Learning Outcomes
After studying this article, you will be able to explain the legal nature and function of indemnities in contract law, distinguish indemnities from guarantees, identify how indemnities operate on contract discharge, and apply the rules governing enforcement and remedies for breach of indemnity. You will also be able to advise on the drafting and interpretation of indemnity clauses for SQE1-style scenarios.
SQE1 Syllabus
For SQE1, you are required to understand the legal principles and practical implications of indemnities as a contractual remedy. Focus your revision on:
- the definition and legal effect of an indemnity clause
- the distinction between indemnities and guarantees
- the enforceability of indemnities and the remedies available for breach
- the operation of indemnities on contract discharge (including performance, breach, and frustration)
- the drafting and interpretation of indemnity clauses in practice
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the key legal distinction between an indemnity and a guarantee?
- When is an indemnity enforceable if the contract has been discharged by performance or agreement?
- What remedies are available to an indemnified party if the indemnifier fails to pay under an indemnity clause?
- True or false? An indemnity is a secondary obligation that only arises if a third party defaults.
Introduction
Indemnities are a common contractual device for allocating risk and providing financial protection against specified losses. For SQE1, you must be able to explain what an indemnity is, how it differs from a guarantee, when it is enforceable, and what remedies are available if it is breached. You should also be able to advise on the effect of contract discharge on indemnity clauses and identify key drafting issues.
Key Term: indemnity
An indemnity is a contractual promise by one party (the indemnifier) to compensate another party (the indemnified) for specified losses, usually arising from certain events or liabilities, regardless of whether a third party has defaulted.Key Term: guarantee
A guarantee is a contractual promise by one party (the guarantor) to answer for the debt or obligation of another (the principal debtor) if that other party defaults. It is a secondary obligation.
The Legal Nature and Function of Indemnities
An indemnity creates a primary obligation. The indemnifier must pay the indemnified party for losses covered by the clause, whether or not anyone else is at fault. This is different from a guarantee, which is only triggered if a third party fails to perform.
Indemnities are often used to allocate commercial risks, such as tax liabilities in business sales, intellectual property infringement, or losses arising from breach of contract. They are enforceable as a matter of contract law, subject to the usual rules of construction and public policy.
Indemnity vs Guarantee
The distinction between an indemnity and a guarantee is central for SQE1:
- An indemnity is a primary obligation to pay for loss, enforceable even if no third party has defaulted.
- A guarantee is a secondary obligation, enforceable only if the principal debtor fails to perform.
Exam Warning Do not confuse indemnities with guarantees. An indemnity is not subject to the statutory requirement for writing under the Statute of Frauds 1677, but a guarantee is.
Indemnity vs Damages
Indemnities differ from ordinary damages for breach of contract. An indemnity may cover losses that would not be recoverable as damages (e.g., losses that are too remote or not caused by breach). The clause may also specify the scope of losses covered, such as direct, indirect, or consequential losses.
Indemnities and Discharge of Contract
Indemnity clauses may survive the discharge of the main contract, depending on their wording and the parties' intentions.
Discharge by Performance or Agreement
If the contract is performed or discharged by agreement, an indemnity will remain enforceable if the clause is expressed to survive termination or completion. This is common in commercial contracts, where indemnities are intended to protect against post-completion risks.
Discharge by Breach
If the contract is terminated for breach, an indemnity may still be enforceable if the clause is drafted to survive termination. The indemnified party can claim under the indemnity in addition to, or instead of, damages for breach, depending on the terms.
Discharge by Frustration
If a contract is frustrated, the effect on an indemnity depends on the clause wording and the Law Reform (Frustrated Contracts) Act 1943. Unless the clause clearly provides otherwise, the indemnity may not be enforceable for losses arising after frustration.
Key Term: frustration
Frustration occurs when an unforeseen event makes performance of the contract impossible or radically different, automatically discharging the contract.
Enforcement and Remedies for Breach of Indemnity
If an indemnifier fails to pay under an indemnity, the indemnified party can claim the amount due as a contractual debt. The usual remedy is a claim for a sum certain, not damages for breach.
Key Term: debt claim
A debt claim is a contractual claim for a fixed sum that is due and payable under the contract, regardless of loss.Key Term: damages
Damages are a monetary remedy awarded to compensate for loss caused by breach of contract.
If the indemnity is not for a fixed sum, the indemnified party may claim damages for breach of the indemnity clause. In rare cases, the court may grant specific performance or a declaration as to the parties' rights.
Worked Example 1.1
A supplier agrees to indemnify a retailer against "all losses, costs, and expenses arising from any product liability claim." A customer sues the retailer for injury caused by a defective product. The retailer settles the claim and seeks reimbursement from the supplier under the indemnity. The supplier refuses to pay.
Answer: The retailer can claim the full amount paid to the customer (and associated costs) as a debt under the indemnity clause, provided the losses fall within the scope of the clause.
Worked Example 1.2
A contract contains an indemnity clause: "The contractor shall indemnify the client against all losses arising from the contractor's breach." The contract is terminated for breach by the contractor. The client claims under the indemnity for losses suffered after termination.
Answer: If the indemnity clause is drafted to survive termination, the client can claim for covered losses even after the contract has ended.
Drafting and Interpretation of Indemnity Clauses
The enforceability and scope of an indemnity depend on clear drafting. Courts interpret indemnities strictly, especially if the clause is ambiguous or unusually broad.
Key drafting points:
- Specify the events that trigger the indemnity.
- Define the types of losses covered (e.g., direct, indirect, legal costs).
- State whether the indemnity survives termination or completion.
- Include any exclusions or limitations on liability.
Revision Tip For SQE1, always check the precise wording of an indemnity clause and whether it is intended to survive contract discharge.
Worked Example 1.3
A business sale agreement includes an indemnity: "The seller shall indemnify the buyer for any tax liabilities arising before completion." After completion, the buyer discovers an unpaid tax bill from before completion and pays it. The buyer claims under the indemnity.
Answer: The buyer can recover the full amount of the tax liability from the seller under the indemnity, as the clause is expressed to survive completion.
Key Point Checklist
This article has covered the following key knowledge points:
- An indemnity is a primary contractual obligation to compensate for specified losses, enforceable as a debt.
- Indemnities are distinct from guarantees, which are secondary obligations triggered by a third party's default.
- Indemnity clauses may survive discharge of contract if drafted to do so.
- The main remedy for breach of indemnity is a debt claim; damages may be available if the sum is not fixed.
- Clear drafting is essential for enforceability and to define the scope of the indemnity.
Key Terms and Concepts
- indemnity
- guarantee
- frustration
- debt claim
- damages
