CONTRACTS: THE IMPORTANCE OF INDEMNITY

(A) WHAT IS CONTRACTUAL INDEMNITY? To provide indemnity, or to promise to indemnify, is to create an obligation to reimburse the other party in full if a particular event happens and the other party incurs a loss as a result. This is sometimes called ‘to make good’ a loss. It means to compensate all of the loss, not just part of it.

(B) WHY ASK FOR INDEMNITY UNDER A CONTRACT? From the point of view of a buyer under a contract, for example, the seller’s agreement to provide indemnity is reassurance that buying a particular asset, such as land, a company, shares, equipment, etc. will not involve a significant financial risk after completion. Imagine that a single-member company with one issued share is selling that share for £750,000. The buyer asks the seller to warrant that the target company is not involved in any unresolved litigation. This is important because the buyer will become liable for paying any settlement amount, damages, and maybe even legal costs, as a result of that litigation if it is resolved only after completion. Let’s say that the seller is unable to provide that warranty because the company is involved in three court cases at the time of the sale. The company is the claimant in one case and the defendant in the other two. The buyer now has a number of choices about what to do next. He or she can • buy the company anyway, and accept the risk; • calculate a reduced price based on the probable cost of the litigation in a worst-case scenario, for example, £400,000 instead of £750,000; or • offer the agreed price and ask the seller for indemnity. If the buyer chooses to ask for indemnity, the promise the seller must give is something like: ‘If you buy the company and the court cases cost you £350,000, I will pay you exactly £350,000. If the court cases cost you £500,000, then I will pay you £500,000. My promise is, for every £1 you lose, I will pay you £1.”

Lawyers sometimes call indemnity a “pound for pound” promise of compensation. A warranty, on the other hand, is a statement of fact, a statement that something is true, such as “there is no unresolved litigation”, which will allow the buyer to claim for damages if the statement is not true and the buyer suffers a loss as a result. In the UK, a claim for breach of warranty does not usually result in the claimant receiving full reimbursement of a loss in the way that a claimant under an indemnity does. Some lawyers say that a breach of a warranty resulting in loss leads to a claim, but if a loss occurs under a promise of indemnity then that situation creates an enforceable debt. Of course, the value of an indemnity is completely dependent on the indemnifier’s ability to pay. The recipient of the indemnity therefore needs to consider whether the indemnifier should be required to take out insurance.

(C) THE TRIGGER EVENT In the above example, the seller’s promise to indemnify the buyer can only be enforced if a certain event happens, in this case, the buyer losing in court and being ordered to pay damages, incurring legal costs as a result of defending a case, or the court ordering the target company to pay the legal costs of the other side. When lawyers discuss indemnity, they refer to this as ‘the trigger event’. This is because the event sets in motion the process of enforcement under the indemnity provision in the contract. The trigger event can be anything defined by the parties. This can include acts, omissions, negligence, a breach of contract or a specific risk, such as the cost of litigation as in the example above. Most lawyers would try to limit any promises of indemnity on the part of their clients, partly because recovering a loss under an indemnity is relatively easy compared to recovering a loss for breach of a warranty. So, while some law firms or company lawyers take the position of “we do not offer indemnity at all”, other lawyers will ask for indemnity for practically every loss that might arise under a contract.

This Environmental Indemnification Agreement (the “Agreement”) is entered into effective as of 7 January 2019 (the “Effective Date”), by and between Chatsworth and Bourne Real Estate plc, (the “Seller”), and Rose Bennington Estates Limited (the “Buyer”).

RECITALS WHEREAS, the Seller currently owns that certain (1) ….. located at 457 Paddington Road Chatsworth, England, which is described in the attached Schedule “A” (the “Property”);

WHEREAS, various historic activities and practices (2) ….. at the Property, including the operation of a “dry cleaning facility” involved the use of (3) ….. substances, including, without limitation, chlorinated solvents such as “dry cleaning solvent”;

WHEREAS, these historic activities and practices at the Property, including the operation of a “dry cleaning facility,” underground storage tanks, and a wastewater (4) ….. system and tanks, have caused the Seller’s Environmental (5) ….. as defined in clauses 12-25 hereinafter to (6) ….. at the Property;

WHEREAS, the Seller has agreed to provide an (7) ….. to the Buyer in relation to certain environmental liabilities as set forth in this Agreement.

SELLER’S INDEMNITIES (a) The Seller shall (8) ….. the Buyer, together with the Buyer’s respective directors, officers, employees, partners, members, shareholders, representatives and agents, even though caused in whole or in part by a (9) ….. defect, from and against claims, losses, lawsuits and legal fees (10) ….. from the Retained Liabilities.

DISCUSSION POINT • Does the concept of indemnity exist in the same way in your legal system to protect the buyers of certain assets from risk after completion?