed may be the result of another persons actions outside of your control. Obviously then, giving an indemnity is something that you want to avoid.

On the other hand, if you can get one from the other party, then you have obtained a legal right that may be very valuable. One of my clients found this to be true.

Some years ago I was asked by my entrepreneur client 'Ross' to draft a simple licence agreement between himself and a computer hardware manufacturer (let's call them "Microhard Pty Ltd"). Ross had the Asia-Pacific rights for computer systems. His activities involved:

importing the raw materials
manufacturing those components into computers (done by Microhard)
distributing the finished products to retail outlets
marketing that product

All of the above activities were on strict time limits, and as you can see, were dependent upon each other. So if one activity got delayed (eg. getting in the raw materials) then it had a "domino" effect on the others, and Ross could be held responsible by the retailer for not getting the finished product to them in time.

My Advice

Given these circumstances I advised Ross that the terms of his licence agreement with the manufacturer had to be tightly drafted. In drafting the agreement I inserted an indemnity clause whereby Microhard agreed to indemnify Ross against any and all loss, including loss of profits from anything that they did during the process which delayed distribution to the retailers.

Microhard objected to the clause. Ross came to see me looking rather pale saying that he was worried that such a clause would ‘break the deal’ at a crucial time that he needed the manufacture and distribution to proceed quickly.

Like most lawyers I had to explain why the indemnity clause should stay in. Luckily for Ross, he trusted my judgment call.

What Happened

As fate would have it, an accident occurred at the plant where the components were being manufactured and packaged. A seal on a filter got clogged and the packaging machine exploded splattering the expensive components all over the roof. The whole shipment was destroyed. It would take weeks, maybe months, to get a fresh supply. Launch dates for the product couldn’t be postponed. It was a disaster for this fledgling enterprise.

If you stand to suffer significant loss in a business deal particularly if the other party does or doesn't do something, then consider inserting a well drafted indemnity clause into your contract.

Conversely, if you are presented with a contract that requires you to give an indemnity, consider striking it out.

The manufacturer said they would re-do the lost goods for free. However they argued they were not under any obligation to make good the indirect loss of Ross's lost marketing expenditure and loss of profits from sales as ‘the damage was too remote” under the basic laws of contract.

I said that may be so but “you signed an indemnity”. They couldn’t squirm out of the indemnity clause that stuck as fast as the raw material did to the roof of their factory. Not only did my client get the money back for the lost raw material but also got a full indemnity in relation to the loss of profits and the wasted marketing expenditure.

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