Care Needed With Indemnity Clauses

Scotland

What is an indemnity clause?
 

In the construction world an indemnity clause is one which reallocates liability or risk for third party claims between Employer and Contractor or between Contractor and Sub-Contractor. In PFI contracts they exist throughout the contractual chain - between the Authority and the project company and between the project company and the facilities management contractor.



How does an indemnity clause operate?
 

Take two examples of indemnity clause wording:-


 

A agrees to indemnify B against any claims, damages, costs, howsoever arising out of the non-performance of the heating system...


 

OR


 

A agrees to indemnify B for any loss or damage suffered by B as a result of any act, omission or negligence of A.


 

These are two very different indemnity clauses with different effects.


 

The first would appear, on a plain reading, to be an indemnity clause which operates regardless of fault on either party, i.e. the party granting the indemnity or the party in receipt of the same (the indemnitee). Do the words “howsoever arising” mean that this clause would be interpreted so broadly that regardless of the cause of the non-performance of the heating system, A has to indemnify B for any losses that might arise as a result? What if the reason for the non-performance of the heating system is, in fact, the negligent maintenance of the same by B? Would the indemnity clause still operate? This is contrasted with the wording of the second example where the indemnity covers much narrower circumstances.


 

In the first example, as indemnity clauses are treated as a brand of exemption clauses they are interpreted strictly against the party in whose favour they operate, the clause would be interpreted in favour of the indemnitee. In Smith v- UMB Chrysler (Scotland) Limited 1978 1WLR 165 HL the Court had to consider whether an indemnity clause could be operated in the face of a negligent indemnitee. Chrysler relied upon an indemnity clause within a contract they had for maintenance of its electrical equipment whereby an electrical fitter employed by the maintenance company was seriously injured as a result of negligence on the part of Chrysler. The fitter sued Chrysler which brought in the maintenance company. The wording of the indemnity was “the supplier (the maintenance contractor) will keep the purchaser (Chrysler) indemnified against:... (b) any liability, loss, claim or proceedings whatsoever under statute or common law...”.


 

The House of Lords found that Chrysler could not rely upon such an indemnity as the indemnity clause did “not cover, either expressly or by necessary implication, the consequences of their own negligence.”. In doing so, they relied upon a 3-test formula which had been advanced firstly in the case of Alderslade v Hendon Laundry Ltd [1945] K.B. 18Canada Steam Ship Lines Limited v The King [1952]9 and restated in A.C. 192 as follows:-


 

1.If the indemnity clause contains language which expressly exempts the person in whose favour it is made from the consequence of his own negligence or those of his servants, it must be given effect to.
2.If there is no express reference to negligence, the Court must consider whether the words used are wide enough in their ordinary meaning to cover negligence on the part of the indemnitee or its servants.
3.If the words used are wide enough, the Court must then consider whether the head of damage may be based on some ground other than that of negligence. If the head of damage could be based on some ground other than negligence it will be fatal to the argument that the clause covers the consequences of negligent acts.

 

The Court did go on to state that the indemnity clause must be read together with all other parts of the contract to assist in establishing its meaning. If other clauses pointed to the indemnity having such a wide application that would support such an interpretation. However, in the absence of any such assistance it was necessary that the clause pass the three test formula. In Smith v UMB Chryslerwhatsoever the reference to the term “any liability, loss, claim or proceedings " (emphasis added) was considered insufficient language in itself to expressly include the consequences of a party’s own negligence.


 

As a result of this line of authority, the wording of indemnity clauses has become increasingly detailed. Some clauses will specifically exclude from the indemnity clause’s application any consequences arising from the negligence of the indemnitee. Others may expressly include the same. The extent to which the party granting the indemnity has agreed to obtain insurance for such risks may assist in determining the ambit of the indemnity.


 

To read the full article including details on recovery of claims and losses, settlement sums and the costs of successfully defending a claim, click here.


 

For our tips on drafting indemnity provisions click here.