Indemnities : Recent decisions by the high court

2020 has seen numerous important decisions by the High Court (“the Court”) which clarify the law in relation to indemnities. In particular, the Court has confirmed its approach of interpreting indemnity clauses strictly, so as to give effect to the parties’ intentions. As a result, it is crucial to pay attention to the specific wording used when drafting the provisions. For example, the Court will require the indemnified party to clearly fulfil the conditions specified (such as giving notice to the other party) in order to trigger relief under the clause. Such conditions can often place large burdens on the indemnified party and thus should be considered carefully when drafting the clauses.

THE CASES 

Dodika Ltd & Ors v United Luck Group Holdings Ltd [2020]

In this case, the Court had to consider whether sufficient notice had been given by the indemnified party to trigger an indemnity clause (specifically, a tax covenant) in a Sale and Purchase Agreement (“SPA”). The SPA related to the disposal of the sellers’ shares in a holding company, and the tax covenant indemnified the buyer for any undisclosed tax liabilities of the group companies.

100 million US dollars had been held in escrow in relation to possible claims under warranties and tax convenants, and Dodika sought final repayment of the amounts. Under the SPA, in order to claim under this clause and be indemnified, the buyer had 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”.

After the Slovenian tax authority launched an investigation into transfer pricing practices, involving one of the group companies owned by the holding company disposed of under the SPA, Dodika provided written notice to the seller United Luck Group. The notice included details of how the investigation would be carried out and the chronology of events. However, the Court held that this did not provide sufficient detail; consequently, it did not give rise to a claim under the tax covenant and Dodika could not recover the final amount held in escrow. Crucially, the Court emphasised that the level of detail required for notice of claims provisions will depend on the exact wording used. In this instance, the phrase “matters which give rise to” required further detail than mere notice that the tax authority was investigating the transfer pricing position of the company.

Towergate Financial Ltd v Hopkinson [2020]

Similar to Dodika, the Court had to consider an indemnity notice clause in the context of an SPA in Towergate. The indemnity in question covered professional negligence claims for mis-selling financial products. Towergate Financial, a financial advisory firm, purchased the entire issued share capital from a company of which the defendants were trustees. Under the SPA, Towergate had to bring any indemnity claim “as soon as possible and in any event prior to… on or before the seventh anniversary of the date of this Agreement”.

After the FCA flagged a number of “major issues” with the company held in trust by the defendants, uncovering that they had given negligent advice on some occasions, Towergate wrote a letter to the defendants with notice of the possible indemnity claims. The letter was sent a week before the seventh anniversary of the SPA. However, even though this was within the range specified in the clause, the Court held that it had not been fulfilled because Towergate had not acted “as soon as possible” (which was construed as an additional requirement). As a result, Towergate could not claim under the indemnity clauses. Like the previous case of Dodika, Towergate therefore emphasises the importance of complying strictly with the conditions specified in the clause.

Gwynt y Môr OFTO Ltd v Gwynt y Môr Offshore Wind Farm Ltd [2020]

This case concerned the sale of a company that operated an electrical transmission link from the Gwynt y Môr wind farm, in Wales. The SPA contained an indemnity covering damage to the assets of the company: “if any of the Assets are destroyed or damaged prior to Completion (Pre-Completion Damage), then, following the Completion, the [sellers] shall indemnify the [buyer]”.

The Court looked carefully at the wording of the clause (particularly, the tense used) and concluded that the parties only intended to cover damage after the SPA was signed. Otherwise, they would have used the formulation “If any of the Assets have been damaged or destroyed”. Therefore, historic damage to the assets in question were outside the scope of the clause and the claim was dismissed. Importantly, the Court placed emphasis on giving effect to the parties’ intentions, which they achieved by considering the language of the clause as a whole. In doing so, the Court reveals its underlying rationale in adopting a strict approach to indemnities, and focusing on the range of losses included within the scope of an indemnity clause.

AXA SA v Genworth Financial Holdings Inc & Anor [2019]

This case the Court had to consider whether a clause in an SPA was an indemnity or rather a covenant to pay. AXA, a global insurer, agreed to acquire the shares in two companies from Genworth. The SPA included a clause requiring reimbursement of certain ongoing compensation payments, which AXA sought to rely on following the miss-selling of payment protection insurance (“PPI”) products by the companies it acquired.

To evaluate their claim, the Court had to decide whether the clause functioned as an absolute covenant to pay, or rather an indemnity to protect AXA against loss (a ‘performance bond’). Ultimately, it held that it was an absolute covenant. However, the reasoning of the Court in coming to this conclusion that is important. 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 Lords Firma C-Trade SA v Newcastle Protection and Indemnity Association (The Fanti). Therefore, like in the previous cases, the Court focused on the ordinary and natural meaning of the language and centred its interpretation on the specific wording used.

CONCLUSION

The narrow approach to indemnities adopted by the High Court in recent cases might be seen as part of a longer trend (see, for example, Zayo Group International Ltd v Ainger & Ors). Its decisions in 2020 confirm how it will construe clauses “contra proferentem” – against the person seeking to enforce them, which in this case is the indemnified party. More importantly, these cases illustrate that the Court will pay strict attention to the wording used and refuse to depart from the specified conditions. Across these cases, the rationale of the Court is the same: construing the clauses according to their natural meaning gives most effect to the intentions of the parties.

PRACTICAL TIPS

Due to the focus of the Court on the specific words used in indemnity clauses, it is highly important to draft them carefully, whilst considering how they might work in practice. For example, when drafting on behalf of either party, it is helpful to ask a series of questions:

  • What period of time should the indemnity cover?
  • What types of loss is the indemnity seeking to cover?
  • How does the indemnity interact with other provisions in the contract?
  • When should the indemnity come into force?
  • What is required to satisfy the indemnity clause?

These questions help to envision how the indemnity clause will function in practice and will therefore avoid any unintended consequences. Careful attention should also be paid to using simple and understandable language, whilst not leaving out important nuance.

Please see the rulings in more details:

For more information, and any guidance or advice on your commercial contracts and liability clauses, Cleveland & Co External in-house counselTM, your specialist outsourced legal team, are here to help.

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