Indemnities: a debt or damages claim?

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When asked to identify the distinguishing features of an indemnity, most practitioners will immediately comment that an indemnity is a debt claim and therefore not subject to the principles of general damages (i.e. mitigation and remoteness of loss). But is this generalisation correct?  In 2015 we benefited from an unusual high number of cases dealing with the issue of indemnities. This instalment on interpreting contracts tackles the potentially contradictory case law and considers firstly, the key issue of whether an indemnity gives rise to a debt or damages claim, and secondly, good practice for drafting indemnity clauses.

Introduction

When drafting an indemnity clause one should always remember that outside the realm of insurance, there is no “law" of indemnity as such, and the meaning of each indemnity clause will be judged on its own facts and circumstances (Total Transport Corp. v Arcadia Petroleum Ltd (The Eurus) [1998] 1 Lloyd’s Rep 351) and the merits (or de-merits) of its own construction. To that end, a draftsman should always be acutely aware that when it comes to indemnities, he or she will either be the author of their own success, or the author of their own demise.

Remoteness of loss and mitigation

Whether an indemnity gives rise to a debt or a damages claim will have a significant impact on the indemnified party’s ability to recover under that indemnity. For instance, if an indemnity is construed as a debt the principles of remoteness of loss and mitigation will not apply, making it far easier for the indemnified party to recover its loss. A detailed analysis of the principles of remoteness of loss and mitigation are beyond the scope of this article but can be summarised as follows:

  • Remoteness of loss

A loss will only be recoverable if it was in contemplation of the parties, that is, it was foreseeable at the time of contract (Hadley v Baxendale [1854] 9 Exch 341). Further, the loss must be foreseeable not merely as being possible, but as being “not unlikely” (Koufos v C Czarnikow Ltd (The Heron II) [1967] UKHL 4). It is not the precise circumstances that occur that must be foreseeable, but rather the type or kind of loss (H Parsons (Livestock) Ltd v Uttley Ingham & Co Ltd [1977] EWCA Civ 13).

  • Mitigation of loss

A party must take reasonable steps to mitigate their loss. A party cannot recover loss which it has either avoided, or which it should have avoided, had it taken reasonable steps to mitigate its loss.

For a party seeking to recover its losses under an indemnity, it is clearly beneficial for remoteness of loss and mitigation to be dissapplied as these will not only narrow the scope of what can be recovered but also provide a defence for the indemnifying party.

Indemnity – a claim for a debt?

The principle that sums due under an indemnity are recoverable as a debt found favour in the case of Royscot Commercial Leasing Limited v Ismail (1993), in which the Court of Appeal held that:

“a claim under a contract of indemnity, such as this, is not a claim in damages at all, but is a claim in debt for a specified sum due on the happening of an event which has occurred. Accordingly, it should not be open to a person providing an indemnity to challenge his obligation to pay under the contract of indemnity by reference to principles relating to the assessment of damages for breach of contract which have no application to debts.”

This approach was also applied by the High Court in the case of Codemasters Software v Automobile Club de L’Quest [2009] 3194 (Ch):

“The law, so far as I am concerned, is therefore that questions of mitigation do not arise under contracts of indemnity” (per Mr Justice Warren paragraph 32).

More recently Flaux J, in ABN AMRO Commercial Finance plc v Ambrose McGinn, Ross Lawrance Beattie, Marcus Leek [2014] EWHC 1674 (Comm), similarly concluded that mitigation is not a relevant consideration under a claim for a contract of indemnity. In this case, the claimant was a factor and had purchased the entire debts of the defendants’ company. The defendants were directors of the company and had provided personal indemnities in favour of ABN AMRO, as part of the arrangement for ABN AMRO to purchase the company’s debts. ABN AMRO used a debt collection company to recover debts owed to the company and, over a two year period, managed to recover in excess of £5.5 million but this still left a balance of over £18.5 million in uncollected and disputed invoices. The company later entered administration and the company’s administrators acknowledged that the company was indebted to ABN AMRO for nearly £9 million.  ABN AMRO therefore sought to call on the personal indemnities of the directors in order to recover the loss. The defendants argued that ABN AMRO could have, and should have, collected more debts than they actually did and, as a consequence, they failed to properly mitigate their losses under the contract of indemnity. Prior to considering the issue of whether ABN AMRO had properly mitigated its losses, the court first had to consider whether ABN AMRO was actually under a duty to mitigate or not.  If the indemnity amounted to a debt claim, as contended by ABN AMRO, the duty to mitigate would never arise.

Flaux J concluded that there was no duty for ABN AMRO to mitigate its losses as a “failure to collect debts does not give rise to a defence of failing to mitigate under a contract of indemnity.” In his judgement, Flaux J relied on the authorities of Codemasters Software v Automobile Club de L’Quest [2009] EWHC 2361 and Royston Commercial Leasing Ltd v Ismail (29 April 1993).

The essence of a debt is that the amount being recovered is for a specified sum (per Hirst LJ Royston Commercial Leasing Ltd v Ismail (29 April 1993)) and consequently, the amount can be determined without further investigation as to quantum. Where the sum to be recovered under the indemnity is for an indeterminate sum, the court will usually treat this as a damages claim and apply the principles of remoteness of loss and mitigation to ascertain the amount to be recovered. So how was the indemnity in the ABN AMBRO case categorised as a debt when the indemnity was for an indeterminable sum (i.e. “all losses you may suffer”)?  

Flaux J’s judgment does not directly address this issue but one assumes that the presence of a conclusive evidence clause was adequate to allow the court to conclude that the loss was sufficiently quantifiable. The conclusive evidence clause in the contract of indemnity stated as follows:

“For the purpose of determining my liability under this Indemnity I shall be bound by any acknowledgement or admission by the Company and by any judgment in your favour against the Company. For such purpose and for determining either the amount payable to you by the Company […] I shall accept and be bound by a certificate signed by any of your directors. In any proceedings such certificate shall be treated as conclusive evidence (except for manifest error) of the amounts so payable…”

Although this article specifically deals with indemnities, the fact that a conclusive evidence clause was upheld by the courts is, in itself, significant.

Indemnity – a claim for damages?

Also in 2015 the case of Durley House Limited v Firmdale Hotels plc [2014] EWHC 2608 (Ch) came before the High Court. In that case the claimant let property from a third party (the “Lessor”) who then sub-let the property to the defendant. Under the sub-lease between the claimant and the defendant, the defendant was obliged to pay the rent direct to the Lessor, rather than to the claimant. Under the lease agreement between the claimant and the Lessor, the claimant was liable to the Lessor for the rent. The relevant clause of the sub-lease imposed two obligations on the defendant: firstly to “bear” all operating expenses (including but not limited to “rent”); and, secondly “to indemnify and keep indemnified” the claimant against all such expenses.

The defendant failed to pay rent to the Lessor and the Lessor served a statutory demand for the rent on the claimant. At the time of this demand, the claimant owed substantial sums to the Lessor and following non-payment the Lessor subsequently brought possession proceedings, after which, the lease was forfeited. The Lessor obtained judgment in those proceedings for arrears in rent of £2,129,830 (plus interest and other continuing costs). The claimant’s only asset was the lease and the claimant became insolvent. The claimant then began proceedings against the defendant to recover the outstanding rent under the indemnity. Whilst there were a number of issues for the judge to consider (such as when liability arises under an indemnity and whether a third party can recover on behalf of the indemnifying party), the main issue under consideration, was whether, under the indemnity, the amounts were recoverable as a debt or a damages claim.

In his judgment, Stephen Morris QC (sitting as Deputy High Court Judge) concluded that any recovery under the indemnity would be by way of damages and not as a debt. Additionally he went further stating that:

“It is certainly the case, that the English authorities are at one in taking the view that the remedy for breach of a contract of indemnity is damages, rather than one for a contractual sum due (i.e. debt).”

Given the High Court’s judgment in the case of ABN AMRO Commercial Finance plc v Ambrose (together with the authorities cited in that case in favour of an indemnity being recoverable as a debt) it is somewhat surprising that Stephen Morris QC was able to reach such an unequivocal conclusion. So how can these two judgments be so different on the issue of whether an indemnity gives rise to a debt or damages claim? As the cases were decided just five weeks apart their judgments do not cross refer to each other.

When one reads the Durley House judgement in its entirety, it’s clear that the majority of the discussions around indemnities relate to, what is commonly referred to as, “hold harmless” indemnities (although Simon Morris QC does not specifically make this distinction). Consider the judgement of Lord Goff (with whom Lord Ackner agreed) in the case of Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti) [1991] 2 AC 1:

“This is, as I understand it, because a promise of indemnity is simply a promise to hold the indemnified person harmless against a specified loss or expense. On this basis, no debt can arise before the loss is suffered or the expense incurred; however once the loss is suffered or the expense is incurred, the indemnified is in breach of contract for having failed to hold the indemnified person harmless against the relevant loss or expense.”

Under this type of indemnity the indemnifying party is under an obligation to ensure that the indemnified party is held harmless from a particular loss. Consequently, if the indemnified party subsequently suffers a loss the indemnifying party is in breach of contract and, given that the remedy for breach of contract is damages, a debt claim will never arise.  Although Mr Stephen Morris QC does not specifically categorise the indemnity given by Firmdale Hotels as a hold harmless indemnity, the preferred interpretation of his judgment is that this is the case. The relevant clause in the sub-lease is potentially ambiguous:

“All Operating Expenses shall be borne exclusively by the Manager and the Manager shall indemnify and keep the Owner indemnified against any and all such Operating Expenses”

The Supreme Court considered the meaning of a “shall defend, indemnify and hold harmless” clause in Farstad Supply AS v Enviroco Ltd (The Far Service) [2010] UKSC 18. In this case, Farstad owned an oil rig supply vessel that it had chartered to Asco. Asco had engaged Enviroco to clean the tanks of the vessel while it was berthed in harbour. An employee of Enviroco inadvertently released oil into the engine room at the same time as the master, under Asco’s instructions, started the engines. A fire broke out causing damage to the vessel.  Farstad only sued Enviroco for damages in negligence. Although Asco had not been sued by Farstad, Enviroco nevertheless joined Asco to the proceedings on the basis they were contributory negligent. 

Clause 33 of the charter party agreement between Farstad and Asco stated that Farstad would:

"defend, indemnify and hold harmless [Asco], its Affiliates and Customers...from and against any and all claims, demands, liabilities, proceedings and causes of action resulting from loss or damage in relation to the Vessel (including total loss) or property of [Farstad]...irrespective of the cause of loss or damage, including where such loss or damage is caused by, or contributed to, by [sic] the negligence of [Asco]".

In this case the key issue was not whether clause 33 gave rise to a debt or damages claim, but whether it amounted to an exclusion of liability.

The Supreme Court was unanimously of the view that this clause provided Asco with a defence to any claim from Farstad. Lord Clarke acknowledged that in some contexts the words “indemnify” and “hold harmless” have the same meaning and said “the natural meaning of that expression is that, since [Farstad] must hold Asco harmless from a claim by [Farstad] in respect of damage to the vessel caused by Asco's negligence, Asco cannot be liable to [Farstad] in respect of such damage.”

Whilst the judgment does not directly address the issue of whether a claim under an indemnity is a debt or a damages claim it does provide clear guidance that a "hold harmless" clause is an obligation to protect a party from loss rather than to reimburse.

Summary

It is clear from the authorities that the term “indemnity” or “indemnify” can, depending on the construction of the remainder of the clause, give rise to either a debt or a damages claim. Using the term “indemnity” or “indemnify” will not in itself, convey a debt.

It appears that an indemnity can fall into broadly three camps (i) a reimbursement indemnity, such as in the case of Royscot Commercial Leasing Limited, Codemasters Software and ABN AMRO, which gives rise to a debt claim, (ii) a reimbursement indemnity for an unspecified sum, which gives rise to a damages claim, and (iii) a hold harmless indemnity, such as in the case of Durley House and Firma C-Trade, which gives rise to a damages claim. Use of the term “indemnity” in isolation seems to add little in determining which interpretation will be preferred, as identified by Lord Clarke (with whom Lord Phillips agreed) in the Supreme Court’s judgment in the Farstad Case:

“In some contexts the words “indemnify” and “hold harmless” have the same meanings. So, for example, in the second edition of the Oxford English Dictionary 1989, “indemnify” is given three meaning, two of which are these:

“1. Trans. To preserve, protect, or keep free from, secure (any hurt, harm or loss); to secure aginst legal responsibility for part or future actions or future action or events; to give an indemnity to.

2. To compensate (a person etc) for loss suffered, expenses incurred, etc).

It would be ill-advised to conclude that simply including the term “indemnity” in a provision would be sufficient to convey a debt. Draftsmen should be clear as to which remedy they require and draft the clause accurately to ensure that the loss is recoverable in the manner envisaged. Where a reimbursement indemnity is required, draftsmen will also need to ensure that the loss is sufficiently quantifiable to give rise to a debt claim (e.g the amount is either specified or there is a clear mechanism by which to calculate the loss). For an indemnity against general breaches of contract the position is more conjectural and the courts may be reluctant to assume that the parties intended to exclude the principles of remoteness of loss and mitigation. This seems more likely with “catch-all” indemnities which try to recover broad indeterminate losses. If there is a risk of this arising, consider the use of a conclusive evidence clause, such as in AMN AMRO, to bolster the prospect of the indemnity being recoverable as a debt. In the ABN AMRO case the methodology applied in the conclusive evidence clause went no further than simply granting a unilateral right to the indemnified party to determine the value of the loss. This appears to suggest that the mechanism for calculating the loss need not be too prescriptive, or indeed, objective.  

The current position on indemnities can be summarised as follows:

Conclusion

In conclusion, the statement that there is no “law” of indemnities as such and that each clause will stand and fall on its own construction, appears to be particularly pertinent. Careful consideration should be given to how the indemnity is intended to operate and whether the indemnified party is seeking to recover a loss as a debt or to be safeguarded from suffering a loss, indeed, it may be both. If the latter is the intention, there should be two clear obligation set out in the contract. If one includes a primary obligation from the indemnifying party to save and hold harmless the indemnified party against a particular loss, then there is scope to include a secondary obligation on the indemnifying party to reimburse the indemnified party (as a debt) for its failure to comply with the primary obligation. The use of common terminology such as “The [Supplier] shall indemnify and hold harmless the [Customer] against …” are potentially ambiguous should be avoided in favour of clearer drafting.