What is an Indemnity Clause?
An indemnity clause, often called a hold harmless provision, in an employment contract is a promise by the employee to reimburse the employer for certain losses it has incurred or may incur in the future. An indemnity obligates the employee as against all types of damages, not only compensatory damages.
A typical indemnity in an employment agreement is something like the following: In consideration of my employment and the salaries and other payments made to me thereunder, I agree to reimburse the company for any loss, cost or damage which it sustains as a result of my breach of this agreement, negligent acts or omissions or willful misconduct. I understand and agree that the employer will take all reasonable steps necessary to limit its loss and I agree to cooperate fully with the employer in this regard. This clause shall survive the termination of my employment for any reason. Some indemnities are much broader, covering any and all costs, losses or damages, however caused, and also including indemnification for legal fees and expenses. Others are narrower, restricting them to specific types of losses (eg . including only losses as a result of the employee’s breach of statutory obligations such as occupational health and safety or the Occupational Health and Safety Act). The clause ensures that in the event an action is brought against the employer by a third party, and the employer incurs legal costs, damage awards or settlements in defending the action, the employee will reimburse the employer. Apart from simply recouping the actual cost to the employer, some indemnities have a deterrent effect against claims. No employee wants to see his or her salary shrink because of legal fees for which they are responsible. If written in a broad fashion, the indemnity might extend to the employee’s obligations for third party claims arising out of employee dishonesty. In such a case, the employee’s own salary or bonus could be at risk. In any event, the indemnity should be such that the employee cannot reasonably foresee the loss that they are indemnifying the employer for. The employer cannot reasonably be induced to accept a limitation of liability in an employment contract if the risk of that limitation is placed on the employee with the effect that the employee will have difficulty fulfilling his or her financial obligations.
The Purpose of Indemnity Clauses in Employment Contracts
Incorporating indemnity clauses as standard provisions in employment contracts is intended to protect both employers and employees. More often than not, these clauses work to protect the employer alone, but it is important to understand how these provisions can protect both parties.
As with all contract terms, the size and scope of an indemnity clause is crucial. A well drafted clause can act as a kind of insurance policy for employers. It can deter employees from acting negligently or dishonestly, since they could be on the hook financially for any damage caused by such actions. For the employee, a more restrictive indemnity clause may mean they have to pay for their boss’s mistakes, such as if the employer did not carry proper insurance or if they did not maintain their business in accordance with health and safety standards.
To protect themselves, employees may also ask that the scope of any indemnity clauses in their employment contract is clearly labelled as being restricted to acts done within the course of employment, and is specifically limited to actual financial loss to the employer, excluding consequential losses or punitive damages. Employees may also wish to ensure that indemnity clauses in contracts do not try to offset the employer’s own liability for their negligence or have unlimited or unreasonable obligations on the part of the employee. Even in the absence of an express limitation, an obligation in an employment contract to indemnify the employer for its negligence will be unenforceable.
Common Situations and Issues Surrounding Indemnity Clauses
Indemnity clauses in employment contracts typically occur in the following scenarios:
A: Workplace Accidents
Odisha v. Sharma (May 2008) dealt with an employee who was in charge of a development site and installed in a construction project. When a worker fell from a scaffold on that site, he sustained severe injuries. The worker sued the employee for negligence, and on the understanding that the case against him would be defended by his employer, the employee counterclaimed against his employer for indemnification. The Ontario Court of Appeal held that the employee was entitled to indemnity under the employment contract. Jackson J.A. stated:
I conclude that the [employment contract] provision did permit the [former employee] to recover payment for costs, charges and expenses incurred […] even though he was negligent. Nor is there anything in the contract that requires the defence of the action at his expense. If he is obliged to defend the action, he must be indemnified on a full indemnity basis, which is to say, without any deduction for his own negligence.
If they had desired to exclude the obligation in whole or in part, the parties could have done so. However, in the absence of clear contractual language to this effect, one can only conclude that the parties would not have intended to exclude the very protection to which the employee was entitled as an employee.
B: Intellectual Property Disputes
In Toyota Canada Inc. v. Fournier, a former employee of a contractor for the Canadian division of a car manufacturer signed a non-disclosure and non-competition agreement, including an indemnity clause providing for reimbursement of the fees of the employer’s legal counsel in the event of a breach. When the employer learned that the former employee had contacted a competitive company, it brought an action against the former employee and his new employer and sought its legal costs and disbursements from both. The trial court judge held that while the former employee had breached the agreement, the Ontario Superior Court of Justice held that the clause’s purpose was to hold the employer harmless for any losses deriving from the former employee’s improper conduct, not to shift litigation costs. The Ontario Court of Appeal upheld this decision. Rogers J.A. held, on behalf of the Court, that the employer bore the burden of showing that it was entitled to have Mr. Fournier pay its costs. On the latter point, Justice Rogers was of the view that it is generally not the case that the loser in litigation should reimburse the winning party’s costs of litigation. Without that element, the purpose of the indemnity was lacking. As this was an imprecise clause that it would have been possible for the drafter to provide additional detail establishing its purpose and inclusion of a cost-shifting element, the drafter should bear the burden.
In Exel Contracting (Sask.) Ltd. v. Tyra, the Saskatchewan Court of Appeal dealt with the novel question of whether a contract governed by the Personal Property Security Act, 1993 (Sask) contained an indemnity clause indemnifying the vendor for loss as a result of any claim related to the purchaser’s use of the property and any contract related thereto. The Court held that there was no indemnity clause in the contract and thus the vendor had to bear the loss of damage caused by the purchaser’s use of misspelled name.
C: Breach of Contract
In Hunter v. Timson Technical Services Ltd., the British Columbia Court of Appeal dealt with the issue of an indemnity clause in a contract of employment. The relevant clause in the contract provided:
12.1. The Employee shall indemnify and save harmless the Employer, its affiliates, and its officers, directors, employees and agents (the "Indemnified Parties") from any and all losses or costs suffered by any of the Indemnified Parties as a result of the Employee’s breach of obligations under this agreement or in respect of any negligent act of the Employee. The Employee’s obligation to indemnify set out in this Agreement will not be recoverable where the loss or cost of the Indemnified Party was as a result of any intentional or negligent conduct of the Indemnified Party that gave rise to the loss or cost.
When the employee was terminated, his breaching activities included misappropriating and/or misusing company funds and company equipment and property, as well as failing to make, deliver and assign, at the request of the company, all rights, title and interest in and to certain technology developed. The British Columbia Court of Appeal held that the clause extended to damages caused by negligent acts that result in breach of the contract, but did not extend to cover fraud or wrongdoing. The misappropriation of funds by the employee amounted to a breach of his fiduciary duty and was not a negligent or unintended activity. Thus the verdict was upheld.
Legal Aspects and Compliance Issues
Employers should be aware that there are legal restrictions on the use of indemnity clauses and that they must be reasonable, unambiguous, and tailored to the circumstances of the employer-employee relationship.
1. Restrictions on Indemnity Clauses
The Employment Rights Act 1996 (ERA 1996) prohibits employers from attempting to limit employees’ contractual rights and liabilities through restrictive indemnity clauses in employment contracts. The courts have held that indemnity clauses will be unenforceable if they substantially remove the employer’s liability towards its employees for losses arising in the course of employment. Section 203(3) of the ERA 1996 states that this type of indemnity agreement will not be enforceable unless it specifically excludes losses that arise from the negligence of the employer or its employees.
The courts have held that indemnity clauses in employment contracts can be void because:
Notwithstanding the prohibition on indemnity clauses, indemnity and set-off clauses are commonly included in employment contracts to cover claims for repayment of loans to the employer and other monetary losses. The clause should be drafted carefully to ensure that it is not drafted too widely, too ambiguously or that it does not go against any specific statutory prohibitions.
2. Reasonableness
Employer-purchased liability indemnity insurance may be viewed by the courts as added protection for the employee to an extent and acts only as an insurance policy rather than an indemnity.
Indemnity clauses will often be assessed and only enforceable if they meet the general common law principles of reasonableness. If an employee is indemnifying itself against the employer’s own negligence, that has to be reasonable. In addition, UK employees have a right not to be unfairly dismissed under the ERA 1996 and the courts consider contractual provisions for repayment of bonuses or training costs to be penal clauses and void if they would risk the employee’s livelihood and are disproportionate to the employer’s legitimate business interests.
3. Unfair Dismissal and Discrimination
Employers must ensure that the inclusion of indemnity clauses in employment contracts does not lead to claims of unfair dismissal. The courts have found that the employer’s requirements to comply with statutory or regulatory requirements will usually be reasonable and therefore enforceable. However, they will consider the effect of an indemnity clause when judging the reasonableness of the dismissal by carefully balancing the value of both the employer and employee’s rights.
Advantages and Disadvantages of Indemnity Clauses
The benefits that indemnity clauses provide for the employer are clear. They provide the employer with the assurance that it will have recourse against the employee for any potential losses that can be attributed to a breach of the employment contract. The existence and specific wording of an indemnity clause can also help level the bargaining power between the parties, particularly for a large corporation, demanding that the employee (likely a junior employee) indemnify the employer for a particular risk.
While the indemnity clause provides significant benefits to the employer, there are some risks associated with using indemnity clauses. Generally, if the effects of a breach are positive, the employee is able to keep those benefits. However, if the breach results in damages, the executed indemnity clause provides a convenient way for the employer to pass the risk to the employee. In situations where an employee breaches his or her CDB obligations, even when he or she has acted with the best intentions, the indemnity clause will allow an employer to avoid absorbing the loss suffered as a result of that breach. After all, it is easy to assume that the employee is solely responsible for the risk and losses related to the breach, but in the eyes of the law, it is not so clear . A significant amount of thought should go into deciding whether to make an indemnity clause broad enough to allow the employer to recover damages from the employee regardless of whether they were negligent or negligent in part. If the indemnity clause is a very broad "catch-all," then it may be used in a way that will cause unintended hardship to an employee. Consider the following example:
An employee creates a new software program that operates a lot more efficiently than the program it replaces by using a new miniaturized technology that the employee invented and patented. They disclose the nature of this invention to their employer, but do not tell them that the software program infringes on their mentor’s patent (that the employee forgot about). The employer deploys the software and discovers that it infringes a third party’s patent. Based on a very broadly worded indemnity clause, the employer sues the employee for damages and costs incurred in defending against the patent infringement claim. As a result of the suit, the employee is declared judgment-proof and is forced to declare personal bankruptcy. The employee believes this to be highly unethical, as they acted negligently but not intentionally, and the employer was able to capitalize off the employee’s labor and resourcefulness.
How to Draft Indemnity Clauses in Employment Contracts
Best Practices for Drafting Indemnity Clauses
When drafting indemnity clauses, it is vital to consider the scope of the indemnity. For instance, the indemnity could be drafted so that the employee indemnifies the employer for all claims (including those brought by third parties) arising from the employee’s breach of their employment contract, negligence, a breach of the employee’s implied duty of fidelity or other conduct prejudicing the employer’s interests. Indemnity clauses, however, may be irrelevant where specific statutes apply to an individual’s conduct, such as a breach of health and safety laws or other legislation governing behaviour in the workplace. Thus, where such specific legislation exists, a claim under an indemnity clause in relation to that behaviour may fail if the employee’s claim for indemnity is inconsistent with the statutory scheme. Care should also be taken in determining the scope of the indemnity in terms of the employee’s conduct. For example, indemnifying the employee against claims brought by the employer’s other employees may not be appropriate where the employee has been derogatory about another employee(s) to their colleagues. As such, the newly implied terms of the employee’s contract that the employee must not, during their employment, act in a manner likely to prejudice the company’s business, or bring the employer into disrepute, may have been breached.
Apart from defining the scope of the employee’s conduct, it is also important to determine the scope of the indemnity. For example, the indemnity may include the payment of employees’ legal costs. However, if the employee is indemnified for any action that a court has found him or her to have been involved in, then this may lead to unanticipated consequences. The employee may be found to have acted negligently by the court, for example, but then be indemnified for all its costs (including the employee’s legal fees) even if the employee did not settle the claim on a basis that the employer would have considered reasonable. This is not to say that an employer cannot seek to include into the employment contract a clause indemnifying the employee for the employee’s legal costs resulting from the claim. But, where employees are indemnified in that way, including a term providing that, to be indemnified, the employee must have acted reasonably, or have first obtained consent of the employer to incur the costs, may be considered.
Also consider placing a yearly cost limit on the indemnity, or providing that indemnification which was previously approved may not be subject to challenge later by the employer, to avoid any unforeseen consequences. Another issue that can arise is with respect to whether the indemnity extends to costs incurred prior to the termination of the employee’s employment. If such costs are included, it should be made clear (in a separate provision, perhaps) whether the indemnity extends to the incurring of legal costs in relation to proceedings brought after the employment is terminated.
How to Approach Negotiating Indemnity Clauses
For the reasons explained in the previous section, it is important that any provision to indemnify an employer be as narrowly worded as possible since this will reduce the prospect of employees seeking to claim that such a term is excessive and therefore unenforceable. Perhaps the best way to limit an indemnity clause is by limiting it to liabilities arising out of fraud, wilful misconduct and negligence.
It is rare for an employee to agree to indemnity a former employer for a former employer’s negligent acts and many employees will accordingly resist attempts by their employer to have such clauses in their contracts in the first place, or leave them in contracts at the time of termination. These situations are often difficult discussions and negotiations for all of the parties involved.
An employee of a trading company or an executive employee is likely to have a greater understanding of their own role than a junior employee may have, and a corresponding ability to assess their own liability, so that it is more realistic for such employees to be asked to provide an indemnity to their employer. This does not mean however that it will be easy for the termination employer to obtain such an indemnity from a departing senior employee.
During the negotiation process, early intervention and the preliminary explanation for the request for an indemnity can deter a request for a lawyer to review the contractual documents. In particular, the employer requesting an indemnity must therefore find a way to communicate effectively with their employee why they believe that the indemnity is fair, reasonable and lawful. For example, an employee acting within the scope of their authority may still be held liable for their negligent acts or omissions and, at law, would be required to indemnify and indemnified party (i.e. their employer). It is often a good negotiating strategy to focus discussions on issues of fairness rather than on legal requirements as the former may bring an employee and their former employer closer together in their respective positions, than focusing on differences. An employee may respectfully and politely request legal advice on the contractual documents with their lawyer and be told that the matter they have raised above bears no relevance because it will be subject to interpretation and subtleties of the wording of the agreement in question. They may also be told that whilst there is some law in force in respect to the enforceability of such clauses (discussed above), that law has not been clearly defined or fully interpreted yet in Australia, such that the circumstances needed to be tested in the Courts before clear guidance could be given. In these circumstances, the employer will succeed in its negotiating position. In addition, where the employee has left their employment, the employer will have a significant bargaining advantage because they have the greater incentive to finalise terms in order to pay out the employee and/or to protect itself.
Case Studies of Indemnity Clauses in Employment Contracts
Real-life cases involving indemnity for employment contracts and disputes have been effectively resolved through the use of indemnity agreements. Several instances have provided employers with the ability to indemnify themselves in complex disputes and maintain a competitive advantage in the employment market.
Redrow v Farmer
In this case, the High Court found that a former employee was bound by an indemnity clause in his contract, which stated that he would indemnify his former employer for any loss it suffered as a result of a breach of his post-termination restrictions. The clause had the effect of removing the $25,000 cap on damages for breach of contract where the former employee had breached his agreement to give three months’ notice prior to resigning and joining a competitor. It was held that the former employee had to indemnify his former employer for all the damages that his employer had paid to its customers after losing them as a result of his conduct. This indemnity prevented the $25,000 cap on damages.
In non-UK jurisdictions, the use of an indemnity to remove the cap of damages has been upheld in case law such as A v B [2004] IRLR 652 and Quayle v The Coventree Trust Co et al. [2013] A.T.L.R. 524.
Harvey v Crawford
In Harvey v Crawford (2007), it was held that an employee was not under an obligation to indemnify his employer for all expenses incurred as a result of his employment. This decision was based on the interpretation of the contract as a whole, and the use of ‘all expenses’. While it is difficult to predict with certainty how any agreement will be interpreted by a court, this example illustrates a common concern—the language used in an agreement can result in different interpretations. As a general rule, even if the contract is silent on the issue of indemnification, it is possible that an employee’s actions will implicitly provide for an indemnity. The challenge is actually enforcing that indemnity, which requires the court to find that an employee breached the terms of the contract.
Taylor v Lockheed Martin, UK
The Taylor v Lockheed Martin , UK case illustrates the difficulties in enforcing post-termination obligations (and indemnities) owed by employees to their employers, as the employee’s actions prior to termination, may not always equate with a breach of contract. The case involved a group of former employees of aerospace defence giant Lockheed Martin, who agreed to take part in a scheme where they were granted shares at a discount to market value. The aim of the plan was to encourage their retention. When former employees left the company, a clawback provision came into force whereby it would require their return of the original share price or its cash equivalent.
Some former employees accepted the clawback provision, others didn’t. The question was whether the director of the company’s shareholders needed to make a payment of a cash equivalent to individual former employees who had participated in the plan at their own cost and also agreed to the clawback provision. It was held that only the reasonable costs of payment could be passed on to former employees. The use of an indemnity clause which would allow the company to indemnify itself for all reasonable costs for claw-back would achieve this outcome. It would also have helped to clarify to the individual former employees that they were obliged to pay these costs. This case highlights how indemnities can have a broad application in employment law.
Agincourt v Boal
This case illustrates how an indemnity clause may be used to enforce post-termination obligations owed by an employee to her employer. In Agincourt v Boal, (an Irish case) the High Court confirmed that a contract transferring good will and a client list was subject to the terms of a restrictive covenant preventing the transfer of the entire business to a competitor for three years without the explicit consent of the buyer. There was no evidence that client lists or good will were assigned in this case. The incorporation of an indemnity clause which would place the buyer in the position of the seller would have helped to clarify whether the seller’s conduct was a breach of contract.