Understanding the pitfalls of standard contractual indemnities

In many a business agreement, indemnities are often viewed as a safety net, offering a semblance of security against potential losses and damages. However, PJ Veldhuizen, Managing Director at attorney firm Gillan and Veldhuizen Inc. warns of the limitations and misconceptions surrounding indemnity clauses in contracts, emphasising the need for comprehensive understanding and cautious drafting of contracts.

Indemnity, a contractual agreement between two parties, is designed to offer financial compensation for losses or damages incurred by one party due to the actions of the other. “The strength of an indemnity lies solely in the credibility and reliability of the party offering it,” says Veldhuizen.

In transactions such as the sale of businesses or shares, the intricacies of warranties and indemnities become particularly crucial. These clauses serve as the purchaser’s protection, ensuring the seller’s accountability regarding the state, financial wellness and legality of the business or shares in question.

As an example, Veldhuizen explains that one common oversight in business sales relates to Section 34 of the Insolvency Act. This section mandates that the sale of a business must be advertised in a regional newspaper in both English and Afrikaans and in the governing gazette within specific timeframes. Neglecting this requirement renders the transaction void against creditors for 60 days. Business owners, in an attempt to circumvent advertising expenses, often offer indemnities to cover any claims made during this period. However, as Veldhuizen points out, “Often, by the time the sale proceeds are received and allocated, the funds necessary to honour such indemnities may no longer be available.” Noting that his firm has been approached to assist clients with this familiar scenario.

Veldhuizen highlights the importance of robust and well-considered contracts, transcending beyond mere indemnity clauses.  “We’ve seen too many cut-and-paste contracts cause major problems and financial loss for parties in an agreement.” The time and financial resources invested in drafting a legitimate, watertight legal contract far outweigh the potential costs and complications that may arise should an indemnity fail to be honoured or upheld.

A solid contractual foundation, encompassing detailed warranties and mindful of legal stipulations, is essential to safeguard interests and avoid obstructive, unintended consequences.