Australia: Indemnities and releases under commercial leases

Indemnities and releases under commercial leases

Indemnities and releases are often the subject of lease negotiations. This is because, at their core, indemnities and releases allocate risk between the landlord and tenant.

Ideally, the risks are allocated fairly having regard to the ability of each party to manage a particular risk. However, this is not always the case and the parties can get caught out if they do not properly consider the indemnities and releases in their lease.

In this article we shed light on how indemnities and releases differ, and highlight some of the points that landlords and tenants should consider when negotiating and agreeing to them.

What is an indemnity?

An indemnity is a promise by one party to hold another party harmless against loss that the indemnified party may suffer.

In a leasing context, a tenant is often asked to indemnify a landlord for loss or damage that the landlord may suffer as a result of the tenant's use and occupation of the leased premises.

Giving an indemnity

In particular, a landlord will typically require a tenant to indemnify it for:

• Damage, loss, injury or death caused by the tenant or third parties within the tenant's control, such as its employees or agents.
• The landlord doing anything on behalf of the tenant as a result of the tenant failing to perform its obligations under the lease, such as carrying out maintenance works to the premises.
• The tenant's breach of environmental or work health and safety laws.
• The tenant's breach of the lease.

The scope of the indemnities sought by a landlord can be intentionally broad and a tenant may therefore seek to limit its exposure by considering some of the following:

• Limit the beneficiary: a tenant should ensure that the landlord is the only beneficiary of an indemnity given by the tenant.
• Keep the indemnity within your control: tenants should resist clauses that require the landlord to be indemnified for anything outside of the tenant's control or which the tenant is unable to cover by way of insurance. Accordingly, a tenant should consider carefully whether its insurances will cover each event where an indemnity may be relied upon by the landlord. If in doubt, tenants should ask their insurance providers to advise on the insurances required to respond to the full extent of the indemnities.
• Limit the origin of the loss: often indemnities are drafted to apply in circumstances where loss or damage has arisen "in connection with" an event. Expressions such as "in connection with" are intentionally wide-reaching. They are intended to extend liability to claims which might otherwise fail under the common law principle of remoteness of damage ¹. Therefore, tenants should seek to limit the application of an indemnity to loss or damage arising directly as a result of the indemnified event.
• Exclude the landlord's negligence: indemnities should exclude or "carve out" liability for the landlord's willful act, negligence, omission or default. This "carve out" should extend to the actions of third parties who are reasonably within the landlord's control, such as employees or agents. In other words, a tenant should avoid giving indemnities where the indemnified event is not triggered by the tenant or its employees.
• Duty to mitigate: in normal circumstances, a breach of contract gives rise to a claim in damages and an obligation on the party making the claim to mitigate its loss suffered as a result of the breach. In the context of indemnities, however, the duty to mitigate normally does not apply. Even so, a prudent tenant will request an express obligation in the lease requiring the landlord to mitigate its loss for any breach of the lease by the tenant.

Receiving an indemnity

On the other hand, for a landlord receiving an indemnity, the aim is to obtain an indemnity that is as broad as possible in the context of the situation. However, it is worth considering the following points:

• Value: what is the value of the indemnity being given? Obtaining a broad indemnity from a tenant may not be worth much in practical terms, if in fact the tenant has no (or limited) financial standing. In these circumstances it is prudent for a landlord to consider whether personal, bank or other third party guarantees should be obtained from the tenant and whether additional policies of insurance are required to cover the risk.
• Context: ensure that the indemnity being sought is appropriate for the context of the transaction. For example, indemnities given by a tenant under a lease will be different from the indemnities given under a fitout deed where a landlord's primary concern is its protection from risk of loss or damage arising from the tenant's fitout works.
• Insurances: in the same way that tenants are encouraged to consider whether their insurances are adequate, landlords should do the same to avoid situations where neither party has appropriate insurances to cover the loss or damage.

What is a release?

Releases are often drafted and grouped together with indemnities, but are a different legal concept.

A release is a promise by one party that it will not exercise its rights against the other party if a certain event occurs and triggers loss or damage. It does not go as far as an indemnity which, as explained above, involves a promise that one party will actually cover any losses that the other party might suffer arising from the action in relation to which the indemnity is being given.

In a leasing context, at a minimum, a landlord will typically require a tenant to release it from liability arising from events outside of the landlord's control or from the landlord's exercise of rights under the lease. The landlord may go further and also seek an indemnity from the tenant in relation to any resulting liability.

When considering releases, parties should consider the same principles as they do when considering indemnities. Key questions to ask include:

• Who is the beneficiary?
• What is the risk being allocated?
• Which party best placed to manage the risk?
• Do exceptions to the releases need to be included?
• Is an indemnity appropriate?

Let's consider an example to illustrate how and when indemnities and releases might be sought in a leasing context.

The scenario

A landlord may agree to provide air conditioning and other services to the tenant under its lease. The landlord may even be prepared to agree to some abatement of rent if those services fail for any reason.

The landlord's perspective

The landlord will not want to be liable for any losses that the tenant may suffer arising from the failure of the services. Consequently, the landlord will almost certainly require the tenant to agree in the lease to release the landlord from any claim by the tenant in respect of the failure of the services. Whether any such release should be subject to the landlord fulfilling certain obligations in relation to the services (such as maintenance and repair obligations) would be a matter for negotiation.

The tenant's perspective

While the tenant may be prepared to agree to release the landlord from any claim by the tenant, it will probably not want to go further and indemnify the landlord against liability otherwise arising from the failure of the services. This is because it will usually be the landlord's responsibility to provide the services – especially in a multi-tenanted building. Indeed, it is unlikely that a landlord would even seek such an indemnity but this example perhaps serves to illustrate the distinction between giving up a right to make a personal claim and holding someone harmless against all claims.

In the above scenario, a prudent tenant will arrange its own insurance to cover loss to its business arising out of any failure of the services. A prudent landlord will ensure that its building insurance covers it for loss and damage where it does not have the benefit of an effective release or indemnity, especially where visitors to the building may be injured as a result of the negligent maintenance of the building services.

Beware the hidden indemnity or release

Tenants should also be generally aware that indemnities and releases can appear in different forms and in different sections of the lease, and not just within the separate 'indemnities and releases' clause. Each indemnity and release needs to be considered carefully, regardless of where it might appear in the lease document.

Key takeaways

For landlords: Keep the scope of the indemnities relevant to the lease or transaction being entered into. Indemnities that do not clearly specify the terms within which the indemnities are intended to operate run the risk of being interpreted in favour of the tenant. Remember also that an indemnity is only as good as the tenant standing behind it and that in some cases third party guarantees or additional insurances may be required.

For tenants: It is inevitable that tenants will be required to give some form of indemnity or release. The key for tenants is to carefully review the provisions and consider whether the trigger events are within the tenant's control, and whether the tenant is reasonably in the best position to deal with the particular risks. Where relevant, a tenant should also consider any policies its organisation may have in relation to indemnities and releases and use these to guide the best possible outcome.

Footnote

¹ Hadley v Baxendale (1854) 2 CLR 517

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.