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What is the difference between a warranty and an indemnity? What is the difference between a warranty and an indemnity?

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Feb 23

What is the difference between a warranty and an indemnity?

Written by Adam Colville-Robins

DDI: 01423 726616
E: adam.colville-robins@raworths.co.uk

Warranties and indemnities are frequently included in commercial agreements. Their aim is to provide a right of redress where one party provides to another critical information which later turns out to be inaccurate or wrong and results in a financial loss.

Disputes about warranties and indemnities arise frequently and are particularly common in the context of business sales, finance and construction contracts, software development agreements, joint ventures and also higher value or complex sale of goods or supply of services contracts.  But what is the difference between them in practice?

Adam Colville-Robins, as Associate in the Dispute Resolution team at Raworths based in Harrogate, looks at this in more detail.

The distinction and why it is important

Before looking at potential dispute resolution options, it is important to be clear about what warranties and indemnities are designed to achieve, how they differ and the rights of recourse that they confer.

Warranties – A warranty is a contractual statement of fact that is designed to give assurance to a party about a particular aspect of the deal that has been struck. For example, in a business acquisition, a series of warranties may be given by the seller to the buyer to provide assurance about the profitability of the business, ownership of assets and the absence of legal disputes (other than those disclosed).

Where the terms of a warranty are breached, it will usually be possible to claim compensation for any harm caused – subject to that harm being a natural consequence of the breach, or one that can reasonably be said to have been in the contemplation of the parties as a possible outcome, and also subject to the affected party having done all they reasonably can to mitigate their losses.

Indemnities – An indemnity by contrast is a contractual promise that, if a certain event occurs, then the party giving the indemnity will compensate the other party for their consequent losses. For example, in a bespoke software contract, an indemnity may be given by the software developer to the end client to cover the risks associated with a threatened, but legally weak, claim of intellectual property infringement, which may have been mooted by a third party who alleges that the developer has used components that are covered by their intellectual property, and which are not properly licensed.

Where the terms of an indemnity are breached, then a claim for compensation will again usually be possible and generally without the claiming party being under a duty to take mitigating steps.

What sort of issues can arise?

Given the fundamental importance of warranties and indemnities when it comes to allocating risk in commercial deals, it will usually be the case that where a dispute arises it will centre on one of four things. The first is whether a breach of the relevant provision has occurred, the second is whether it has caused the losses that are being claimed (where this is a prerequisite), the third is the extent to which those losses can be recouped, and the fourth is the extent to which liability for those losses may be restricted by a related exclusion or limitation of liability clause.

Assessing where you stand in relation to the dispute will necessitate careful consideration of not only the relevant warranty or indemnity itself, but also the wider contract in which it is contained and the circumstances that are alleged to have led to the warranty or indemnity being breached.

It is crucial to understand how the terms of a warranty or indemnity provision are likely to be interpreted by a Court, what a potential violation may mean for you in a best- and worst-case scenario, and whether there may be other potential causes of action that need to be considered, like a possible claim for misrepresentation.

How to deal with claims

More often than not, the mechanism by which a warranty or indemnity claim must be resolved will be stipulated in the contract itself under a pre-agreed dispute resolution clause. Where this is the case, then it will normally be necessary for you to follow the procedure that has been prescribed.

In all other cases, the approach to dispute resolution is usually an incremental one, which begins with negotiation and then moves on to other ‘non-court’ based options, such as:

  • mediation, where the involvement of an experienced intermediatory may help you and your opponent to explore and hopefully agree on mutually acceptable terms for compromise;
  • early neutral evaluation, where an independent legal expert (typically a barrister or a retired judge) can be asked to give you and your opponent an assessment of the merits of your respective cases, and which can then be used as a basis for further negotiation;
  • expert determination, where a professional advisor can be asked to make a binding decision on a technical point of importance to your dispute – like the amount by which you can fairly be said to have overpaid for the shares or assets of a business that you have acquired, where it transpires that the financial information provided by the seller was incorrect; or
  • arbitration, where an independent expert in the subject matter of your dispute can be appointed to make a relatively quick, confidential and legally binding decision on whether a warranty or indemnity claim can indeed be made and, if so, the appropriate compensation.

It follows that the instigation of proceedings at court should always be considered to be a step of last resort, although where proceedings are justified then they should of course be issued promptly.

How to contact the Dispute Resolution team at Raworths

To find out more, please contact Adam Colville-Robins, an associate in the Dispute Resolution team at Raworths via email at adam.colville-robins@raworths.co.uk or on 01423 566666.

Raworths is based in Harrogate, North Yorkshire.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.

Published on 6 February 2023

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