Contracts are a jumble of words, phrases and long sentences sometimes unintelligible to the masses. An established company may have a panel of legal advisors at their disposal to review contracts on their behalf but for the majority of small businesses with limited resources, their executives may have to occasionally execute contracts without the benefit of legal advice and without full understanding of the implications of key contractual terms.
Key contractual terms in a contract are not limited to the subject matter (i.e. the goods and services), the quantity, the price or the delivery terms, which are most often the terms which people pay attention to prior to executing a contract. While a contract cannot exist without these key terms, there are other common terms such as warranties and indemnities, which proves to be just as important. Warranties and indemnities are important especially post-execution of the contract because they are assurances made to the parties of a transaction that what they are agreeing to is what is being represented.
What then are warranties and indemnities and how do they protect you?
Warranties
The below clause is a sample warranty clause:
“Each party represents and warrants that it has the right, power and authority to enter into this Agreement and that the persons executing this Agreement have the authority to act for and to bind each respective party.”
Warranties are essentially a situation where one party warrants that he will perform or abstain from performing something and a breach would give rise to right to damages. According to a learned judge, “the duty of one party to perform the obligations under a contract is substituted with a duty to pay damages in lieu of such performance.” As long as there is a breach of warranty by the promisor party, a right to damages would arise in favour of the other party.
Indemnities
The below is a sample indemnity clause:
“the Vendor shall hold harmless and indemnify and keep indemnified the Purchaser against any and all liabilities, losses penalties, fines, damages, claims, costs, expenses and legal or professional fees and disbursements incurred, suffered or sustained by the Purchaser arising out of any failure by the Vendor to comply with all relevant and applicable Environmental Laws at any time on or before the Completion Date.”
According to case law[1], a contract of indemnity is ‘a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself or by the conduct of any other person’. In simpler words, a contract of indemnity is merely a promise to indemnify or pay damages to one party upon occurrence of a trigger event caused by the other party. A trigger event can be anything defined by the parties, including among others a breach of contract, a party’s fault or negligence or any other specific action.
The Key Difference between Warranties and Indemnities
The key difference is that a warranty claim is based upon a breach of a term in the contract. It is strict liability – this means that if one party breaches a warranty term in the contract, that party would be strictly liable to pay damages to the other party. There is no necessity for the party claiming damages to prove fault as long as there is a breach of warranty. In the event that there are no damages suffered, the party claiming is still entitled to nominal damages for the breach of warranty.
On the contrary, an indemnity is a separate obligations agreed by the parties. On occurrence of the event specified under the indemnity clause, the claimant party needs to show that the other party is at fault for causing the loss. The claimant must also prove that he or she has suffered loss before he or she may succeed. In short, proving loss is an essential ingredient for a successful claim and without which, the claim will fail.
Does one provide better protection than the other?
Warranties and Indemnities are different legal ideas and provide assurances for the transacting parties in different ways. In reality, contracts often contain a mixture of warranties and indemnities and the onus is on the parties whether they accept the legal promises for the transaction they are entering into.