Seeking an indemnity from supplier

15 October 2003
More legal news

16 October 2003

Q: We are a small manufacturing company based in Somerset. I have been asked to look at seeking an indemnity from suppliers against the potential damages, costs and expenses arising out of the supply of defective products. We are being asked similar questions by some of our customers. Ideally this would be incorporated in our purchase order contract terms, but how should I go about it? Should we put a financial limit on it, and what if the supplier was not adequately insured?

A: Dick Jennings, partner at solicitors Ford & Warren, writes: A promise to "indemnify" against something is a promise to pay the full cost of that thing. So an "indemnity" from suppliers against the consequences of defective product is simply a promise that they will see you right for financial consequences you suffer as a result of the defect.

This sounds mild enough, particularly since virtually any contract with a supplier of goods comes with a promise ("warranty") that the goods are not defective, and hence liability on the supplier if they are. Such a promise is implied by statute, even if not expressly agreed by you.

So what's so special about an indemnity? The difference is that when a supplier has to pay compensation ("damages") for breaking its warranty, centuries of common law checks and balances apply to make sure that the compensation is balanced and fair. In contrast, an indemnity simply obliges the supplier to pay all your loss, fairly or not. None of the common law protections apply.

There are two main differences in practice. One is that, on a damages claim, the supplier is only liable for a reasonably foreseeable loss. The other is that you can only claim for loss that could not be reasonably avoided ("mitigated"). That leads to grey areas. Is the payment to your customers to keep them sweet an "avoidable" cost, since you weren't forced to make it, or was it necessary to avoid the costs of losing them forever?

Indemnities are about enforcing a promise to pay. If the supplier contracted to pay "all losses, costs, expenses, liabilities and claims", so be it. Never mind that the loss was unforeseeably huge and it could have been avoided. That's what makes an indemnity so attractive to you as customer, and so fearsome to a supplier.

As the customer, consider avoiding the word "indemnity" altogether. It always sets a red alert light flashing in the supplier's mind and you can achieve exactly the same result without using the word ("...the supplier promises to be financially responsible for, and to pay the customer in cleared cash funds the full amount of..."). You could also negotiate a financial limit as you suggest, but that only draws attention to the indemnity, so it could be counterproductive.

Understanding the differ-ences between warranties and indemnities also helps you as a supplier facing indemnity demands from customers. By ensuring that you indemnify only for foreseeable loss that could not have been avoided, you have little more risk than under the equivalent warranty.

Insurance is a separate matter. Obviously you want your suppliers to be insured, and the more dependent on them you are, the more you need to check insurance levels. However, an indemnity gives you a stronger contractual position either way.

SMoct2003

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