Does an indemnity cover future losses?
K/S PRESTON STREET v SANTANDER [2012]
This case concerned the scope of an indemnity and, in particular, whether it extended to cover future losses. An indemnity is a contractual undertaking to underwrite a particular risk. Indemnities have traditionally been most common in relation to the risk of third party intellectual property infringement claims where the supplier agrees to indemnify the customer against any damage it may suffer from using a particular deliverable should it infringe. However, indemnities in respect of other risks/losses are becoming more common.
Facts:
- P had taken out a loan for a fixed period but on terms which permitted early repayment or ‘prepayment’ (both terms were used interchangeably). Early repayment can result in a lender incurring certain losses.
- The terms of the loan provided that:
- the borrower agreed to indemnify the lender ‘on demand’ for ‘any loss or expense’ suffered in connection with the early "termination or reversing" of applicable hedging arrangements; and
- in the event of prepayment the borrower agreed to indemnify the lender "on demand against any cost, loss, expenses or liability (including loss of profit and opportunity costs)" that the lender "incurs as a result of the repayment of the loan" at any time during the ten-year term of the loan.
- P repaid the outstanding balance of the loan and S claimed £165,000 under the indemnities for what it claimed were losses it suffered as a result of P's early repayment of the loan. S argued that it was entitled to recover an amount equal to the interest it would have received under the loan agreement but for the early repayment, less any interest it could earn by lending the repaid sums in the interbank lending market for the remainder of the term of the original loan.
- S conceded that its calculation of loss was dependent on estimates of future net interbank interest rates and that there was a risk it would be overcompensated if interest rates rose.
Decision:
- The Court held that under the indemnity S could only recover for losses actually incurred up to the date the loan was repaid. Its claim for the indemnity to capture future and estimated losses could not succeed because although the parties had been free to include future losses within the scope of the indemnity had they so wished, the wording did not provide for that degree of recovery. The Judge interpreted the indemnity as applying only in respect of a ‘crystallised liability’. In other words, S could only seek to be indemnified in respect of a loss that it had already incurred.
- The Judge said "If it had been intended that the lender should be entitled to recover a sum in respect of a future loss then the clause would not have referred just to the word "incurs", but would have used words to the effect of "incurs or to be incurred". He went on to say “the word "loss" is a word of ordinary English meaning and which can only mean a loss which has been suffered at the time when demand is made for an indemnity in respect of it”. That may be a surprising conclusion to many!
Points to Note:
- It is important to note that this was not a case involving an indemnity in respect of losses arising from breach of contract, although there is no particular reason to expect that a different conclusion would be reached in such circumstances.
- There was no question of the early repayment fees (which were expressly payable in addition to the indemnity) constituting a penalty and therefore being unenforceable at law. This was because they were not payable following a breach since the borrower was simply exercising an express contractual option to terminate early.
- This was only a summary judgment and therefore carries comparatively very little judicial weight in terms of precedent value. It also remains to be seen whether the case is subject to an appeal.
- Indemnities in respect of ‘all losses’ are relatively rare and it is perhaps questionable whether they are appropriate in the context of unquantified liabilities. Nevertheless, some parties insist upon them and they are seen from time to time.
- Those drafting such contractual indemnities would therefore seem to be well advised to include the ‘incurred or to be incurred’ formulation so as to avoid, so far as possible, any interpretation that the indemnity will only cover accrued losses and not an estimate, however reasonable, of possible future losses.