Indemnity claims: Cutting your losses

An indemnity is a promise to meet a specific loss and most standard form contracts and subcontracts contain an indemnity clause.

Those which relate to third party claims arising from death or personal injury are readily recognisable.

There the contractor will typically indemnify the employer for such claims and the subcontractor will indemnify the main contractor for the same and so on. This will also usually extend to damage to property other than the works.

They are also used to cover losses arising from a breach of contract. They will usually be passed down the contractual chain with the main contractor indemnifying the employer; the subcontractor indemnifying the main contractor; the sub-subcontractor indemnifying the subcontractor and so on.

How does a claim under an indemnity differ from a claim for damages for breach of contract?

The advantages of claiming under an indemnity (depending on its drafting) are:

• That any right of action under it does not accrue until the loss indemnified against is suffered by the party calling on the indemnity (the indemnitee) so extending the limitation period;
• It can cover all losses arising from a set of circumstances regardless of fault
• The rules on remoteness and mitigation of loss which can limit claims for damages for breach of contract do not apply.

These are potentially significant advantages. So what are the types of loss they cover? Indemnities can be used to reallocate risk without reference to fault. It is for this reason that exclusions will often be included within the indemnity clause – for example, for claims which arise by reason of the fault of the indemnitee. If the clause is silent on that situation, it is a matter of interpretation whether it extends to cover losses which were caused or contributed to by the fault of the indemnitee.

The general principle is that an indemnity clause will be construed strictly in the same way as exemption clauses. If the clause is to cover the consequences of the indemnitee’s negligence, it must:

• Make very clear in its wording that it does so; or
• It must be established that there are no other circumstances on which the indemnity can reasonably apply except where there is indemnitee negligence.

These principles have been derived from two leading cases: Alderslade vs Hendon Laundry Ltd and Canada SteamshipLines Ltd vs The King (Canada).

The application of these principles was considered recently in the decision of  Greenwich Millennium Village Ltd vs Essex Services Group and others, where Robson Mechanical Services Ltd, an M&E sub-subcontractor, was found to have caused a flood at the Millennium Village. Its sub-contract contained the following provision: “The subcontractor hereby agrees to indemnify HS Environmental Services Ltd [the contractor above it in the contractual chain] in respect of any liability, loss, claim or proceedings of whatsoever nature such as shall arise by virtue of the breach or breaches of this subcontract agreement by, or act, default or negligence of the subcontractor.”

Robson argued that it should not be liable under the indemnity for the losses caused by the flood where the contractor above it in the chain had been negligent itself - in this case it had failed to inspect and detect the shortcomings. In rejecting that argument Mr Justice Coulson and the appeal court found that any question of negligence further up the chain could not prevent Robson’s liability under the indemnity - it was not limited to defects which could only have been identified on reasonable inspection. This is not a surprising decision but a reminder that the terms of a wide indemnity are likely to be scrutinised closely.

As an indemnitee is claiming a specific loss for which the granter has accepted responsibility, a claim on an indemnity is generally interpreted as a claim for a debt rather than a claim for damages. This can avoid limitations on the amount recoverable.

In Codemasters Software Co Ltd vs Automobile Club de L’Ouest, the organiser of the Le Mans motor race granted Codemasters (a computer game designer) a licence to use the branding of its endorsements and indemnified Codemasters for any losses suffered by its breach of contract.

It had actually granted rights it did not have. Ferrari, Porsche and Lamborghini sued Codemasters and it claimed against Le Mans under the indemnity. Le Mans was not allowed to argue heads of claim were too remote or that Codemasters had failed to mitigate its losses. The court distinguished between a claim for breach of contract (where such arguments could be made) and a debt claim under an indemnity.

Generally, indemnities present an easier win for those calling on them than a breach of contract claim. These decisions illustrate the importance for those granting indemnities to know what they are signing up to. 

Lindy Patterson QC is a partner and solicitor advocate in the construction team of CMS Cameron McKenna