What If - Indemnity, Liability & Insurance
Why do we need indemnity and liability in a contract
Indemnity & Liability in a contract - image showing a book called The Fine Print
Credit - Unsplash
It’s important to remember while reviewing a contract that, out of the many purposes of a contract, an important one is to provide for the worst-case scenario - as to what happens when the parties cannot get along or one of them fails in their duties or promises. This leads us to a very important topic – repercussions, which can be of different types.
In this article we’ll focus on monetary repercussions – which brings us to the most complex topic of contracts. If you struggle with understanding indemnity and liability, worry not, you are not alone. Even the most seasoned contract experts have taken years to reach a level of expertise on these.
The very basics of Indemnity and Liability – your cheat-sheet
Let’s try and break it down to the basics:
(1) Simply put, if someone doesn’t do as they promise, we expect that:
a. One, they will be responsible for it, which is their liability
b. Second, we would be compensated for it, especially if we suffered due to it – that, is indemnity; at the same time, we don’t expect that someone will be responsible to an endless limit for all the consequences, down the chain or by ripple effect. To bring certainty into commerce and business, that liability usually needs to be limited to a certain extent, or boundaries drawn around it.
(2) Whenever you think of the word indemnify and get confused, replace it in your head by the word compensate:
a. Then check - is your client being compensated, or are they being made to compensate.
b. If they are being made to compensate, is that ok.
c. Is there a cap of liability to keep it under control.
d. Are the triggers too broad.
e. Is it for third party claims only, or anything else (this is an advanced topic and we will have more on this later)
f. If they are the ones receiving indemnity/compensation, is it sufficient, are the triggers too narrow.
(3) Whenever there is no limit of liability in a contract, that means that person’s liability is uncapped - this is worsened if there is an open or broad indemnity clause undertaking to pay compensations and claims.
a. So one of the first things to do on the liability topic is to search if your client’s liability is capped or not.
b. If there is a liability cap - does it apply to your client, or does it protect only the counterparty.
It’s possible to make it mutual, but depending on their respective roles and responsibilities, the risks on each party are different, hence this is not a recommended approach.
As always, ensure that you review keeping in mind which side of the table you/your client is sitting at.
Even without these clauses, each party has the right to go to the court and claim damages that it can show that have arisen out of breach, but having an indemnity/compensation clause in its favour in the contract helps show the intention of the parties, and also improve from the default position under the law. Similar effect for limitation of liability clauses.
The overlap between Insurance and Liability
Insurance - image showing a microscopic lens on top of an insurance policy
Image Credit - Unsplash
Insurance is when we try and cover risks that are high in financial exposure or likelihood by asking an insurance company to pay for claims to a certain extent. If the incident happens, it will reduce our exposure. If the incident doesn’t happen, we still pay certain amounts called premiums, towards covering that risk, and we are probably happy that those dreaded incidents did not occur.
There is a lot of confusion in the business world around insurance and liability. People sometimes think that taking insurance means liability is covered. They will quote the insurance limits (the maximum amount an insurance company covers) as a limit of liability.
While there is indeed a bit of an overlap, they are actually two separate concepts. Liability remains as per the contract and law irrespective of insurance. Insurance might just make it easier and bring in a level of comfort and certainty that the responsible party can probably rely upon the insurance company to pay out claims, while keeping in mind that it is not foolproof, since every insurance policy has exclusions from the scope of what it covers, and claims can be rejected as well.
These topics are heavily related. We cannot look at one without the other, especially liability and indemnity.
Of course these are very complex and nuanced concepts and the above is just a preliminary understanding, but the idea from this overview is really just that, when you start to review a contract, you should be able to identify these clauses – and then try and reduce and limit the situations in which you compensate the other party and are taking on liability, by including relevant limits and exclusions. I will write another post with examples soon.
Insurance if being promised to the other party should always be checked against the existing policies and remain within that framework, while insurance being obtained from the other party should be as comprehensive as possible.
If you want UAE Specific, do continue reading
The enforceability of such provisions in each country is different, e.g. in the UAE, the courts have the authority, as per the law, to change the limit of liability amount from the one decided in the contract. Which means that, a party suing here will have to work harder to prove the actual damages that have arisen from a breach, and also to show that it did not play a role in the breach. The party defending it will have to prove harder to stay within the limit of liability if it’s not reasonable as per the facts of the matter. Just mentioning an amount in the contract might not be enough.
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