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Example of feedback to an Indemnity clause.

What does indemnity mean?

Indemnity definition

Indemnity in general terms is a security or protection against a potential loss or financial burden. In the context of contracts, indemnities are written into contracts to protect and also enforce a particular party to cover certain losses identified in writing. Depending on how the contract is drafted and interpreted when reviewed before and after signing, it can bring a wider or narrower interpretation of what losses need to be covered by the indemnity clause.​


Why is indemnity used?

The primary purpose of inserting indemnity clauses in a commercial contract is to shift and re-allocate potential liabilities from one party to another. This is done in the form of a business transaction that obligates one party to pay costs and damages that may normally be incurred by the other party. In these situations, to indemnify a party is to protect a party from third-party lawsuits such as:

  • Direct damages, indirect damages, consequential damages

  • Claims, liabilities, losses, expenses, and damages arising from a breach of contract, omission, neglect, or default.


Another reason why indemnities are used is that an indemnity can be triggered by losses incurred without needing to prove who was at fault. This makes the process of pursuing losses much more straightforward as legal proceedings do not need to be initiated and are more difficult to avoid.

Claiming back these losses can be much more straightforward as well because most indemnity clauses outline and quantify the losses.


What is the scope of Indemnity?


The scope of indemnity clauses differs depending on the business conditions between parties. However, in general, indemnity clauses will be drafted in a way to include as many circumstances as they can. Conduct, action, or negligence that creates a situation where any loss or anticipated loss may be covered. These situations in which the indemnity clause stipulates may be beyond ordinary circumstances and can extend into circumstances that may have otherwise been unforeseeable.


Indemnity versus breach of contract

Indemnity clauses in comparison to the breach of contract claims have distinct benefits regarding substantive and procedural advantages. Indemnity claims only require the establishment of the event that triggers the obligation to pay out a loss as stipulated in the contractual agreement. In contrast, an action for breach of contract is a much higher threshold as the party claiming the breach of contract needs to establish that there has been a breach of contract and that damage has occurred due to that breach. Evidence regarding all this needs to be adduced as there may also be a need to establish the severity of the damage.


These are onerous and difficult thresholds to meet and prove. Therefore, the use of indemnity clauses is normally the path of least resistance and is a frequently negotiated term. It is important that you understand these clauses in a contract and review them carefully.


Indemnity for negligence

Indemnity in the context of negligence is normally limited to the damages that were caused by the contractor. This party, therefore, is only required to indemnify the owner for portions of the damage that had arisen from the contractor's fault or negligence. The scope of this normally covers in whole or in part in instances that are not the owner’s “sole negligence”. If the contractor is even in part or 1% to blame for the loss, the indemnity is normally triggered, and the contractor would not be liable for this loss. However, if the owner is solely negligent or 100% at blame, then the contractor would in this instance be relieved of any obligation to indemnify.

Indemnity for breach of confidentiality

An indemnity for breach of confidentiality typically arises in contracts that apply to third party claims, for example in instances where a confidentiality agreement is signed to protect the information of one company that belongs to a third party. Therefore, this indemnity for breach of confidentiality would protect from third-party claims of breach of contract relating to confidential information. Such confidential information may include general and specific categories, general categories of information may include sales strategies, marketing information, customer lists, or manufacturing procedures among others. Specific categories may range from the specifics of a short-term project, or certain sensitive information about the business relationships involved with the project.


The scope of a breach of confidentiality may typically involve a limitation of discussion and disclosure of information and may obligate both parties to make reasonable efforts to secure this information. The typical confidentiality clauses that may be indemnified relate to the disclosure of third-party confidential information, a level of care expected when handling confidential information, and damages for breaches of this. Review the contract carefully before signing.


Indemnity and limitation of liability


The difference between an indemnity and a limitation of liability is that the limitation of liability clause relates to the extent to which liability can be assigned to one party. The limitation of liability in contractual contexts will establish monetary limits in certain situations stipulated where the contract is breached. In contrast, indemnity clauses will directly stipulate a predetermined cost in the event of damages arising out of a specific loss. In practice, indemnity clauses are utilized more advantageously by larger companies, in the form of more favorable terms in indemnity clauses.


Direct Damages vs. Indemnification


Direct damages are damages that arise due to direct harm caused by a party. It is common practice to have direct damages capped to the value of the deal as the potential damages and risk that a company chooses to expose themselves to - should not exceed the value of the deal being made. Consider this when reviewing the contract.


Can indemnity be caped?


Depending on the context of what is negotiated, indemnity clauses can be ‘capped’ or ‘uncapped’. It is more typical than these clauses are mutual meaning that if indemnity clauses are uncapped for you, it would be reasonable for you to expect that indemnity clauses would be uncapped for the other contractual counterparts. In general, the negotiation of caps on indemnity clauses revolves around the idea of risk management and not exposing yourself to more liability than the value of the deal. It is often how companies define their contract review guidelines. However, capping indemnity clauses may also mean that one party has an uncapped liability which could be caused by a third-party infringement and by no fault of their own.

What is a Double Indemnity?

Double Indemnity often refers to a type of agreement that stipulates that a party will pay double the amount stated in the contract. In a business context, double indemnities are included when contractual agreements include subcontracting companies hired for completing an aspect of the project at hand.


What is a Letter of indemnity, Indemnity Bonds, and Bonds of Indemnity?


A letter of Indemnity is a contractual document that guarantees that certain clauses and obligations in a contract will be carried out by both parties. Typically, these letters are drafted by third parties and are also enforced by them in the form of an agreement. This third party will then pay out financial restitution if one of the parties cannot satisfy their financial obligation to the other party. The process outlined is typically seen as ‘holding someone harmless’, which is the process of absolving one or all parties in a contract, from liability for loss or damages.


The frequent context in which Letters of Indemnity are often used is in instances where goods are being transported by second parties such as delivery services or moving companies. In arrangements such as these, the letter of Indemnity would ensure that the valuables are insured and any damages or losses of the goods are protected. They can also be used in the context where a second party borrows something from the first party. In this instance, a Letter of Indemnity can be issued by the owner of the good being borrowed to the second party, stating the second party is solely liable for any damages to the good being borrowed.


What is the purpose of the Letter of Indemnity?

The Letter of Indemnity is implemented with the primary objective that the parties of the contract comply with the stipulated requirements to avoid losses relating to this transaction. In eliminating losses through the drafting of this letter of Indemnity, the ramifications of mistakes made by both parties are minimized. The core concept of the Letter of Indemnity, therefore, is to protect both parties from the claims and legal actions stemming from the specific events that they are not directly responsible for.

What is a Letter of Indemnity Insurance?

In the context of a shipping contract, the Letter of Indemnity insurance is an added layer of protection that offers protection from any liability when a party violates its obligations. These violations can come in the form of:

  • Goods have been delivered to the wrong destination

  • When Documents are flawed

What does Indemnity mean?
Why is Indemnity used?
What is the scope of Indemnity?
Indemnity for negligence
Indemnity for breach of confidentiality
Indemnity and limitation of liability
Indemnity versus breach of contract?
Direct damages vs. Indemnification
Can indemnity be caped?
What is a Double Indemnity?
What is a letter of indemnity?
What is the purpose of a letter of indemnity?
What is a Letter of Indemnity Insurance?


Please note that this document is not legal advice. Legly, and its representatives, are not responsible for the content herein or the suitability for your company’s business. We recommend you use this in conjunction with legal advice and not as a substitute.

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