We tend to find provisions for indemnity and / or warranty In most of the commercial and transactional agreements.
Both of these provisions are intended to protect a party receiving such indemnity and / or warranty from any costs, economic risks and liabilities. Even though the intent under both these provisions is to protect such party, there is a difference in the way both these provisions operate.
Indemnity is way of mitigating any potential risk on one party, whereby the indemnitor (i.e., party providing indemnity) assures the indemnitee (i.e., party receiving indemnity) that the latter will be compensated or protected from certain defined set of risks and liabilities that could emerge from a specific event or circumstance.
Warranty, on the other hand, is typically an assurance or authentication of a fact, event, circumstance or information provided by one party to another party.
Breach of indemnities and warranties can expose a breaching party to economic liability or penalty and provide non-breaching party a recourse in terms of economic remedy in the form of compensation or damages.
Let us examine the difference in these two concepts in some specific respects.
Scope: Under indemnity, indemnitor will be required to provide indemnity to indemnitee from any specific losses or damages occurred from its own acts or third party acts or claims as specifically agreed by the parties. Under warranty, a party will provide assurance about certain facts and statements to other party in order to make other party believe such facts and statements and to enter into the agreement or transaction.
Remedy: Indemnitor will be required to take certain actions or proceedings to compensate indemnitee for losses or claims incurred by indemnitee. Under warranty, if a party breaches warranties or provides a false warranty, then breaching party will have to compensate non-breaching party for breach of warranty.
Duration: There is no specific cap on survival of indemnity obligation, depending on the nature of transaction, indemnity provision could survive for years without any consideration to termination or expiration of the Agreement. On other hand, warranties normally come with a limited tenure such as 3 months, six months, one (1) , two (2) years etc. In fact, sometimes the party seeking warranty has to pay for extended warranty!
Drafting indemnity and warranty clauses is no easy task it requires a lot of effort from the parties to ensure these provisions are appropriately crafted balancing liabilities and risks.
Here are some tips that may be kept in mind while drafting or negotiating indemnity and warranty provisions:
a) Do not agree to blanket indemnity obligations, always agree to provide indemnity only in case of occurrence of specific acts or events and that too limit such acts or events to the extent you are good enough to take them legally and financially. In simple, never take any indemnity obligations you do not anticipate being capable of honouring.
b) Do not provide unnecessary warranties and ensure each warranty intended to be included in the contract is relevant and appropriate in the context of the contract. For example, for software licensing agreement, inclusion of software warranty is appropriate, but including services warranty, without services being covered under the licensing agreement may be inappropriate and irrelevant.
c) Make sure your warranties are accurate and correct as false information means an invitation to liability.
d) Clear and accurate communication and flow of information is crucial to reduce or avoid unwanted disputes – do not hide or withhold any important or material information.
e) Party taking economic risk or liability has to be careful with risk allocation and mitigation as any negligence in this aspect could prove to be a costly affair.
f) Party receiving economic remedy or benefit requires to ensure such economic remedy or benefit is proportionate to legal and economic risks undertaken by such party.
To sum up, indemnity and warranties are key provisions from legal, factual and economic prospects and there is no margin for error in drafting these provisions. The parties, therefore, need to take utmost care and attention in crafting these provisions to ensure all legal, economic and business aspects are appropriately covered.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
