Claim under indemnity challenged
RUST CONSULTING v PB [2011]
This case demonstrates that just because you have the benefit of an indemnity from a third party, you cannot act without considering the interests of the indemnifying party.
Issue:
- An indemnity is essentially when one contracting party, often a supplier, indemnifies or ‘holds harmless’ the other party if a certain event occurs. If that event does happen, then the party giving the indemnity (‘Indemnity Giver’) will reimburse the other party (‘Indemnity Receiver’) for its losses according to the wording of the indemnity. Where a third party claim is involved, the indemnity wording will often include provisions giving the control of the defence of the claim to the Indemnity Giver.
- Indemnities are most often seen in the context of intellectual property infringement claims but they can equally apply in respect of simple breaches of contract.
- If the Indemnity Giver has not expressly agreed to be bound by the Indemnity Receiver's settlement of the third party claim, even where that Indemnity Receiver has settled the claim in good faith, the Indemnity Giver may refuse to pay under the indemnity. It may argue that the indemnity did not cover the claim or that the amount paid was not due. This was the issue that arose in this case.
Facts:
- R and P entered into an asset purchase agreement (‘APA’), under which P bought R’s business and various assets.
- R was then subsequently sued by a former client, E, for loss that E claimed it had suffered due to R's negligence and breach of contract. R was in liquidation and the liquidators, with the apparent active involvement of R, agreed to judgment for (or payment of) the total amount claimed. (This is referred to as a ‘judgment by consent’ and this amount then becomes a ‘judgment debt’.)
- The liquidators tried to recover the judgment debt from P under an indemnity in the APA.
- The indemnity was drafted so that P assumed “responsibility for the satisfaction, fulfilment and discharge of all of the outstanding Liabilities and Contracts of [R’s] Business” and indemnified R “against all proceedings, claims and demands in respect thereof”. P, however, refused to indemnify R in respect of the judgment debt.
- Seemingly and importantly at the time of the settlement, the liquidators had not asserted that R might be liable under the indemnity and R had previously received legal advice which led it to believe that it would not be liable under the indemnity.
Decision:
The Court said P did not have to indemnify R in respect of its liability to E for two reasons:
- R was indemnified against “proceedings, claims and demands” but only in respect of any actual liability which R had to E. To claim under the indemnity, R had to establish it was actually liable for the sum claimed. The Judge decided that the judgment debt was not an actual liability at the date of the indemnity because R had failed to prove that it was liable for the damages E claimed or the amount of the judgment by consent;
- R was not entitled to recover under the indemnity merely because there was a judgment against it in favour of E. There was no principle of law that a party, in this case P, who had given an indemnity against third party claims, is necessarily prevented from challenging the reasonableness of the settlement of the claim. There was no evidence here that R had in any way altered its position in reliance upon the indemnity.
Points to Note:
- It will often be the case that an Indemnity Receiver will have a contractual right to conduct the defence and settlement of any claim but query whether the Indemnity Receiver will always want to hand over control? If you are the receiver of an indemnity take care to check whether the Indemnity Giver has any such rights and if it does not (or it does not take control), exercise caution when settling any claim to ensure, so far as possible, that it will not challenge the existence and extent of its liability under any indemnity.
- When drafting an indemnity consider including express provisions dealing with: control and settlement, prompt notice of claims, co-operation by the parties and undertakings not to prejudice the defence of any claim.
- Be aware that an Indemnity Giver can sometimes, as in this case, successfully challenge that it is liable under an indemnity. This will always depend on the individual circumstances but the following factors should be considered in assessing whether the Indemnity Giver will be bound by any settlement:
- whether the Indemnity Giver had notice of the claim;
- what active involvement the Indemnity Giver had in the defence or settlement of the proceedings; and
- whether the Indemnity Giver positively agreed with the settlement by the Indemnity Receiver.
- In this particular case the indemnity was the only basis upon which P could have any liability. However, indemnities will often typically involve an underlying breach of contract and the Indemnity Giver may still be liable for damages even if the indemnity does not provide protection.
- This decision was based on the peculiar circumstances which existed at the time of the settlement which meant that neither party appreciated that the indemnity might be relevant. This is a rare situation but it does demonstrate that the wording of any indemnity must be scrutinised very carefully to ensure that it does actually cover the liability in question.
- The scope of indemnities is entirely dependent on their precise drafting, so getting the wording absolutely right is crucial. It will be extremely unusual that an indemnity is worded so that it makes the Indemnity Giver automatically liable for any settlement of a claim.