Banking and Business Monthly – March 2022

Indemnity clauses are a common feature in contracts. Yet, despite their seemingly universal inclusion, indemnity clauses can exercise a disproportionate influence over the future of the parties in any given contract, particularly towards the indemnifying party (or indemnitor). Of particular note are indemnity clauses for a breach of the contract, which may needlessly shift additional risks to the potential indemnitor and can result in unintentional consequences.

But what is an indemnity clause? An indemnity is an obligation by one party, the indemnitor, to compensate the losses of another party (the “indemnitee”), resulting from either the indemnitor or a third party. Generally speaking, indemnity clauses for the acts of third parties are an uncontroversial feature of many contracts, as sellers and suppliers understand that assurances to a potential buyer to mitigate risks from outside forces are a necessary part of any commercial transaction. However, indemnity clauses between parties can lead to various problems that are often outside the control of the indemnitor, so an indemnitor should think carefully before allowing them.

There are several reasons for a potential indemnitor to avoid offering such a provision when contracting with other parties. Notably, an indemnity clause for breach of contract is often broad in its language, seeking to cover every possible breach by the indemnitor and to reimburse the indemnitee for “all losses.” Such sweeping language can leave the indemnitor on the hook for even the most minor, immaterial breaches. Such clauses may also create an unfair allocation of fault as well when both parties contributed to the breach, with the indemnitor being forced to shoulder all the costs, even if the breach was largely the fault of the indemnitee. Furthermore, when combined with warranties, such indemnity clauses can increase the risk associated with offering a warranty to the indemnitee, given the sweeping nature of these clauses.

Perhaps the most important reason for an indemnitor to avoid offering an indemnity clause, at least with respect to the indemnitor’s breach of contract, is that, from the perspective of protecting the indemnitee, it may not be necessary. People who seek indemnity clauses often do so under the belief that, if that sort of protection is not included within the contract, then they have no recourse in the event of damage or loss. What is often overlooked is that, if one party breaches a contract, then the other party has a cause of action against the breaching party. While claims for damages are often seen as inferior in terms of guaranteeing recovery compared to an indemnity clause, courts have developed various means of determining the appropriate amount of damages, whether in the form of the aggrieved party’s reliance on the breaching party, restitution, or even punitive damages if paired with an independent tort action stemming from the same set of circumstances, as well the overall fairness to the party seeking recourse. The methods are so deeply embedded into how courts adjudicate such disputes that often times those same standards are also used when adjudicating indemnity contracts or clauses.

That is not to say that indemnities should never be offered. Far from it, indemnification clauses are a necessary feature in contracts to protect one party from unfair losses or costs, and indemnity clauses for third-party claims are standard practice, as stated previously. If such an indemnity is purportedly non-negotiable, then there are steps you can take to protect yourself from unanticipated risks, such as requiring the indemnitee to mitigate its losses in the event of a breach, or adding qualifying language to address the indemnitee’s own acts and omissions. It should also be noted that Illinois courts, while permitting such clauses in contracts, tend to disfavor them and will interpret them strictly and against the indemnitee. See e.g. Bates v. Select Lake City Theater Operating Co., 78 Ill. App. 3d 153, 155 (1979) (“Indemnity agreements are not void, but are sufficiently disfavored that they must be strictly construed.”); Hankins v. Pekin Ins. Co., 305 Ill. App. 3d 1088, 1093 (1999) (“This court has recognized that an indemnity contract will not be construed as indemnifying one against his own negligence unless such intention is clearly and explicitly or unequivocally expressed in the contract.”). This gives potential indemnitors in Illinois some breathing room in the event such clauses are litigated. However, if you are a supplier or any other party that may need to indemnify another party, then you may want to avoid offering an indemnity covering your breach of the contract, since the non-breaching party may have a sufficient claim for damages in its breach of contract claim.

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