Does Indemnification Cover Only Losses from Nonparty Claims?

Is there no end to the confusion prompted by the verb indemnify?

Recently in this post and this post I considered how a claim for indemnification relates to a claim for contract damages. In the first of those posts, reader Gord offered the following comment:

Canadian lawyers when using indemnification language in contracts have had to consider and contend with an Alberta case (the results of which were given the stamp of approval by the Supreme Court of Canada) of Mobil Oil Canada Ltd. v. Beta Well Service Ltd. (from 1973-1974). The gist of this case is that the concept of indemnity is limited to third party claims not to direct damages. Thus on this theory of interpretation if “Party A agrees to indemnify Party B if [___ fill in trigger for obligation___]” this would only protect Party B from claims made by third parties against Party B. It has been suggested that if direct loss and claims by 3rd Parties are supposed to be covered then added language is required such as “Party A agrees to be liable to Party B for Party B’s losses and agrees to indemnify Party B against any claims against B by other Persons if [___ fill in trigger for obligation___]. Not sure how relevant you will find this in the context of your CDA discussion but it is something Canadian lawyers must consider whenever using indemnification language.

Intrigued, I had a look at this case. Click here for a copy of the opinion of the Alberta Supreme Court, Appellate Division; click here for a copy of the opinion of the Supreme Court of Canada.

The case involved a claim brought by Mobil against contractor Beta in connection with collapse of an oil rig. Here’s the language at issue:

INDEMNIFICATION BY CONTRACTOR

Contractor (Beta) shall be liable for and shall indemnify and save harmless Mobil Oil of and from all manner of actions, causes of action, proceedings, claims, demands, loss, costs, damages and expenses whatsoever which may be brought or made against Mobil Oil, or which it may sustain, pay, or incur as a result of or in connection with the performance, purported performance or non-performance of this agreement or other work hereunder by Contractor or his sub-contractors and whether the same results from or in connection with the use by Contractor or his sub-contractors of any machinery, tools or equipment belonging to Mobil Oil, or from or in connection with the negligence or wilful acts or omissions of Mobil Oil, its servants, agents, employees or its other contractors, while acting under the direction or control of Contractor or his sub-contractors, and Contractor shall further indemnify and save harmless Mobil Oil from all claims, suits, and demands for infringement of any patent or similar right growing out of or incident to Contractor’s performance of said work or the use of material or equipment furnished by Contractor.

According to the Appellate Division, the question was whether, as Mobil contended, this language operated “in effect, as an insurance clause under the terms of which the Contractor agrees to insure and indemnify Mobil against, not only claims of third parties, but also to be liable for direct loss or damage which it may suffer as a result of any of the operations of the Contractor under the Contract.”

The court first considered whether, out of the string of nouns following the opening verbs, “loss, costs, damages and expenses” might relate  to “shall be liable for” and “actions (etc.)” might relate to “shall indemnify and save harmless.” But it went on to say the following:

But it must be noted that the “liability” provision and the “indemnification provisions” are linked together by the conjunction “and” – “The contractor shall be liable for and shall indemnify and save harmless Mobil Oil” etc. The clause may therefore be interpreted as providing for the acceptance by the contractor (Beta) of liability for, and an undertaking to indemnify Mobil Oil against, claims of third parties, rather than direct claims of Mobil Oil against the contractor for loss or damage it might sustain. I think, reading the clause as a whole, this intention may fairly and properly be drawn from its provisions.

When courts blithely step into the tar pit that is and, the results are invariably unhappy. And that’s the case here—I can see no reason why this and supports the court’s conclusion.

If I had been called on to interpret this language, I would have pointed to a part that the court ignored—”which may be brought or made against Mobil Oil, or which it may sustain, pay, or incur.” That reinforces the duality that the court considered then discounted.

And more generally, the notion of limiting indemnification to claims by nonparties is inconsistent with how I see the word used. For example, in M&A contracts it’s standard to refer to indemnification for claims brought by one party against another for inaccurate representations or breached obligations as well as for nonparty claims.

The Supreme Court of Canada sustained the judgment of the Appellate Division. But interestingly, it invoked a different analysis. In particular it referred to the following language in schedule A of the contract, which the Appellate Division had said didn’t apply:

Beta will be bound on to carry out the services requested in good faith and to the best of its ability, being held responsible only for its wilful misconduct and failure to exercise good faith at all times.

So it seems that rather than relying on the notion that indemnification inherently applies only to nonparty claims, the Supreme Court of Canada was more interested in the fact that the contract was inconsistent regarding the contractor’s liability.

But as usual, my interest lies not in rummaging in the entrails of a contract dispute but instead in drafting so as to avoid dispute. Rightly or wrongly, at least some Canadian transactional lawyers are under the impression that the Mobil Oil case stands for the notion that indemnification inherently applies only to nonparty claims. What to do?

If I’m called on to include indemnification in a contract, usually I’ll incorporate language that addresses procedures to use in direct claims between the parties and procedures that apply to nonparty claims. That would preclude anyone suggesting that indemnification has nothing to do with direct claims.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.