Indemnities can significantly increase the risk to your client

Corporations are increasingly using standard form agreements to conduct business with suppliers. If your client is faced with one, watch out for the inclusion of an unlimited indemnity.

A standard form agreement provides several benefits to the corporation that drafts it. First, management and the corporation’s lawyers predetermine what terms and level of risk the corporation will accept. Second, it eliminates the need for protracted contractual negotiations. Third, it minimizes legal costs associated with negotiations. If the standard form agreement is accepted, further legal review by the corporation’s lawyers will not be required.

But a standard form agreement often contains terms that aren’t commercially reasonable for a supplier. If the agreement contains an indemnity, signing it may significantly increase the risk to your client.

Consider the general measures of damages (in Ontario) for: (a) breach of contract, which is the amount of money that would place the plaintiff in the position that the plaintiff would have been in had the contract been performed; (b) a tort, which is the amount of money that would place the plaintiff in the same position as if the tort had not occurred.

Regardless of whether a breach of contract or a tort is involved, not all damages are recoverable in Ontario. Courts award damages to a plaintiff that are reasonable, are not too remote, and are based on legal precedent.

For example, while damages directly flowing from a breach of contract are recoverable, pure economic loss usually isn’t. Likewise, tort claims for lost profits, lost sales, reputational harm, etc. are difficult to obtain because of a multi-step legal test applied to the plaintiff. Reasonable steps must be taken to mitigate losses or the damages may be denied.

A contractual indemnity typically waives all these safeguards. The corporation will be indemnified against all losses and damages suffered or incurred as a result of the acts or omissions by your client as described in the indemnity.

If an act or omission triggers a contractual indemnity, an insurer could be faced with losses up to policy limits for a relatively minor claim. The extent of damages could be managed by a limitation-of-liability clause. Unfortunately, such clauses in standard form contracts often don’t apply to the indemnity.

And efforts by your client to delete an indemnity provision from its customer’s standard form agreement, or to insert a limitation-of-liability clause, may result in a “take it or leave it” offer from the customer. Given the strong negotiating position larger customers possess, they often demand unlimited indemnities from their suppliers.

A contract which includes an unlimited liability provision signals additional risk and requires the attention of brokers, underwriters and risk managers.

A broker should consider whether the acts and omissions covered by a contractual indemnity are included or excluded under the client’s policy. A contract with unlimited indemnity may require the consent of the underwriter to be covered. If the unlimited indemnity is covered by the policy, does the insured have sufficient coverage limits? If not, the unlimited indemnity puts the viability of the insured’s business at risk.

Underwriters who are advised of unlimited indemnities should assess the extent of risks, and whether the contract effectively extends the policy to the company receiving services from the insured. Plus, risk managers at the supplier should review their systems to try to prevent a breach that would give rise to a claim.

Unlimited liability clauses deserve special attention. Clients may be inclined to accept risks associated with an unlimited indemnity, but the extent of the risk needs to be explained, the risk needs to be assessed and managed, and the financing needs to be considered.

It’s prudent to review the contract with professional advisors. Canadian courts regularly uphold indemnities which exceed typical damages for breach of contract.

 

Indemnity clauses are complex, and this article is not intended to be legal advice. Michael Carey is a corporate commercial lawyer in Toronto with over 20 years of experience in insurance law and the drafting and negotiating contracts. He can be reached at mcarey@msmlaw.ca. This article is excerpted from one that appeared in the November 2021 edition of Canadian Underwriter.

Feature image by iStock.com/ridvan_celik