Discharge of contract and remedies - Indemnities

Learning Outcomes

This article explains the legal nature and function of indemnities in contract law, distinguishing them from guarantees and highlighting why the classification matters for enforceability and exam problem questions. It examines how indemnities operate as primary obligations, when they give rise to an action for an agreed sum (debt) versus a claim in damages, and how remoteness, causation and mitigation principles apply differently to each form of claim. It explores the impact of contract discharge—by performance, agreement, breach and frustration—on the continuing effectiveness and survival of indemnity clauses and accrued rights. It analyzes drafting and interpretation issues in SQE1-style scenarios, including the writing requirement for guarantees and the absence of such a requirement for true indemnities, the structuring of clauses to address third‑party claims, notice and conduct of claims provisions, and settlement mechanics. It also reviews statutory and common-law controls such as UCTA 1977, the CRA 2015, limitation periods, interest, penalty doctrine risk, and public policy limits, and shows how careful drafting on caps, exclusions, survival wording and interaction with other remedies can secure “pound‑for‑pound” recovery while avoiding double recovery.

SQE1 Syllabus

For SQE1, you are required to understand the legal principles and practical implications of indemnities as a contractual remedy, with a focus on the following syllabus points:

• the definition and legal effect of an indemnity clause
• the distinction between indemnities and guarantees
• the enforceability of indemnities and the remedies available for breach
• the operation of indemnities on contract discharge (including performance, breach, and frustration)
• the drafting and interpretation of indemnity clauses in practice
• the writing requirement for guarantees under the Statute of Frauds 1677 and why indemnities are not subject to it
• when an indemnity gives rise to an action for an agreed sum (debt) and when damages are appropriate
• how remoteness and mitigation principles apply differently to debt claims and damages claims
• statutory controls over indemnities that function as exclusions or limitations (UCTA 1977; CRA 2015)
• penalty doctrine risks where a clause requires payment on breach and how to avoid them through legitimate interest and proportionate drafting
• limitation and interest on indemnity claims, and accrual of the cause of action
• settlement and “conduct of claims” provisions that govern third-party claims under an indemnity

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the key legal distinction between an indemnity and a guarantee?
2. When is an indemnity enforceable if the contract has been discharged by performance or agreement?
3. What remedies are available to an indemnified party if the indemnifier fails to pay under an indemnity clause?
4. True or false? An indemnity is a secondary obligation that only arises if a third party defaults.

Introduction

Indemnities are a common contractual device for allocating risk and providing financial protection against specified losses. For SQE1, you must be able to explain what an indemnity is, how it differs from a guarantee, when it is enforceable, and what remedies are available if it is breached. You should also be able to advise on the effect of contract discharge on indemnity clauses and identify key drafting issues. In commercial practice, indemnities are frequently used in business sale agreements and land transactions to allocate known liabilities (for example, identified tax or environmental liabilities), whereas warranties are used to allocate unknown risks. Understanding how indemnities operate alongside damages claims, limitation and interest, and statutory controls is essential.

Key Term: indemnity
An indemnity is a contractual promise by one party (the indemnifier) to compensate another party (the indemnified) for specified losses, usually arising from certain events or liabilities, regardless of whether a third party has defaulted.

Key Term: guarantee
A guarantee is a contractual promise by one party (the guarantor) to answer for the debt or obligation of another (the principal debtor) if that other party defaults. It is a secondary obligation.

The Legal Nature and Function of Indemnities

An indemnity creates a primary obligation. The indemnifier must pay the indemnified party for losses covered by the clause, whether or not anyone else is at fault. This is different from a guarantee, which is only triggered if a third party fails to perform.

Indemnities are often used to allocate commercial risks, such as tax liabilities in business sales, intellectual property infringement, or losses arising from breach of contract. They are enforceable as a matter of contract law, subject to the usual rules of construction and public policy. Because an indemnity is a primary obligation, it is typically enforceable as a straightforward action for an agreed sum when the amount due is ascertainable “pound-for-pound.” This means principles such as remoteness and mitigation do not generally limit a debt claim under a properly triggered indemnity, though the indemnified must prove the loss falls within the clause’s scope.

Indemnities also operate independently of the debtor’s default: they can cover losses from third-party claims, statutory liabilities, or specified events. They may be drafted as “pay on demand,” “keep indemnified against liability,” or “keep indemnified against loss.” These formulations affect when liability accrues and when the sum becomes due:

• indemnity against liability generally crystallises when the indemnified’s liability to a third party becomes established (e.g., by judgment, award, or binding settlement)
• indemnity against loss usually requires actual loss (e.g., payment) before a claim lies
• “on demand” indemnities become due following a compliant demand, if the triggering conditions are met

Indemnity vs Guarantee

The distinction between an indemnity and a guarantee is central for SQE1:

• An indemnity is a primary obligation to pay for loss, enforceable even if no third party has defaulted.
• A guarantee is a secondary obligation, enforceable only if the principal debtor fails to perform.

The writing requirement is different. A guarantee must be evidenced in writing and signed by the guarantor (Statute of Frauds 1677), otherwise it is unenforceable. The memorandum may consist of multiple documents and need not be the contract itself, but it must evidence the essential terms and be signed by or on behalf of the guarantor. In contrast, indemnities, being primary obligations, do not need to be evidenced in writing to be enforceable (though they usually are in practice).

The substance prevails over labels. A clause labelled “indemnity” that in reality only bites upon the default of another may be characterised as a guarantee, bringing it within the Statute of Frauds. Conversely, a genuine indemnity remains effective even if the primary agreement with the principal debtor is set aside or unenforceable; a guarantee would usually fail with it because of its secondary nature.

Exam Warning

Do not confuse indemnities with guarantees. An indemnity is not subject to the statutory requirement for writing under the Statute of Frauds 1677, but a guarantee is. If a clause operates only on a third party’s default, it may be a guarantee regardless of its label.

Indemnity vs Damages

Indemnities differ from ordinary damages for breach of contract. An indemnity may cover losses that would not be recoverable as damages (for example, losses too remote under the Hadley v Baxendale principles). The clause may specify the scope of losses covered, such as direct, indirect, or consequential losses, legal fees, interest, and taxes. In contrast:

• damages are compensation for breach, subject to causation, remoteness, and mitigation rules
• recovery for “consequential” or “indirect” loss is restricted to losses within the second limb of the remoteness test and must have been in reasonable contemplation at contract formation (for example, Victoria Laundry principles)
• “cost of cure” damages must be reasonable and not disproportionate (Ruxley Electronics guidance)

An indemnity claim framed as a debt is not limited by remoteness or mitigation; the focus is on whether the defined risk/event occurred and the losses fall within the agreed scope. If the indemnity does not produce a sum certain (for example, because liability is disputed or the amount is unliquidated), the indemnified may instead claim damages for breach of the indemnity promise, in which case remoteness and mitigation will apply.

Finally, the penalty rule generally targets payments triggered by breach of contract. Many indemnities are triggered by defined events or third-party liabilities, not breach, and so fall outside the penalty doctrine. If an “indemnity” is, in substance, an obligation to pay a sum on breach and the sum is out of proportion to a legitimate interest in performance, it may attract the penalty analysis and be at risk. Draft with care to show legitimate interests and proportionate risk allocation.

Indemnities and Discharge of Contract

Indemnity clauses may survive the discharge of the main contract, depending on their wording and the parties’ intentions. As a baseline principle, termination for breach discharges future primary obligations, but accrued rights and liabilities survive. Whether new indemnity claims can be brought for post-discharge losses depends on survival wording and the clause’s construction.

Discharge by Performance or Agreement

If the contract is performed or discharged by agreement, an indemnity will remain enforceable if the clause is expressed to survive termination or completion. This is common in commercial contracts, where indemnities are intended to protect against post-completion risks (for example, pre-completion tax liabilities discovered after completion). Absent survival wording, any indemnity covering liabilities that have already accrued by completion can still be enforced as an accrued right; but coverage for liabilities arising after discharge will be uncertain without an express survival clause.

Where parties agree a mutual release on termination or completion, ensure the release carves out indemnity obligations intended to continue. Entire agreement clauses and releases can otherwise extinguish future claims under an indemnity if not expressly preserved.

Discharge by Breach

If the contract is terminated for breach, an indemnity may still be enforceable if the clause is drafted to survive termination. The indemnified party can claim under the indemnity in addition to, or instead of, damages for breach, depending on the terms. Avoid double recovery: if the indemnified recovers specific losses under an indemnity, those should not be recovered again as damages. Contract drafters often specify whether the indemnity is the exclusive remedy for certain risks or sits alongside common law damages.

In the absence of express survival wording, indemnities may still respond to liabilities that accrued before termination. For losses occurring after termination, the safer position is an express survival provision stating that the indemnity applies “notwithstanding termination or expiry, however arising.”

Discharge by Frustration

If a contract is frustrated, the effect on an indemnity depends on the clause wording and the Law Reform (Frustrated Contracts) Act 1943. Frustration automatically discharges both parties from further performance of future obligations; money paid may be recoverable and money payable ceases to be payable, subject to the court’s discretion to allow recovery for expenses or benefits conferred.

Unless the clause clearly provides otherwise, an indemnity may not be enforceable for losses arising after frustration. Parties can, however, allocate the risk of supervening events (often in a force majeure clause coupled with an indemnity) so that frustration does not apply because the event has been foreseen and contractually provided for. Clear survival wording is required if the parties intend an indemnity to respond to losses arising on or after frustration.

Key Term: frustration
Frustration occurs when an unforeseen event makes performance of the contract impossible or radically different, automatically discharging the contract.

Enforcement and Remedies for Breach of Indemnity

If an indemnifier fails to pay under an indemnity, the indemnified party can claim the amount due as a contractual debt. The usual remedy is a claim for a sum certain, not damages for breach. This “action for an agreed sum” avoids issues of remoteness and mitigation, but the claimant must establish that the indemnity has been triggered and that the amount is due and ascertainable under the clause.

Key Term: debt claim
A debt claim is a contractual claim for a fixed sum that is due and payable under the contract, regardless of loss.

Key Term: damages
Damages are a monetary remedy awarded to compensate for loss caused by breach of contract.

If the indemnity is not for a fixed or ascertainable sum at the time of suit, the indemnified party may claim damages for breach of the indemnity promise. Remoteness and mitigation then apply, and the claimant must prove loss caused by the breach (for example, the failure to reimburse within the contractual timeframe leading to loss).

Courts may also grant declaratory relief as to the scope and effect of an indemnity, or in rare cases, specific performance ordering payment where damages are inadequate and the sum is ascertainable. Interest on sums due under indemnities may be recoverable either under contractual interest provisions or, absent such a term, at the court’s discretion on judgment (e.g., under the County Courts Act 1984 or Senior Courts Act 1981).

Where the indemnity relates to third-party claims, practical issues arise:

• notice: many clauses require prompt notice of the third-party claim as a condition precedent
• conduct of claims: clauses often give the indemnifier the right to take over the defence or conduct settlement, or require the indemnified to act reasonably in settlement
• reasonableness: if the indemnified settles, recovery commonly depends on showing the settlement was reasonable and within the scope of the indemnity
• no double recovery: the indemnified should give credit for sums recovered from third parties or insurers if the clause so provides

Limitation periods apply as usual: six years from accrual for simple contracts and 12 years for deeds. The accrual point depends on the wording: “against liability” indemnities generally accrue when liability is established; “against loss” when loss is suffered (e.g., payment); and “on demand” when a valid demand is made according to the clause. This can be critical for time-bar arguments.

Statutory controls may police indemnities. In business-to-business contracts, indemnities that exclude or restrict liability for negligence or breach may be subject to the reasonableness test under the Unfair Contract Terms Act 1977. In consumer contracts, terms requiring a consumer to indemnify a trader for risks the trader should bear, or which obscure the consumer’s rights, may be unfair and unenforceable under the Consumer Rights Act 2015.

Worked Example 1.1

A supplier agrees to indemnify a retailer against "all losses, costs, and expenses arising from any product liability claim." A customer sues the retailer for injury caused by a defective product. The retailer settles the claim and seeks reimbursement from the supplier under the indemnity. The supplier refuses to pay.

Answer:
The retailer can claim the full amount paid to the customer (and associated costs) as a debt under the indemnity clause, provided the losses fall within the scope of the clause.

Worked Example 1.2

A contract contains an indemnity clause: "The contractor shall indemnify the client against all losses arising from the contractor's breach." The contract is terminated for breach by the contractor. The client claims under the indemnity for losses suffered after termination.

Answer:
If the indemnity clause is drafted to survive termination, the client can claim for covered losses even after the contract has ended.

Worked Example 1.3

A business sale agreement includes an indemnity: "The seller shall indemnify the buyer for any tax liabilities arising before completion." After completion, the buyer discovers an unpaid tax bill from before completion and pays it. The buyer claims under the indemnity.

Answer:
The buyer can recover the full amount of the tax liability from the seller under the indemnity, as the clause is expressed to survive completion.

Worked Example 1.4

A lender requires “an indemnity” from a parent company stating: “Parent will pay any sums owed by Subsidiary if Subsidiary does not pay.” There is no written, signed memorandum of this promise. Subsidiary defaults. The lender sues Parent.

Answer:
Despite the “indemnity” label, this is functionally a guarantee because it bites only on Subsidiary’s default. It must be evidenced in writing and signed by Parent to be enforceable. Without such writing, the claim is likely to fail.

Worked Example 1.5

A technology supplier agrees to indemnify a customer against “all losses arising out of any intellectual property infringement claim.” The customer receives a credible claim, promptly notifies the supplier, and reasonably settles for £200,000 after taking advice. The supplier disputes the amount and argues the customer should have fought the claim to trial.

Answer:
If the indemnity contains a standard conduct-of-claims provision and the customer complied (notice, consultation, reasonable settlement within scope), the customer can recover the settlement sum as a debt. There is no general duty to mitigate in a debt claim. The key question is whether the settlement was reasonable and within the indemnity’s scope.

Drafting and Interpretation of Indemnity Clauses

The enforceability and scope of an indemnity depend on clear drafting. Courts interpret indemnities according to ordinary principles of contractual construction, with particular care where the clause is unusually broad or operates to relieve a party of liability for its own negligence or breach. While “contra proferentem” is used sparingly in modern commercial contracts, clear words are generally required if an indemnity is intended to cover losses caused by the indemnified party’s own negligence.

Key drafting points:

• Specify the events that trigger the indemnity. Different triggers (“arising out of,” “in connection with,” “caused by”) can be broader or narrower in scope.
• Define the types of losses covered (e.g., direct, indirect, consequential loss, diminution in value, and “all reasonable legal and professional costs”).
• State whether the indemnity survives termination or completion, and for how long (claims periods).
• Include any exclusions or limitations on liability, and make clear whether any overall liability cap does or does not apply to indemnity claims.
• Coordinate with damages and other remedies: specify whether the indemnity is exclusive or without prejudice to other remedies, and address “no double recovery.”
• Include notice and “conduct of claims” provisions: who controls defence and settlement, duties to cooperate, and reasonableness standards.
• Address credit for insurance or third-party recoveries, and whether the indemnifier has subrogation rights after paying.
• Clarify whether the indemnity is against liability, loss, or on demand, which in turn affects accrual and limitation.
• Consider statutory controls: if the indemnity effectively excludes or restricts liability for negligence or breach, ensure it is reasonable under UCTA in B2B standard terms, and transparent and fair under the CRA 2015 in consumer contracts.
• Guard against penalty risk where payment is triggered by breach: articulate the legitimate interest protected and ensure the amount is proportionate.
• Precision on taxes and withholding: include gross-up and tax treatment as needed to ensure “pound-for-pound” recovery.

Courts will typically give effect to commercial risk allocation agreed by sophisticated parties in clear terms. However, ambiguous indemnities may be construed narrowly, particularly where one party seeks indemnification for its own negligence or regulatory fines. If coverage of such liabilities is intended, say so expressly and ensure the clause is reasonable and consistent with public policy. Clauses that purport to indemnify a party for criminal penalties or its own fraud are vulnerable.

Revision Tip

For SQE1, always check the precise wording of an indemnity clause and whether it is intended to survive contract discharge. Identify whether the obligation is against liability, against loss, or on demand, and how that affects enforcement, limitation, and quantification.

Key Point Checklist

This article has covered the following key knowledge points:

• An indemnity is a primary contractual obligation to compensate for specified losses, enforceable as a debt.
• Indemnities are distinct from guarantees, which are secondary obligations triggered by a third party's default and must be evidenced in writing.
• Indemnity clauses may survive discharge of contract if drafted to do so; accrued rights survive in any event.
• The main remedy for breach of indemnity is a debt claim; damages may be available if the sum is not fixed or ascertainable at the time of suit.
• Clear drafting is essential for enforceability and to define the scope of the indemnity, including triggers, losses, survival, conduct of claims, and interaction with caps.
• Statutory controls (UCTA 1977; CRA 2015) may restrict indemnities that function as exclusions or allocate negligence risk; penalty doctrine may apply to payments tied to breach if out of proportion to legitimate interests.
• Limitation and interest rules apply: accrual depends on whether the indemnity is against liability, against loss, or on demand.

Key Terms and Concepts

• indemnity
• guarantee
• frustration
• debt claim
• damages