A fundamental role of many contracts is to set out the terms and conditions on which an ongoing relationship between two parties will be governed. For instance, this is the case in contracts between lenders and borrowers, suppliers and distributors, and even employees and employers.

It is very common, at one point or another in the contract that creates these ongoing relationships for one or more parties to insist on some kind of indemnity. And this should come as no surprise as indemnities are often critical aspects of a contract, giving one party the comfort they need to enter into a legal relationship with the other.

What is an Indemnity?

An indemnity, as its name suggests, is simply a promise to do something to protect another party in case things go wrong. Usually the “something” that the indemnifier is promising to do is to reimburse the other party the for amount of money they lost due to whatever went wrong. To use a simple example, consider the following:

A is a contractor working for B on a part-time basis. In their contract, A agrees to indemnify B for any losses to B resulting from A’s conduct, if that conduct falls outside of the scope of services A has agreed to provide to B. Conversely, B indemnifies A for any losses to A as a result of A’s conduct, if that conduct falls within the services specified in the contract.

In this, arrangement if A suffers a loss because it was doing what it had contracted to do, B will reimburse A for that loss. However, if B sustains a loss because A acted outside of the scope of its contract (for instance, by causing damage to B’s property outside of business hours), then A would repay B for that loss.

This is a simple example of a fairly balanced indemnity. The indemnity exists to provide a level of assurance that if a party breaches the contract or otherwise causes the other party to sustain a loss, the losing party should not be responsible for that. This of course is always subject to exactly what was agreed upon, as the scope of any indemnity will be the product of its circumstances, and particularly the legal relationship between the contracting parties.

One question that often comes up when discussing indemnities is, how does an indemnity differ from simply suing a party for compensation (a right which any party would have even without an indemnity). After all, the underlying principle of awarding damages is to compensate a wronged party for their loss. This sounds a lot like an indemnity, and indeed it is, but are important differences which make indemnities such critical elements of many contracts.

The key benefits of an indemnity are tied to the freedom that the parties have to negotiate just what an indemnity should say. To contrast this with the alternative (that is, suing in court), an indemnity allows the parties to negotiate exactly when and how much the other party will be compensated. They can determine what triggers the payment and how the amount of loss will be calculated.

Without an indemnity these matters would be left up to the courts to decide, whether a breach has occurred, and the resulting amount to be paid out will be judged by the courts according to established legal principles and rules, and parties will be held to standards that they perhaps would rather avoid, such as the duty to mitigate losses. An indemnity allows parties to avoid these rules, and gives them the freedom and flexibility to make these determinations themselves. Of course this can work against a party with limited bargaining power, but it should be noted that an indemnity does not prevent any party from suing in court, it simply adds another layer of protection for one or more parties.

Indemnities can be incredibly useful provisions, and when used properly they ultimately foster more frequent and efficient business deals by allowing the parties to make their own rules regarding who is responsible for what when things go awry, and thus giving all sides additional peace of mind.

This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact Hugues today.  613-747-2459 ext.304, [email protected]