Indemnities in outsourcing agreements

Liability provisions are always a topic of discussion in outsourcing agreements (after all, all roads lead to Rome in the sense that the liability clause is where the parties will end up looking in the event that things go seriously awry). Other than just the amounts of the liability caps themselves, another aspect of these clauses which tends to get a significant amount of attention is the scope of the indemnified losses….but why is this so?

The first thing to note is that indemnities are creatures of contract drafting – they do not exist as a matter of statute or regulation. They will therefore "mean" whatever the relevant contract provisions say that they mean, but in common law jurisdictions at least, this interpretation can be backed up by a history of case law and binding precedent.

Under English law at least, we can see the following distinctions between a damages claim and an indemnity claim:

Damages Claim

o    Basis: A damages claim arises when there is a breach of contract (ie one party must be "at fault").

o    Purpose: The aim is to compensate the injured party for the loss suffered due to the breach, i.e to put them in the position which they would have been in, had the contract been properly performed.

o    Timing: Can only be claimed after a breach has occurred.

o    Mitigation: The claimant must mitigate their losses as a matter of common law, meaning they must take reasonable steps to reduce the damage and cannot simply "sit back" and let the losses accumulate.

o    Scope: limited to losses claimable according to the Hadley v Baxendale principles of recoverable contractual losses

Indemnity Claim

o    Basis: An indemnity claim is a contractual promise to compensate the indemnified party for the indemnified loss or damage, regardless of whether a breach has occurred or whether the indemnifying party has actually done anything "wrong".

o    Purpose: To put the indemnified party in the position they would have been in had the loss not occurred.

o    Timing: does not require any particular contract breach to have occured, as long as the loss falls within the scope of the indemnity (ie if the relevant trigger event or circumstance has arisen).

o    Mitigation: There is generally no obligation for the indemnified party to mitigate their losses (arising from a line of cases which characterise indemnity claims as a form of enforcement of a debt…albeit that there is some conflicting case law in this regard).

o    Scope: can cover a broader range of potential losses, depending on the drafting of the relevant clauses

If we were rendering this down to brass tacks, it would be simplest to say that the quantum of an indemnified claim is likely to be greater than under a damages claim.

So when do they arise in an outsourcing context? There are two types of loss which are almost ALWAYS indemnified, namely:

·         IP infringements; and

·         The pre-existing employment related liabilities of personnel whose contracts of employment transfer automatically by virtue of TUPE/ARD

Even here, though, there will be room for negotiation and differences in drafting. For an IP indemnity, for example, will the indemnity only cover amounts payable to third party claimants, or will it also cover other costs and losses incurred by the indemnified party connected with or by reason of such third party claim?

Outside of those two perennial examples, we see various other forms of indemnity sneaking into outsourcing agreements. They may for example cover breaches of confidentiality, breaches of law or regulation, or breaches of specific provisions (such as IT security obligations or data protection commitments). At the most aggressive level, they might be drafted so as to cover ANY breach of a warranty or representation (which – when coupled with a warranty to utilise reasonable skill and care in the provision of the outsourced services – would likely be enough to ensure that ANY claim against the relevant service provider arising from any defective elements of the services would likely be an indemnity claim rather than a damages claim).

However, it is important to note that the negotiations do not finish just with the scope of the indemnities. It is essential to also consider how those provisions interact with the other provisions in the outsourcing agreement, including:

·         Who has conduct of the defence and/or settlement of the indemnified claim?

·         Is the indemnified claim still within the ambit of the relevant limits of liability, or is the indemnified loss claimable on an unlimited basis?

·         Similarly, do any of the contract exclusions (such as those regarding indirect loss, loss of profit/revenue etc) apply to indemnity claims in the same way that they apply to claims for damages?

The drafting of these ancillary provisions can then make a massive difference in the practical impact of the indemnified losses.