Tenants’ Indemnity Covenants in Leases 1 Comment

Tenants’ Indemnity Covenants in Leases

Proposition:  A covenant by a tenant under a lease to indemnify the landlord should (if included at all) be limited to third party liabilities incurred by the landlord as a result of the tenants’ failure to comply with specifically identified existing liabilities; it should not provide another remedy for the landlord alternative to the landlord’s right to damages for breach of the tenants’ own covenants.

The practice of landlord’s legal advisors is almost invariably now to include in a draft lease a covenant by the tenant to indemnify the landlord in relation to loss of any kind caused to the landlord as a result of the breach by the tenant of any of the tenants’ covenants in the lease.  I am not sure that all solicitors advising tenants are aware of all of the potential consequences; an indemnity can provide the landlord with remedies which are in many ways different and more onerous for the tenant than the remedies normally available for breach of contract.  I have fought this for years when acting for tenants, rarely with any success – the clause has come to be regarded as standard.  The principal differences are set out below:-

1.  Limitation.Old Father Time

All forms of civil proceedings are subject to periods of limitation under the Limitation Act 1980.  The usual limitation period for a “simple” contract is six years, but the majority of leases are deeds, and an action by the landlord against the tenant (or by the tenant against the landlord) is an action upon a “specialty”, and by virtue of s.8 of the Act the limitation period is extended to twelve years. The general rule is that the relevant limitation period begins to run when the  cause of action accrues; this is normally when there is in existence a person who can sue and another who can be sued (and when there are present all of the facts which are material to be proved to entitle the claimant to succeed).  Once the limitation period has ended, of course, the prospective claimant will not in most cases be able to bring any proceedings at all.

In  the case of an indemnity covenant, the right of action will not, therefore, accrue until the person indemnified incurs a liability which is within the scope of the indemnity.  Assuming (and this might perhaps justify further thought) that the indemnity clause ceases to have any effect on the expiry of the lease so far as future liabilities are concerned, there remains the possibility of the landlord having suffered indemnifiable damage towards the end of the lease, in which case I think it is at least strongly arguable that the limitation period would run from the date of the landlord’s loss, notwithstanding the expiry of the lease, leaving the tenant exposed for up to another twelve years.

2.    Mitigation of Loss.

MitigationIn the case of an action for breach of contract, the claimant must take all reasonable steps to mitigate the loss which he has sustained consequent upon the defendant’s default; if he fails to do so, he will not be able to claim damages for any such loss which he ought reasonably to have avoided.  Again the question arises of whether a similar rule would apply in an action based on an indemnity covenant.   There is little case law, but one relevant decision is Royscott Commercial Leasing Limited v Ismail (Court of Appeal 29 April 1993, apparently unreported but the transcript is available online at lexisnexis.com). That case dealt with a lease in which the lessee agreed to indemnify the landlord if the landlord incurred certain costs.  The tenant argued that the landlord should have tried to mitigate the expenses and the Court of Appeal held that an indemnity was a debt claim and therefore the mitigation rule did not apply.  However, as mentioned, the claim related to particular expenses and was not concerned with the general indemnity for breach of contract; the same can be said for the other cases considered in Royscott i.e. Scottish Midland Guarantee Trust v Woolley [1964] 144 LJ 272 and White and Carter (Councils) Limited v McGregor [1962] AC 413.  In all of these cases it would have been difficult to see how the expenses could have been mitigated.  A court may be more likely to apply the rule in the case of the kind of general indemnity under consideration here, but there is no certainty.

3.  Remoteness of Damage.Charterparty Agreement

The rule in Hadley v Baxendale [1854] 156 ER 145 is that in an action for breach of contract it does not follow that all damage suffered by the injured party is recoverable.  Sometimes, damage occurs which is seen as so improbable and incapable of being foreseen that the loss cannot be claimed unless the parties had special knowledge of the particular circumstances giving rise to the loss.  Again, there is a paucity of authority on the subject. I have only been able to find one case; Total Transport Corpn v Arcadia Petroleum Ltd, The “Eurus” [1998] 1 Lloyds Rep. 351, where the Court of Appeal was concerned with remoteness of loss following a breach of a  clause.  The Court did not consider Royscott, but made the interesting point that the courts have used “indemnity” in two senses; it could mean “damages”; and it could mean an obligation to pay “all losses”.  In The Eurus the court considered it to be a question of fact in each case, but in the case before them they decided that there was no sufficient indication that the parties intended to exclude the usual common law rules.  In the case of a general indemnity clause in a lease, the wording generally used (see below for examples) would very likely tend to support the opposite conclusion.

4.  Causation

In addition to the requirement that the plaintiff suffered a loss that is not too remote, in a claim for damages for breach of contract the claimant must also show that the breach must have causally contributed to the damage i.e. there must be a sufficient cause or connection between a breach and the loss sustained.  Once again, it is at best unclear whether a similar principle would be implied in an action under an indemnity.  On the assumption that an indemnity gives rise to a debt, it seems unlikely – it would be a matter of interpreting the clause and again the examples in common use to which I refer below would not appear to leave room for the principle to apply.

Fault LineThese issues have been discussed elsewhere, and I am particularly indebted to the Property Law Company for its Practice Note “Indemnities : Their Uses and Abuses”.

Of course, an indemnity clause could be qualified by expressly providing for all of these matters and again I am indebted to PLC for its “Standard clause: Indemnity,” which is heavily qualified – in fact to the extent where I can see little point in including it as the way in which it is worded means that it almost certainly does not (and that is clearly the intention) add to the contracting parties’ liability for breach of contract.  I also note that this heavily qualified clause is published in the “PLC Commercial and PLC IPIT & Communications” whereas in the property section the precedent “Lease of Whole with Prescribed Clauses” contains (clause 35) an indemnity covenant by the tenant in the following terms:-

The Tenant shall keep the Landlord indemnified against all expenses, costs, claims, damage and loss (including any diminution in the value of the Landlord’s interest in the Property and loss of amenity of the Property) arising from any breach of any tenant covenants in this lease, or any act or omission of the Tenant, any undertenant or their respective workers, contractors or agents or any other person on the Property with the actual or implied authority of any of them”.

That is very wide, and, looking again at the two senses of “indemnity” referred to in the Court of Appeal judgement in The Eurus it would seem clearly to fall within the second category i.e. an obligation to pay all losses.

I also looked at the Encyclopaedia of Forms and Precedents (Butterworths) Volume 22(2) A “Landlord & Tenant (Business Tenancies)” where under s.3; Offices, precedent 11 “Lease of the whole of an office building, with or without land, where the landlord does not own adjoining property” the precedent contains at clause 3.14 this covenant:-

The Tenant must keep the Landlord fully indemnified against all losses arising directly or indirectly out of any act, omission or negligence of the Tenant or any persons at the Premises expressly or impliedly with his authority [and under his control] or any breach or non-observance by the Tenant of the covenants, conditions or other provisions of this Lease or any of the matters to which this demise is subject.

This clause is however followed by a note by the learned authors (118) stating:-

The tenant should seek to delete all general indemnity provisions on the basis that his remedies for breach of contract and in tort adequately protect the landlord. The tenant should argue that an indemnity unreasonably exceeds his liability.  If this clause is omitted, however, it should be replaced by a covenant to observe and perform the restrictions etc. to which the demise is subject, possibly coupled with a specific indemnity in respect of any breach.

The above note certainly recognises the difficulties which I have outlined and I respectfully agree with it to the extent that it suggests the clause be omitted; I am not entirely clear what is meant by “a specific indemnity in respect of any breach”.Remoteness of Damage

Finally, I looked at Ross on Business Leases (Butterworths) where Precedent 5 in the precedent section is intended for use as a lease of a suite of offices and contains at clause 3.14 the following covenant by the tenant:-

The Tenant must keep the Landlord fully indemnified against all losses arising directly or indirectly out of any act, omission or negligence of the Tenant, or any persons at the Building expressly or impliedly with his authority [and under his control], or any breach or non-observance by the Tenant of the covenants, conditions or other provisions of this Lease or any of the matters to which this demise is subject.

This is not qualified by any note and (apologies to Mr Ross if I have missed it) I could not find anything in the commentary section of the book which addresses the same issue as the note in the Encyclopaedia of Forms and Precedents.

One would have thought that this was the kind of point which might be covered in the Code for Leasing Business Premises in England and Wales 2007; so far as I can see it is not, and perhaps the organisations endorsing the Code might consider including a provision advising against the inclusion in leases of indemnity clauses where there is already a remedy in contract subject to the usual common law restrictions to which I have referred.

Conclusion:  Indemnity clauses in leases should be limited to potential third party liabilities of which the tenant has been made aware; they should not extend to loss arising from the tenant’s breach of his covenants in the lease itself, where the landlord already has a perfectly adequate remedy.

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This Post Has 1 Comment

  1. Paul French says:

    Raymond, thank you for an interesting read. I am researching the effect of a clause in a sub lease to indemnify the Landlord for all claims, losses etc, and where the Landlord had agreed a financial dilapidations claim with the Superior Landlord. The contention is that the Landlord has suffered loss, and that the settlement is prima facie evidence of the loss, and that the sub tenant must now indemnify the Landlord. It transpires the Landlord’s settlement may have been premature as the Superior Landlord had intentions to substantially refurbish the premises on termination and its is possible most of the settlement would be regarded as superseded if the Landlord’s surveyor had acted on this knowledge.

    The Landlord is clearly trying to recover monies expended through the use of the indemnity clause even though there is a possibility the Landlord has created the loss by its own actions.

    Would you be prepared to comment?

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