Interpretation of Contractual Indemnities by TurksLegal

Interpretation of Contractual Indemnities By Roger Walter | October 2007 Area of Expertise | General Insurance

Summary This is the ﬁrst NSW decision at appellate level on the construction of indemnity clauses since the High Court decision in Andar Transport Pty Ltd v Brambles Ltd (2004) 217 CLR 424. This recent decision illustrates the difﬁculties often encountered in the construction of indemnity clauses and how the law is applied in resolving them.

Who Does This Impact? Businesses and their liability insurers.

What Action Should Be Taken? Exercise caution with contractual indemnities and make sure they mean what they appear to say having regard to the circumstances. Bare indemnities are to be avoided; if indemnity clauses are to operate despite the negligence of the indemniﬁed party, they should say so.

Introduction In BI (Contracting) Pty Limited v AW Baulderstone Holdings Pty Limited [2007] NSWCA 173 (unreported decision dated 17 July 2007), the NSW Court of Appeal was required to determine the effect of an indemnity clause in a construction contract. The head contractor (Baulderstone) claimed it was entitled to be indemniﬁed by the sub-contractor (BIC) in respect of a personal injury claim brought by a BIC employee, even though the injury was partly the result of Baulderstone’s own negligence. The claimed indemnity was established at trial. On appeal BIC asked the Court of Appeal to construe the indemnity clause by applying what is sometimes referred to as the “third rule” in the Canada Steamship 1 case and dismiss Baulderstone’s claim. In dismissing BIC’s appeal and upholding the Baulderstone claim, the Court of Appeal held that it was not obliged to apply the “third rule” in Canada Steamship, which is a rule of secondary construction that is considered useful in the interpretation of indemnity clauses in the English courts 2. This is the ﬁrst NSW decision at appellate level on the construction of indemnity clauses since the 2004 High Court decision in Andar 3, a case in which the High Court was required to determine the effect of an indemnity clause and chose not to comment on the relevance or validity of the third rule in Canada Steamship. The BIC case is of interest for this reason alone. The Court of Appeal’s approach to the interpretation of the indemnity clause is also a good example of how the courts in the modern era will construe contracts by having due regard to the surrounding commercial context before determining the plain meaning of the contract wording.

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Interpretation of Contractual Indemnities by Roger Walter

The Facts In 1963 Baulderstone contracted with the SA Government for the construction of buildings at the Royal Adelaide Hospital. BIC contracted with Baulderstone to undertake asbestos insulation work required in the course of construction. A Baulderstone employee at the site, Mr Stutley, later developed mesothelioma as a result of inhaling asbestos. He brought proceedings against Baulderstone and agreed to accept a sum in settlement, with no admission of liability by Baulderstone. Baulderstone, by way of cross-claim brought proceedings for contribution against BIC. The trial judge found BIC and other cross-defendants liable as to 80 per cent of Baulderstone’s liability to Mr Stutley. Baulderstone also claimed a complete contractual indemnity against BIC on the basis of a clause of its sub-contract with BIC. The trial judge upheld Baulderstone’s claim and held that BIC was required to indemnify Baulderstone. In claiming the indemnity Baulderstone relied on clause 6 of the sub-contract, which said: The Subcontractor shall take out and maintain workmen’s compensation insurance and public risk insurance policies in respect of the subcontract works and shall pay all premiums thereon and all fees required by any public or local government authority in respect of the subcontract works and shall indemnify the builder against all liability relating to the subcontract works. (emphasis added)

Construction of Indemnity Clauses The three rules identiﬁed in 1952 by the Privy Council in Canada Steamship were as follows: 1

If the clause contains language which expressly exempts the person in whose favour it is made (hereafter called ‘the proferens’) from the consequence of the negligence of his own servants, effect must be given to that provision.

If there is no express reference to negligence, the court must consider whether the words used are wide enough, in their ordinary meaning, to cover negligence on the part of the servants of the proferens. If a doubt arises at this point, it must be resolved against the proferens...

If the words used are wide enough for the above purpose, the court must then consider ‘whether the head of damage may be based on some ground other than that of negligence’, to quote...Lord Greene in [Alderslade v Hendon Laundry Ld [1945] KB 189, 192]. The ‘other ground’ must not be so fanciful or remote that the proferens cannot be supposed to have desired protection against it; but subject to this qualiﬁcation, which is no doubt to be implied from Lord Greene’s words, the existence of a possible head of damage other than that of negligence is fatal to the proferens even if the words used are prima facie wide enough to cover negligence on the part of his servants.

In the majority judgment in Andar the High Court gave no analysis of the status of the these rules of secondary construction, preferring instead to draw an analogy between a contractual indemnity and a contract of guarantee so as to take advantage of the strictissimi juris rule, which says that contracts of guarantee are to be construed strictly, with any ambiguities being resolved in favour of the party giving the guarantee. Commentators have observed that it was a little surprising that the High Court drew this analogy 4. These commentators have also been critical of the High Court for not addressing the tension that exists between the modern, commercial construction approach and the narrower, rule-based approach evident in Canada Steamship.

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Interpretation of Contractual Indemnities by Roger Walter

As observed in the present case by the Court of Appeal, in Darlington 5 in 1986 the High Court rejected the longstanding notion that exclusion clauses should be construed strictly. Rather, the High Court said that the meaning of an exclusion clause had to be: … determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract and, where appropriate, construing the clause contra proferentem in case of ambiguity. 6

In Glebe Island Terminals 7 this approach was then applied in NSW to indemnity clauses. In 2004 the majority of the High Court in Andar held, following their reference to the rules governing the construction of contracts of guarantee, that, to the extent that there was an ambiguity in an indemnity clause, … [those] rules of construction … require the provisions [of the indemnity clause] to be construed in favour of [the party providing the indemnity]. Earlier in their judgment, their Honours endorsed the following statement about the “well-known rules of construction in relation to guarantees”: … [a contract of guarantee] falls to be construed strictly; it is to be read contra proferentem; and, in case of ambiguity, it is to be construed in favour of the [party giving the guarantee]… these rules do not ... mean that where parties to such a document have deliberately chosen to adopt wording of the widest possible import that wording is to be ignored. Nor do they oust the rule that where wording is susceptible of more than one meaning regard may be had to the circumstances surrounding the execution of the document as an aid to construction. In the present case BIC contended, with reference to the third rule in Canada Steamship, that, upon construing clause 6 strictly, the indemnity did not extend to Baulderstone’s liability to its own employee – as it did not say as much and the clause had work to do without such an extension of its meaning. BIC submitted that the indemnity was directed to requiring BIC to indemnify Baulderstone for any vicarious liability Baulderstone might incur for BIC’s negligence to BIC employees or to third parties. BIC argued on this basis that Mr Stutley’s claim against Baulderstone fell outside the indemnity because the claim’s success (in light of the pleadings and settlement) was based on Baulderstone’s breach of its duty of care to Mr Stutley and was not dependent upon BIC’s negligence. In reply Baulderstone submitted to the Court of Appeal that the third rule in Canada Steamship did not represent the law in Australia. The Court of Appeal held that an “examination of the joint judgment in Andar reveals that their Honours’ approach to the construction of the indemnity clause was ﬁrst to construe the clause strictly in the context of the contract as a whole and, to the extent that there remained any ambiguity, to construe the indemnity in favour of [the party granting indemnity]: see [24]-[29], especially at [29].” Proceeding on this basis the Court of Appeal held as follows: The language of cl 6 is in the widest terms and as a matter of ordinary construction would encompass the injury, loss and damage for which Baulderstone was liable to Mr Stutley. However, it was BIC that was undertaking the works that caused Mr Stutley’s injury. It is

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Interpretation of Contractual Indemnities by Roger Walter

probable that the parties had it in their contemplation, therefore, that BIC should be responsible for whatever loss or damage was caused by the carrying out of those works. In other words, it is apparent from its terms that cl 6 is a risk allocation clause and it was intended to allocate the risk for all liability that arose relating to that part of the building works undertaken by a particular sub-contractor, in this case, BIC for the asbestos insulation work carried out by it. The negligent performance of building work is not unusual. … Accordingly, it is likely, in my opinion, that the parties would have had it in contemplation that BIC should be liable for its negligence, notwithstanding that Baulderstone was also negligent. In this regard I am of the opinion that there is no ambiguity in the provision so as to cause the clause to be construed in favour of BIC so as to make cl 6 inapplicable to the present circumstances. The Court of Appeal also held that the result would not have been different if it had applied the third rule in Canada Steamship. It was signiﬁcant in this regard that the contract in question incorporated certain provisions in the head contract.

Implications In the end the NSW Court of Appeal applied the plain meaning of the provision in question, but only after considering the contract as a whole and looking to the commercial context and particularly the relationship between the parties. A different context or relationship may have led to the opposite result. The guidance on the construction of contractual indemnities from the High Court of Australia, although subjected to some criticism from commentators for not contributing in Andar with statements for or against the secondary rule of construction known as the third rule in Canada Steamship, was sufﬁcient for the NSW Court of Appeal to resolve the dispute in this case. Finally, the present case is another reminder that simply adopting old phrasing without giving thought to making provision for particular characteristics of a relationship may well lead to being caught up in a long and expensive dispute that might have been avoided with some professional use of clear and precise language at the outset. Use of an indemnity clause that expressly contemplates the negligence of the party being indemniﬁed will put the issue beyond doubt.

Endnotes 1

Canada Steamship Lines Ltd v The King [1952] AC 192 HIH Casualty and General Insurance Ltd and Ors v Chase Manhattan Bank and Ors [2003] 2 Lloyd’s Rep 61 3 Andar Transport Pty Ltd v Brambles Ltd (2004) 217 CLR 424 4 Carter JW and Yates D, “Perspectives on Commercial Construction and the Canada SS Case” (2004) 20 JCL 233; Gosewisch D, “Difﬁculties with indemnities between business entities” (2006) 34 ABLR 89. 5 Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 6 at 510 7 Glebe Island Terminals Pty Limited v Continental Seagram Pty Limited (1993) 40 NSWLR 206 2

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Interpretation of Contractual Indemnities by Roger Walter

For more information, please contact: Roger Walter Partner T: 02 8257 5736 roger.walter@turkslegal.com.au

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