Many contracts strive to cap financial liabilities but often overlook the necessity of capping indemnities. This oversight is akin to leaving your car windows down during a rainstorm—inviting trouble!
Understanding Indemnities
Indemnities often cause confusion, partly due to convoluted language in contracts. For instance, you might encounter, “The indemnifying party indemnifies the indemnified with indemnities.” What does that even mean?
In simple terms, an indemnity is a promise within a contract to compensate the other party if something goes wrong in the business relationship. Imagine if the other party accidentally leaks sensitive information to your competitors, resulting in financial loss. Naturally, you would want compensation. That compensation is what an indemnity covers.
A Practical Example
Consider a scenario where Jane uses software from Bob that infringes on Alice’s intellectual property rights.
Jane gets sued by Alice!Shouldn’t Bob cover Jane’s legal costs and damages?
Many companies seek to include indemnities in their contracts to secure faster financial compensation compared to pursuing a breach of warranty in court. However, if you are a supplier or service provider, uncapped indemnities can pose significant risks. It’s crucial to limit this exposure in your contracts.
Can Liability Be Limited?
Absolutely, capping liability is a common practice in commercial contracts. Yet, this might not fully protect you...
Does a Liability Cap Include Indemnity Claims?
This is where things become complex. The classification of an indemnity as either liability or debt depends on the contract's wording. If a court determines your indemnities are debt, and only your liabilities are capped, you could face unlimited claims.
Is this fair? Certainly not. This is why meticulous wording in contracts is invaluable, often justifying the cost of hiring a skilled lawyer. A good lawyer ensures your contract doesn't leave you vulnerable.
When Indemnities are Viewed as Debt
Courts might interpret indemnities as money owed, thereby classifying them as debt. This distinction is significant since indemnities are typically paid out more quickly than liability claims. To avoid this, ensure your contract clearly states that both liabilities and indemnities are capped. Some contracts limit indemnities separately without considering the overall liability cap, which can be problematic.
Revisiting Jane and Bob’s Contract
Suppose Jane agrees to indemnify Bob for any data protection breaches.
One day, Jane breaches data protection protocols, resulting in damages worth £100k—ouch!
Jane owes Bob this amount, classifying it as a debt.
However, if elsewhere in the contract it states that Jane and Bob's liabilities are capped at £50k, a dilemma arises.
Should Jane pay Bob £50k or £100k?
Arguments exist for both sides, but the risk is that courts might rule the debt is not subject to the liability cap. To avoid this uncertainty, the contract should specify that “this indemnity is subject to a cap of £xxx.” Such a straightforward solution is often overlooked.
Crafting a Solid Contract With Cloud Contracts 365
Navigating indemnities can be challenging. Even with a stated cap on indemnities, there’s no guarantee courts will uphold it (hopefully, you'll never have to find out).
The best approach is to utilise a tool like Cloud Contracts 365, which offers a comprehensive contract builder, manager, and reviewer.
Cloud Contracts 365 not only helps you draft contracts but also highlights potential risks, ensuring that your indemnities and liabilities are clearly defined and capped.
This way, you can protect yourself from exposure to unfair and unforeseen claims without the need for constant legal intervention.