Reading time: 5 minutes

An indemnity clause is a common sight that is seen on most commercial contracts. It allows a party (‘the indemnified party’) to be compensated by the other (‘the indemnifier’) if they suffer loss. An indemnity is often called a ‘hold harmless clause’. This is because the one party to the contract agrees to hold the other party harmless and must cover any losses. The issue with indemnities is that they can have a broad scope of liability. This means that the indemnifier could be paying a large sum of costs to the indemnified party. This is why you should be careful when providing a contractual indemnity. This article will outline when you should be and should not be providing indemnities.

What is an Indemnity?

An indemnity is a legal obligation to cover the costs to another party if they were to incur a loss during the contract. A contractual indemnity is usually activated due to a ‘trigger event’ that causes the party to cover some sort of loss. The trigger event can be a breach of contract or some fault on behalf of the party.

Breach of Contract 

Usually, a breach of contract claim will cover a party for a loss suffered. However, a breach of contract claim is only applicable where the other party causes the loss because they breached the contract. An indemnity is broader and allows for parties to be compensated if a loss is incurred:

  • through the actions of a third party; or
  • because of some other circumstance that does not require a breach of contract.

Therefore, an indemnity is safer insurance for those who want to be compensated for loss during a contract.

When Should You Provide a Contractual Indemnity?

The issue with providing a blank indemnity is that you might be forced to pay a significant sum disproportionate to the loss suffered. This is because an indemnity can cover a broad scope. Therefore, you should be careful when agreeing to provide an indemnity.

Lesser Bargaining Position

The first situation you may be required to provide an indemnity is when you are in a lesser bargaining position than your counterpart. In that situation, you may be more inclined to provide an indemnity if your main goal is to get the contract signed and performed. The party in the stronger negotiating position is more likely able to dictate the terms of your contract. However, it is still vital that you weigh up the costs of signing a contractual indemnity. You will want to make sure that the benefits of the contract still outweigh the drawbacks.

Breach of Contract Claim

Another situation where a contractual indemnity may be required is when a breach of contract claim may not reap the same compensation as an indemnity. A breach of contract claim may not satisfy the loss that the other party may incur. This is why they may insist that an indemnity clause is added to cover their bases.

If you are in a position where the contract contains a high amount of risk, then an indemnity may agreed on to cover any loss.

When Should You Agree?

You should only agree to provide an indemnity if you can afford to pay up in the case that you are required to. If you cannot afford to cover costs if the indemnified party suffers damages, you may be liable to court proceedings. This could leave you in a worse position than when you started.

You can always limit the scope of liability that an indemnity clause covers. For example, you could alter the clause to disallow any liability being put on you by the actions of a third party to the contract. You could also set a limit on the amount that you have to compensate the other party.

Key Takeaways

An indemnity is a helpful clause to close contracts out as it encourages the other party to sign them. This is because they are covered in the case of a loss caused during the duration of the contract. However, if you are the indemnifier, it is essential to know when and when you should not provide an indemnity. You should only provide one if you can afford to do so; otherwise, you could risk losing a lot more than you initially hoped. It is a good idea to limit the scope of the indemnity so that you are not liable to put for losses that are not directly caused by the contract. This could be a third party or monetary limit. 

All in all, if you can avoid having to provide an indemnity, you should do so. However, if you cannot get around it, then make sure you know your obligations. If you need any legal assistance with indemnity clauses, contact LegalVision’s experienced contract lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

Are indemnity clauses required on every contract?

No, they only appear if they are agreed between the two parties. However, they are commonplace in a commercial contract.

How risky can indemnity clauses be?

If they are not limited, then they can be extremely risky as the amount of compensation you could be required to pay may be significantly high.

Can I get out of an indemnity?

You can only get out of an indemnity after you have signed the contract with the permission of the other party. 

About LegalVision: LegalVision is a commercial law firm that provides businesses with affordable and ongoing legal assistance through our industry-first membership.

By becoming a member, you'll have an experienced legal team ready to answer your questions, draft and review your contracts, and resolve your disputes. All the legal assistance your business needs, for a low monthly fee.

Learn more about our membership

Need Legal Help? Get a Free Fixed-Fee Quote

If you would like to receive a free fixed-fee quote or get in touch with our team, fill out the form below.

Our Awards

  • 2019 Top 25 Startups - LinkedIn
  • 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice Winner – Australasian Lawyer
  • 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2021 Law Firm of the Year - Australasian Law Awards
  • 2020 Law Firm of the Year Finalist - Australasian Law Awards