Warranties and Indemnities are frequently misunderstood and taken to mean the same thing. What ‘they do’ is essentially allocate risk and cost from a legal perspective in commercial contracts.
What is an Indemnity?
An indemnity is a promise to reimburse the indemnified party where a particular type of known liability should it arise. They typically cover specific risks: long-term or peculiar risks e.g. environmental liabilities.
Indemnities are forward looking. They seek to allocate the cost where a particular thing or event happens. As such, no breach of contract is required to claim under an indemnity. All that is required is that the thing or event has happened. This makes indemnities a particularly powerful legal mechanism to have in one’s favour and should not be given lightly for that reason.
Where a party seeks to enforce an indemnity, it is a relatively straightforward process to obtain a judgement in court, akin to the enforcement of a debt. The judge will not be concerned with whether there was a breach of contract, all he/she will consider is whether the indemnified event has occurred and that party seeking the judgment has followed the procedure set down in the commercial contract.
For example, in most standard Software licensing contracts, the Licensor will indemnify the Licensee for any loss it may suffer based on a third-party IP infringement claim against the Licensee.
Also unlike a warranty an indemnity is not limited by a disclosure.
A warranty is a statement of fact by the seller to the buyer regarding the state of affairs of the product or service and the seller agrees to pay damages if this statement is untrue.
Warranties relate to the past or present state affairs.
For example, typical warranties found in a Software Licensing contract include the below.
- That the operation of the software will materially conform to the specification.
- That the software provided will not contain any viruses, worms, Trojan Horses.
- In some instances, the Licensor will provide an “interoperability” warranty whereas in others it will specifically exclude this warranty.
Warranties play an important role in commercial contracts and have the following below benefits.
- They help flush out the seller and encourage the seller to make disclosures (disclosures will help limit liability in respect of a warranty),
- They help identify specific liabilities that may result in a reduction in the purchase price or perhaps a specific indemnity in favour of the buyer.
- They help identify situations that may require corrective action.
- They allow for retrospective price adjustment and provide the buyer with a remedy if the value of the target is not “as warranted”.
Warranties and Indemnities are typically a heavily negotiated aspect of a commercial contract because they will set out what happens when things don’t go according to plan. For example, the buyer feels that it did not receive what it paid for. It should be noted that when considering allocating costs and risk in a commercial contract one must also look to the ‘Limitation of Liability’ clause found in most commercial contracts. In some cases, the Limitation of Liability clause will cap the maximum amount that can be recovered under a warranty and perhaps even under an indemnity.
It should also be noted that there is the option of utilising ‘Warranty and Indemnity Insurance’. Such insurance provides cover for losses arising from a breach of warranty and/or indemnity. It can be taken out by either the seller or the buyer and can give a certain level of comfort to a seller for example that it will not be hit with a large claim for breach of warranty or based on an indemnity claim in the future.
If you would like to learn more about the topics raised above, please do not hesitate to contact Dean Cunningham at firstname.lastname@example.org
The content of this article is provided for information purposes only and does not constitute legal or other advice.