Pay Me Everything – Contractual Indemnities and Indemnity Costs

The recoverability of costs is a significant factor in legal proceedings. Most commercial agreements contain clauses seeking to indemnify an innocent party absolutely against any legal costs that might be incurred because of another party’s breach.

Unfortunately, clauses of this type are regularly recycled from existing precedents, without any regard to the relevant authorities and the strict approach taken by the court in determining the scope of such clauses.

All too often, this leads to significantly less protection against costs than intended by the parties to a contract (and in many cases, by the solicitor responsible for preparing the document).

Considering the potential commercial advantages that may be obtained by a favourable costs order, commercial lawyers and litigators alike ought to be aware of the difficulties that may arise in seeking to enforce a contractual indemnity in respect of costs and ensure that their clients are properly advised in this regard. 

Standard vs indemnity basis for assessment

Upon conclusion of legal proceedings, orders are usually made entitling one or more parties to recover its costs of the proceedings from other parties.

Costs of proceedings are most often ordered to be assessed, either on:

(a) the ‘standard basis’ for assessment; or

(b) the ‘indemnity basis’ for assessment.

A standard costs order typically entitles a party to recover 50% – 66% of its actual costs incurred. An order for costs on the indemnity basis might entitle a party to 90% – 100% of its actual costs.

In the case of a significant commercial dispute, the difference between standard vs indemnity costs can represent hundreds of thousands of dollars.

Parties are routinely made aware of the consequences of an adverse costs order from the outset of a commercial dispute. The prospect of having to pay the other side’s costs on an indemnity basis will motivate all but the bravest of litigants to give frank consideration to their prospects of success, and whether a fight is indeed worth having. This often avoids the fight altogether, or at least encourages early negotiations.

How is an indemnity costs order obtained?

The starting position is that costs are to be assessed on the standard basis. However, the court has discretion to order costs on the indemnity basis where it is considered appropriate to do so. For example, costs may be ordered on the indemnity basis where:

  • a party unreasonably delays court proceedings;
  • claims made in a proceeding are shown to be baseless; or
  • a reasonable offer of settlement has been refused.

Relevantly, the court may exercise its discretion to award costs on the indemnity basis where an agreement exists between parties to the proceeding that costs would be payable on the indemnity basis.

Clear and unambiguous agreement for indemnity costs

Irrespective of any contractual agreement between parties to a proceeding, the discretion to order indemnity costs remains with the Court. However, the court will usually exercise its discretion to order indemnity costs to give effect to a contractual provision which “plainly and unambiguously” provides for costs to be assessed other than on the standard basis.

A contractual agreement to pay costs will be construed as an agreement to pay costs on the standard basis unless it is plain and unambiguous that costs are to be ordered on an indemnity basis.

In Chen v Kevin McNamara and Son Pty Ltd (No 2), the Victorian Court of Appeal held that the following clause in a building contract was not sufficiently clear to warrant an order for costs on the indemnity basis:

The Owner shall pay to the Contractor:  Any costs and fees incurred by the Contractor in enforcing or further securing its rights under this Agreement.”

Platinum United II Pty Ltd v Secured Mortgage Management Ltd (in liq.) the Queensland Court of Appeal considered a contractual indemnity in the following terms:

The Borrower shall indemnify and keep indemnified the Lender against any loss, expenses or tax which the Lender may reasonably sustain, incur or be required to pay as a consequence of:-

(C) the enforcement of all or any of the securities under all or any of the Transaction Documents”.

cl 17.4(a): “The Borrower shall indemnify and upon demand reimburse the Lender for all legal fees on an indemnity basis, documentary costs and out of pocket expenses including and without limiting the generality of the foregoing all other expenses of the Lender in connection with the negotiation, preparation, execution, completion and enforcement of all Transaction Documents.”

In considering the above indemnity, Fraser JA relevantly said:

The general principle is that a mortgagee is ordinarily limited to (standard costs) but a court will usually exercise the discretion as to costs to give effect to a contractual provision which “plainly and unambiguously” provides for taxation on another basis. It is doubtful whether cl 15.1(C) of the agreement confers an entitlement to have costs assessed on the indemnity basis in sufficiently clear terms to justify the exercise of that discretion, but the expression “on an indemnity basis” in cl 17.4(a) clearly comprehends “the indemnity basis of assessment” of costs” (emphasis added)

“In my opinion cl 17.4(a) of the agreement does plainly and unambiguously oblige the first appellant to indemnify the respondent against its costs of the appeal on the indemnity basis. …”

In Willmott v McLeay, the Court of Appeal dealt with a contract for the sale of property which contained the following clause:

9.7 Seller’s Damages

The Seller may claim damages for any loss it suffers as a result of the Buyer’s default, including its legal costs on an indemnity basis and the cost of any Work or Expenditure under clause 7.6(3).”

In giving the judgment of the Court, Holmes JA said:

This is not a case in which the parties have contracted “plainly and unambiguously” for payment of costs on an indemnity basis. The right to claim such costs as a component of damages for loss resulting from the buyer‘s default is a different and less certain thing; apart from anything else, the recovered deposit could be brought to account in calculating the loss. Because the appellants have not established a clear right under the contract so as to warrant the exercise of the costs discretion in favour of granting indemnity costs, I would confine the award of costs here and below to costs on the standard basis.” (emphasis added)

There have been several cases, however, in which the court has held that a contractual indemnity entitled a party to indemnity costs. Ultimately, the court will consider the precise wording and nature of the indemnity to determine whether a plain and unambiguous agreement that costs are to be ordered on an indemnity basis exists between the parties.

Takeaways

When preparing commercial contracts, solicitors should pay careful attention to the precise wording and effect of indemnities against costs.

If it is intended that an innocent party should be entitled to recover its costs incurred as a result of a breach by another party on an indemnity basis, the terms of the contract should clearly and unambiguously state that this is the case (having regard to the previous decisions of the court on this point). However, even in that case, a court may exercise its discretionary not to order indemnity costs.

Depending on the negotiating power of the respective parties, mutual indemnities in respect of costs may be required. In which case, consideration should to be given to whether a mutual indemnity supporting an order for indemnity costs is appropriate for your client (usually requiring an assessment of the likelihood and consequences of each party breaching the relevant agreement).

Importantly, a right to recover costs on the indemnity basis, or even an order from the court that costs be paid on the indemnity basis, will not guarantee that a party entitled to recover 100% of its legal costs. Almost always, a percentage of costs is inevitably thrown away.

Clients should be made aware of the above points prior to entering into commercial agreements, and prior commencing legal proceedings to enforce such agreements.


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