Indemnity Costs in New South Wales: When Are They Awarded and Why?

Litigation can be an expensive and time-consuming process, and legal costs are often a key concern for parties involved in court proceedings. In most cases, the general rule is that the losing party pays the winning party’s legal costs on what is known as a party/party basis—meaning only reasonable and necessary costs are covered. However, in certain circumstances, a court may order the unsuccessful party to pay indemnity costs, which are significantly higher and cover almost all legal expenses incurred by the successful party.

Indemnity costs serve as a warning against unreasonable or improper conduct in litigation and provide greater compensation to a party who has been unfairly burdened by unnecessary legal proceedings. This blog explores the concept of indemnity costs in New South Wales, the legal principles behind them, and the circumstances in which they may be awarded.

What Are Indemnity Costs?

In NSW, the general rule is that a party will bear their own legal costs unless the court orders otherwise. This is known as "costs follow the event," meaning that the losing party usually pays the costs of the successful party. However, indemnity costs are not the default position and are awarded in exceptional circumstances.

Indemnity costs represent a higher scale of legal costs compared to the usual party/party costs. Under rule 42.5 of the Uniform Civil Procedure Rules 2005 (NSW) (UCPR), an order for indemnity costs allows the successful party to recover all reasonable legal costs incurred, rather than just the portion deemed fair and necessary by the court.  They are meant to fully indemnify the party awarded the costs for the expenses they have incurred during the litigation process.

This can be a substantial financial burden for the losing party, as indemnity costs often result in a significantly higher amount being payable than under a standard costs order. The rationale behind such an order is to penalise a party for conduct that is unreasonable, improper, or imprudent in the course of litigation.

The awarding of indemnity costs is discretionary, meaning the court will assess each case on its merits before determining whether such an order is appropriate.

Legal Principles Governing Indemnity Costs

The principles guiding the award of indemnity costs in New South Wales stem from case law and the UCPR. Courts will consider whether a party has engaged in conduct that justifies indemnity costs, and various decisions have outlined the key circumstances in which such orders may be made.

Past Court decisions have held that a range of circumstances that may warrant an indemnity costs order, including:

• Making allegations of fraud or serious misconduct without proper foundation;
• Continuing proceedings that have no reasonable prospects of success;
• Engaging in misconduct that causes unnecessary delay or expense;
• Rejecting a reasonable settlement offer where it was clear that settlement should have been accepted;
• Bringing proceedings for an ulterior or improper purpose.

Circumstances Where Indemnity Costs May Be Awarded

1. Unreasonable Rejection of a Settlement Offer

One of the most common grounds for indemnity costs is the unreasonable refusal of a formal offer of compromise. Under rule 42.14 of the UCPR, if a party makes a formal settlement offer and the opposing party rejects it, only to later receive a less favourable judgment, the court may award indemnity costs from the date the offer expired.

2. Pursuing a Hopeless Case

Courts will award indemnity costs against a party who persists with litigation that has no reasonable prospects of success. This includes cases where:

• A claim or defence is frivolous or vexatious or with no merit;
• A party continues proceedings despite clear legal authority against them;
• The court determines that the case was pursued in bad faith.

3. Allegations of Fraud Without Evidence

If a party makes serious allegations, such as fraud, without providing sufficient evidence to support their claim, the court may impose indemnity costs. This is because such allegations can significantly increase legal costs and unnecessarily damage the reputation of the opposing party.

4. Delay and Misconduct in Litigation

Indemnity costs may also be awarded where a party engages in conduct that causes unnecessary delay or increases the cost of litigation. Examples include:

• Failing to comply with court orders or procedural deadlines;
• Filing unnecessary or excessive applications to delay proceedings;
• Withholding key documents or evidence, thereby prolonging the case;
• Unreasonably refusing a reasonable offer of settlement.

5. Bringing Proceedings for an Improper Purpose

If a party initiates legal action for reasons other than obtaining a legitimate legal remedy—such as to harass, intimidate, or pressure the other party—indemnity costs may be imposed as a deterrent.

Courts strongly discourage the misuse of legal proceedings and will penalise parties who bring claims for an ulterior motive.

The Effect of an Indemnity Costs Order

An order for indemnity costs significantly increases the financial burden on the losing party. Unlike party/party costs—where only reasonable legal fees are recoverable—indemnity costs cover all legal expenses that are not unreasonably incurred.

This means that:

✅ The winning party is better compensated for their actual legal costs.
✅ The losing party pays more than they would under a standard costs order.
✅ It discourages improper conduct in litigation by increasing the risks of financial penalties.

While indemnity costs orders are not automatic, they serve as an important tool for courts to deter unjustified legal action and reward parties who act reasonably in litigation.

The History of Indemnity Costs in New South Wales

The history of indemnity costs in NSW dates back to the early development of the common law and its approach to costs in litigation. Historically, English courts operated under a system where costs were awarded on an indemnity basis only in very limited circumstances. As the legal system evolved, so did the notion of costs, with the introduction of rules and legislation to address the growing complexity of litigation.

In the late 19th and early 20th centuries, the rule that a losing party should pay the legal costs of the successful party became firmly entrenched in the common law system. However, the idea of indemnity costs was still a rare and exceptional remedy. It was not until the modern era, particularly with the advent of the Civil Procedure Act 2005 (NSW) and the Uniform Civil Procedure Rules (UCPR), that the award of indemnity costs became more defined and codified.

Over the years, the NSW courts have refined their approach to indemnity costs through case law, which has helped clarify when they may be appropriate. The courts recognize that indemnity costs serve a dual purpose: they provide a more comprehensive remedy for parties who have been forced to incur unnecessary costs due to another party's unreasonable conduct, and they act as a deterrent against conduct that abuses or exploits the legal system.

Key Takeaways for Litigants

If you are involved in litigation, it is crucial to understand how indemnity costs may impact your case. To avoid the risk of an indemnity costs order:

✅ Carefully assess the merits of your case before proceeding.
✅ Consider settlement offers seriously—rejecting a reasonable offer can have costly consequences.
✅ Ensure all claims and defences are properly supported—do not allege fraud or misconduct without strong evidence.
✅ Avoid unnecessary delays or procedural misconduct—comply with court directions and act reasonably.
✅ Do not pursue litigation for ulterior motives—courts will penalise misuse of legal proceedings.

By approaching litigation with reasonable and justifiable conduct, parties can minimise their exposure to indemnity costs and avoid unnecessary financial risk.

Conclusion

Indemnity costs play an essential role in ensuring that litigation is conducted fairly and efficiently in New South Wales. Courts will only impose these costs in cases where a party’s conduct is unreasonable, improper, or unjustifiably prolongs proceedings.

Whether you are an individual, business, or legal representative, understanding the risks and principles behind indemnity costs is crucial. A strategic and well-informed approach to litigation can prevent costly mistakes and improve the likelihood of a favourable outcome.