What Is an Indemnity? The Essentials of Indemnities

Indemnity agreement

An indemnity is a contractual term which promises to reimburse another party in respect of a loss or damage. The only party indemnified is the one that is identified as the beneficiary of the indemnity.

If the benefit of that indemnity is to be transferred to another party it must be done formally-for example with a written note or record assigning the benefit of the indemnity to the recipient of the assignment.

Potential liabilities are covered in two ways:

  1. Between parties to the contract where party 1 gives party 2 an indemnity, and
  2. Third party claims against the beneficiary of the indemnity

What losses will be covered by the indemnity will depend on the drafting of the indemnity clause which can be narrowly or broadly drafted. What losses are intended to be covered by the indemnity? Direct losses? Indirect losses?

A narrow drafting would see only direct losses being covered. A broad drafting would cover all losses including direct, indirect, consequential, and so forth. An example of a broadly drafted indemnity would be as follows:

“all damages, liabilities, demands, costs, expenses, claims, actions and proceedings (including all consequential, direct, indirect, special or incidental loss or punitive damages or loss, legal and other professional fees, cost and expenses, fines, penalties, interest and loss of profit or any other form of economic loss (including loss of reputation))”

How enforceable is an indemnity? This will depend on the resources of the party giving the indemnity. That party can, of course, take out indemnity insurance which would ensure resoursces would be available to meet the losses arising from the indemnity.

Some indemnity claims will arise by operation of law-for example, an agent is indemnified by his principal as a consequence of the law of agency.

Many indemnities will arise in a contract and in a contract of guarantee as an indemnity is less vulnerable to an attack than a guarantee.

It is important to understand that the period during which an indemnity can be enforced is 6 years from the date on which the indemnifier refuses or fails to honour the indemnity.

It is also worth considering whether there is a need for an indemnity; you would see if you can rely on simply suing for breach of contract or breach of a warranty, for example.

The drafting on an indemnity requires close attention with consideration given to how broad or narrow it needs to be.

The effect of the indemnity should be to give rise to damages for breach of contract or damages generally. Check if the effect of the indemnity in a breach of contract will give rise to other remedies-for example termination of the contract-or compensation/reimbursement.

Should you need an indemnity you would be well advised to have it drafted specifically for your particular purposes and circumstances. Avoid a boilerplate indemnity which may not be appropriate or suitable for your situation.