UK: Indemnities: Recent cases underline the importance of careful interpretation and drafting

A recent group of reported cases on the interpretation of indemnities and related clauses highlights the extra care that should be taken when drafting indemnity clauses, due to the courts' general approach of interpreting such clauses so as to give effect to the parties' intentions.

Interpreting notice clauses

2020 has seen two notable High Court decisions relating to the interpretation of indemnity notice clauses:

  1. In Dodika Ltd & Ors v United Luck Group Holdings Ltd, a sale and purchase agreement (SPA) disposing of the sellers' shares in a holding company contained a tax covenant indemnifying the buyer for any undisclosed tax liabilities of the group companies. Crucially, in order to claim under this clause, the buyer was required to give "written notice to the [sellers] stating in reasonable detail the matter which gives rise to such Claim, the nature of such Claim and (so far as reasonably practical) the amount claimed in respect thereof".

    At a later date, the buyer provided a notice containing details of an investigation by the Slovenian tax authority into transfer price practices, involving one of the group companies owned by the holding company disposed of under the SPA. While the notice did include details of how the investigation would work and a chronology of events, the court held that this did not qualify under the indemnity as it did not provide sufficient detail of the circumstances that the buyer was relying on to support its claim, and therefore did not give rise to a claim under the tax covenant.

  2. Towergate Financial Ltd v Hopkinson also centred around an SPA, this time including an indemnity against professional negligence claims for mis-selling financial products, on the condition that the buyer notified the seller of any claim "in writing … as soon as possible and in any event prior to … on or before the seventh anniversary of the date of the Agreement."

    The buyer later attempted to serve a notice on the sellers, before the long-stop date but over a year after notifying its insurers of the circumstances giving rise to the claim. The court held that, despite the notice being served before the long-stop date, the notice clause in the SPA had not been complied with because the buyer had not also acted "as soon as possible", which the court deemed to be a separate and additional requirement.

These 2020 decisions are not isolated incidents, and they follow a wider trend in recent years of the courts narrowly construing notice requirements (see, for example, the High Court's 2017 decision in Zayo Group International Ltd v Ainger & Ors). They also underline the importance of strictly complying with such notice requirements in order to benefit from the related operative clauses.

Giving effect to the parties' intentions

While the courts' strict approach to interpretation may be partly influenced by the potentially severe consequences on the indemnifying party of an indemnity clause being triggered, we think the courts' ultimate aim is to give accurate effect to the parties' intentions. This was particularly evident in Gwynt y Môr OFTO Ltd v Gwynt y Môr Offshore Wind Farm Ltd, another 2020 High Court decision concerning the sale of a business that operates the electrical transmission of a windfarm in Wales.

In that case the court was asked to decide whether an indemnity clause protecting the buyer of a business from "pre-completion damage" should cover historic damage caused months or years before the sale. The court emphasised the importance of construing the clause in accordance with the parties' intentions, finding that the language of the clause as a whole suggested that the indemnity should only cover damage caused after the SPA was signed.

Favouring natural meaning over rigid classification

It is important to be aware that generic statements that some lawyers make about the nature of indemnities can be misleading and do not always stand up to judicial scrutiny. This was especially apparent in AXA SA v Genworth Financial Holdings Inc & Anor, a High Court decision handed down at the end of 2019 which related to a dispute over the SPA used to acquire two insurance businesses. The SPA included a clause requiring reimbursement of certain ongoing compensation payments by the seller. Following a disagreement over the nature of the reimbursement requirement, the court was asked to decide whether the clause was an indemnity to protect the buyer from loss, or an absolute covenant to pay (a 'performance bond'). The seller argued that the clause was an indemnity, and that there was a duty on the buyer to mitigate its loss and raise any defences available against payment of the sums. Meanwhile, the buyer argued that the clause, as a performance bond, gave rise to automatic recovery of the sums. It also argued that, even if it were an indemnity, there would be no duty to mitigate as an indemnity creates a debt obligation.

In making its decision, the court placed more importance on interpreting the ordinary and natural meaning of the language, than on rigidly classifying the clause according to a technical legal doctrine. It held that the clause described an absolute obligation to pay, rather than a promise to protect the buyer from loss suffered, and therefore the clause was not considered an indemnity. Importantly, the judge also stated that if the clause were found to be an indemnity, it would give rise to a claim in damages rather than a debt, citing the 1991 House of Lords decision in Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti) and stating:

"I consider that the weight of authority, and the more orthodox view, is that a claim under a contract of indemnity is a claim in unliquidated damages." (para 117)

In conclusion…

We think that the AXA v Genworth decision is typical of the courts' approach to interpreting indemnities and related clauses. Rather than relying on generic but potentially misleading ideas about the legal nature of indemnities (such as that they create debts, that they do not impose duties of mitigation and that they are not subject to the usual principles of remoteness of damage), lawyers advising clients on an indemnity clause should focus primarily on interpreting the clause as drafted. The courts will generally give effect to the parties' intentions by interpreting the language used, rather than classifying the clause according to generic legal rules. Naturally, this also means that lawyers should take the utmost care when drafting indemnities and related clauses, as the courts will be equally if not more careful in their interpretation.

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