4 July 2013

Making a rod for your own back

The vast majority of Leases will contain a covenant by a tenant to indemnify the landlord in relation to any loss caused to the landlord as a result of a breach of covenant by the tenant.

Unwittingly, many tenants fall into the trap of blindly accepting these indemnity covenants without pausing to consider what they are actually agreeing to.

The unfortunate reality is that these indemnity covenants provide the landlord with the luxury of remedies that go way beyond the remedies normally available for breach of contract.

Why does this matter? How does being liable for breach of contract differ from being liable under an indemnity covenant?

Limitation

The usual limitation period for a breach of contract is six years but this is extended to twelve years where contracts have been made as a deed. The vast majority of leases are deeds. The 12 year limitation period starts to run when the cause of action accrues and once that 12 year period has expired, the landlord will not be able to bring a claim.

If however a lease contains an indemnity clause, the limitation period will not start to run until the landlord has incurred a liability. The landlord may not of course incur that liability until many years after the tenant’s breach which means that the tenant can be left exposed to an indemnity claim by the landlord for many years after the breach, and far longer than it would be in the absence of an indemnity clause.

Mitigation of loss

In the case of an action for breach of contract, a claimant must take all reasonable steps to mitigate its loss. If it fails to do so, it will not be able to claim damages for any loss that it ought reasonably to have avoided.

In the case of an action based on an indemnity covenant, the landlord is fully entitled to argue that the mitigation rule does not apply. If the rule does not apply, the landlord can sit back and do nothing to mitigate its loss. The landlord will simply point to the terms of the indemnity covenant and argue that the tenant is plainly and simply required to indemnify the landlord against all loss that it suffers.

Remoteness of damage

Generally, in an action for breach of contract, a claimant can only recover damages where the loss suffered by the claimant is reasonably foreseeable. Sometimes, damage occurs which is so improbable and incapable of being foreseen that the loss cannot be claimed.

However, in the case of an indemnity clause in a lease, a landlord is entitled to argue that this “foreseeability test” does not apply and that the tenant is responsible for indemnifying the landlord irrespective of how improbable or unforeseeable the damage is.

Causation

In cases of breach of contract, the claimant must generally show that there is a clear causative link between the breach of contract and the damage suffered. In the absence of any link between the breach and the loss, the claim will fail.

In the case of an indemnity clause however, all the landlord has to do is show that it has suffered a loss as a result of the tenant’s breach of covenant, no matter how tenuous or indirect the link between the breach and the landlord’s loss may be. The strict rules relating to causation do not apply.

Conclusion

Tenants should ensure that when presented with a draft lease, they check the indemnity clauses carefully. The clause should be limited to indemnifying the landlord against potential third-party liabilities of which the tenant has been made aware. The indemnity clause should not extend to loss arising from a breach of covenant by the tenant. In respect of loss caused by tenant breach, the landlord already has a perfectly adequate remedy in the form of damages for breach of contract. Adding an indemnity to that remedy is a luxury that the tenant should avoid at all costs.

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About the Author
Andrew Cave, Partner
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