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There will be an indemnity clause in most contracts you sign. Indemnities are essentially a clause in a contract that will protect one party at the other party’s expense to the contract. Indemnity clauses are commonplace in contracts and parties use them to encourage contract formation. However, it is not always a good idea to have broad indemnity clauses. This article will outline why you should limit indemnities in New Zealand contracts.

What is an Indemnity?

An indemnity is a legal clause in a contract that requires one party (‘the indemnifier’) to compensate another party (‘the indemnified party’) for a loss incurred during the contract. You can add an indemnity clause to contracts and ut will alter the standard legal approach. Usually, a party will only be liable for the loss it causes. However, an indemnity clause shifts that liability to the indemnifier. Indemnity clauses are helpful as a party is more likely to sign a contract if it covers them in the case of loss.

What Are the Different Types of Indemnities?

The three main types of indemnities are:

  • a standard indemnity that covers any loss that is incurred by performing the contract;
  • an indemnity that covers any claims by third parties; and
  • an indemnity that covers any loss because of a breach of the contract.

However, these indemnities must be limited in order to make sure indemnifiers are not overly exposed.

Reasons to Limit Indemnity Clauses

Indemnity clauses are helpful. However, their scope can sometimes make you liable for things that a standard breach of contract would not cover.

Liable for Loss Unconnected to Contract Breach

One reason to limit an indemnity clause is to make sure that you are not liable for loss or harm that is so far removed from any potential contract breach. For example, limiting an indemnity may exclude liability for any mental stress caused by a breach of contract. This is because that harm would be considered too remote. Also, indemnities can be so broad that they make indemnifiers liable for costs, even if there has been no breach of contract.

Indemnifier Required to Cover Loss

Another reason to limit indemnity clauses is that it could require an indemnifier to cover a significant loss. This is because, under a breach of contract between two parties, the party who is suffering the loss must do everything they can to mitigate any further losses caused by that breach of contract. However, any party that is indemnified is under no such obligation to mitigate their loss. This means you could be liable for losses that you could have easily prevented. 

This is why you should limit your indemnity clause so that any loss you pay is either: 

  • capped at a monetary limit; or 
  • for a certain term after the loss was first reported.

Compensate for Third Party’s Loss

You should also limit your indemnity clause as it could force you to compensate the other party for loss that either party to the contract did not cause, but rather a third party. For example, a third party may damage goods. If the indemnity clause does not limit the scope of the indemnifier, they could be liable to pay for this. Therefore, it is important to outline exactly what the indemnity clause should cover.

Loss Suffered a Long Time Ago

Finally, limiting an indemnity clause will also mean that you will not be liable to cover costs for a loss that you suffered a significant amount of time before making a claim. A standard indemnity clause may allow the indemnified party to claim loss a long time after it may have actually incurred. They may still be able to recover even if the contract is not active anymore.

Key Takeaways 

An indemnity clause is a great way to cover parties for any loss in a contract. The reason why parties use indemnity clauses is to encourage a party to enter into a contract. Additionally, they can alter standard contract law so that a party is liable for damage they or anyone else causes. However, how far an indemnity clause goes is dependent on how the contract limits it.

An indemnity clause could cover loss for third party damage if there are no alterations to the clause to prevent this. It could also mean a party is liable for any loss that is so far removed from the original breach. An indemnity clause does not require a party to mitigate any further losses that may incur as a result of an initial loss. Indemnifiers may then be liable for preventable loss, which could be significantly high. A party can also exercise indemnities any time after they incurred the loss. This means an indemnifier may be liable years after the loss has actually occurred. If you need any legal assistance with indemnity clauses, contact LegalVision’s contract lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

How far can I limit an indemnity clause?

You can limit an indemnity clause as much as you want, but the indemnified party may not sign the contract if it is limited too much.

How much of a loss can an indemnifier be liable for?

If the scope of an indemnity clause is not limited, then you could be liable for the whole extent of the damage.

Do I have to include an indemnity clause in a contract?

No, it is not a requirement but rather a way of encouraging parties to sign the contract as they know their losses will be covered.

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