15 Jul 2014, by Brett Saal at Saal & Associates Lawyers
Most contracts will include some form of either or both a warranty and an indemnity being given by one party to the other. It seems likely that contracts are signed without the party giving the warranty or indemnity thinking much about the obligations being imposed by those provisions. This article is intended to provide a quick overview of the commitments being undertaken by giving either or both a warranty or indemnity.
Essentially, a warranty is a guarantee that a factual statement is correct. In commercial contracts, warranties often become an issue when it comes to latent conditions.
In a contractual situation, a warranty is very important because it can lead to a breach of the contract. The general rule where a party breaches a contract is that the “innocent” party is to be put in the same position as it would have been had the breach not occurred. If the factual statement turns out to be incorrect, it immediately puts the party that has given the warranty in a position where it has breached the contract.
In a civil works contract, the Subcontractor may warrant that the subsurface conditions are of a particular nature. Sometimes, it will be the Contractor, the principal or owner that has undertaken some testing and the Subcontractor has not carried out any such testing, yet is obliged to provide the warranty. Upon commencing works, it has been known that parties have found granite or other subterranean problems. Granite can require blasting to clear, with delays to other project works whilst the blasting takes place and there can be further significant costs in moving the blasted rock.
In this situation, the Subcontractor can be liable for the costs of blasting, removal of the rock and any delays caused to the project by the need for blasting and removal of rock. Those costs can range from significant to ruinous.
Party A has given a warranty that a design does not infringe anyone else’s intellectual property rights. If that is untrue, then it would be liable for any amount that Party B has to pay for a breach of the intellectual property rights. Such a breach could be trivial, or it could be many millions of dollars.
The difficulty with this particular type of warranty is that Party A has no clear or intelligible way of calculating the risk that is associated with giving the warranty.
A warranty is generally considered to be either a condition or an intermediate term of a contract. The breach of a condition allows the “innocent” party to terminate the contract. Whilst a little bit more obscure, at least in the way it works in practice, a sufficiently serious breach of an intermediate term can give the “innocent” party a right to terminate the contract.
Thus, a breach of a warranty may not only entitle the “innocent” party to claim damages, it may entitle it to terminate the contract.
Warranties given in a contract are also likely to be representations for the purposes of the Australian Consumer Law. That law allows damages to be awarded for any false or misleading representation. Virtually by definition, if the statement of fact for which the warranty has been given is incorrect, the party giving the warranty will have made a false representation and be liable for any loss suffered by the other party under the Australian Consumer Law.
When giving a warranty, you should try to restrict it to matters that are within your actual knowledge at the time that the warranty is given, i.e. at the time of signing the contract.
A party that is the beneficiary of a warranty obviously wants it to be as wide as possible and as unconditional as possible. This gives that party the most protection. Therefore, for example, it might not want a warranty limited to matters that are within the other party’s actual knowledge.
On the other hand, one must consider the message that is being sent by demanding a warranty about facts that are not within the other party’s knowledge. Does this send a message that the party demanding the warranty is acting fairly and in good faith? Does it engender trust between the parties?
Fairly obviously, the only reason for including warranties in a contract is to be able to rely upon them in the event that the facts for which the warranties have been given are untrue. In our view, to demand that the other party to the contract give a warranty that a particular fact is true when it has no way of knowing whether the fact is true or not, does not seem fair and can only engender distrust.
A party should not shy away from seeking a warranty where it is appropriate and the other party is clearly in a position to know the truth of the fact for which the warranty is given. However, to seek a warranty in relation to matters that the other party is not in a position to know whether the fact is true or not can send a message that you are out to protect yourself by fair means or foul.
Indemnities are serious. What an indemnity does is for the person giving it to offer to accept the consequence if a particular event occurs. The event does not need to have been caused or contributed to by the person giving the indemnity. It can have been totally the fault of the person to whom the indemnity is given. In that regard, it is essentially an insurance policy. The person giving the indemnity is essentially saying, “If X happens and you have to pay any money because of it, then I will pay you the amount that you have to pay”.
Most contractual indemnities operate between the parties. Party A seeks to be indemnified against any loss or damage that Party B might suffer because of any breach of the contract by Party A. The aim of the indemnity is total protection. As one judge put it in the context of the delivery of goods, Party A (the beneficiary of the indemnity) wants to be able to deliver what it wanted, when it wanted and in whatever condition it wanted and not be liable if what it delivered was not what had been ordered, was not delivered in time or was not in a condition to be used.
Put that way, the indemnity seems unfair. However, they are a legitimate device and, if properly expressed, the Courts will, if sometimes reluctantly, enforce them.
One small saving grace is that if an indemnity is ambiguous, the indemnity itself is to be construed in favour of the party giving it. Generally, this will mean that will be construed in such a way that it limits the liability of the person giving it. However, the Court will not go out of its way to find that an indemnity provision is ambiguous. If it is in good, clear English, it will be given its natural meaning.
The Court has held that it is not unreasonable for a party to seek and obtain an indemnity for its own negligence. Nor will the court “rewrite a provision to avoid what it retrospectively perceives as commercial unfairness of lack of balance”.
If you have to give an indemnity, you should attempt to limit the extent of the indemnity, e.g.
Another issue is that, if a claim is made against the indemnified party, does the indemnifying party wish to be able to take control of the claim and any legal proceedings. If so, it is probably necessary to include provision for the indemnifying party to be given notice of any claim that is made and the power to defend such claims.
The beneficiary of an indemnity will want it to be as wide and all encompassing as possible. To that extent, it will want the reverse of the matters set out above.
However, as with the matter of warranties, you should consider what message is being sent if you seek an indemnity that essentially means that the other person has no claim whatsoever against you for any loss that it might suffer because of your actions or negligence. Does this send the right message, e.g. that you will treat the party giving the indemnity fairly and take responsibility for one’s actions etc.?
It is not clear that any particular insurance policy will cover the risk associated with an indemnity that has been given. Thus, whilst it is normal for companies to take out public liability policies in relation to work that they intend to carry out, such policies normally insure the person for things that the person does or does not do. In essence, the insurer is providing the insurance for a risk that the insured person can, at least to some extent, control.
It is not immediately obvious that a standard insurance policy would insure a person for damages suffered by a third person because, for example, the negligence of the other party to a contract and without there being any negligence on the part of the insured person. However, if the insured person has given the other party to a contract an indemnity in relation to death or personal injury arising out of or in connection with the contract works, he or it may be liable under the indemnity.
We do not know if any insurance company provides a policy of insurance that provides insurance cover for the risk that arises from the giving of an indemnity to another party. This is something that you may wish to investigate, both whether your standard policies provide such cover and, if not, whether any policy that covers the liability created by the giving of an indemnity can be taken out.