Warranties v Indemnities – considerations and differences

The terms indemnities, warranty and representation are used a lot in the context of share sale or business sale agreements, but the terms warranty and indemnity permeate through all forms of contracts, not just business sale agreements.  Almost any supply contract will include warranties, or representations expressly in an agreement, or implied by law, such as those relating to satisfactory quality or fitness for purpose in certain consumer agreements.

What is a warranty, representation and how do they differ from indemnities?

A warranty or representation in the context of a contract is a statement of assurance, breach of which will give rise to a breach of contract.  This is where the key difference between an indemnity and a warranty or representation lies.

Under contract law, damages recoverable for a breach of contract are limited by certain established principles.  Firstly, any claim for damages must not be “too remote”, i.e. the damage must be reasonably foreseeable as flowing from the contractual breach.  In addition, any party pursing for a breach of contract has a duty to mitigate their loss, which means that any amount claimed will be reduced by the amount that they could have recovered or saved if they had taken action, irrespective of whether or not the party actually did take action to do.

Indemnities are different.  An indemnity is a promise to reimburse another for loss arising.  The principle difference between an indemnity and a warranty or representation is that there is no duty to mitigate loss when claiming under an indemnity.  All losses are recoverable under an indemnity.

When is an indemnity appropriate?

As set out above, the key difference sits around recoverability of damages in the event of breach – liability under an indemnity can be extensive and therefore, you must be careful about the wording and under what circumstances you are prepared to offer an indemnity.

In business sale agreements, indemnities should only be given for very specific issues, where loss can be quantified.

In contracts for the supply of services or goods, they should only be given as a last resort, however, often the inequality of bargaining power between a seller and a buyer plays its hand and the weaker party is forced to accept them.  Tips to consider when reviewing such clauses include:

• Limiting the indemnity – drafting is key and the wording should be limited to losses directly flowing from a specific event;
• Limit liability to that suffered directly and exclude recoverability of losses flowing from a third party; and
• Be clear that you can indemnify what you are indemnifying. For example, if you are indemnifying another against IP infringement from your code or software, make sure that you have carried out an IP audit of your software / code development to ensure you do own this and that the audit trail shows no third party code has crept in the development phase.  If the product has been put together with different software and code, limit any indemnity offered by you  to that which you have created and which you know you can indemnity for.