What is an indemnity and exactly how important is their inclusion in commercial contracts? - Christopher Buck

What is indemnity?

In simple terms an indemnity is a form of contractual promise that seeks to provide for payment in the instance that a certain event or set of circumstances occur, which usually arises on a breach of contract. The purpose of an indemnity is to shift the risk of a potential breach on to the party providing the indemnity. These contractual promises will be outlined within the contract so it is clear as to when a breach will have occurred.

How does an indemnity work?

Indemnities work on a pound for pound basis and seek to provide the party subject to the breach with compensation in respect of the loss they have suffered. A key advantage of an indemnity is that it seeks to ensure repayment for the injured party in respect of those losses that may not ordinarily give rise to a claim in damages under a breach of warranty claim. Indemnities therefore provide an extra layer of protection. When considering indemnities in comparison to warranties, there is also no obligation imposed upon the injured party to mitigate their losses or to demonstrate that they have done so.

Another key advantage of an indemnity is that the limitation period for claiming for the loss incurred starts from the date on which the loss was actually suffered. Therefore, theoretically speaking, the limitation period is longer in comparison to the limitation period under a warranty claim which begins to run from the date of the breach itself. Although an indemnity appears to cover unlimited losses by its very nature, it is not the case that 100% of the total loss incurred will, in every circumstance, be recoverable. This is why the contractual wording is key to ensuring that as much as possible of the total loss incurred is recoverable. For example, ensuring that all legal costs incurred in bringing a breach of contract claim are recoverable under the indemnity clause. The clause itself will of course be interpreted in conjunction with the entire contract.

What should you do if you need more information about how an indemnity works?

Whether you are the party giving the indemnity or the receiver of this contractual promise it is key to ensure that you understand the mechanics of how an indemnity works. If you require legal assistance with regards to reviewing and understanding an indemnity clause that may be incorporated into a contract that you are a party to, or if you require us to draft an appropriate clause, then please do not hesitate to contact Christopher Buck, Associate Partner in our Commercial Services Department.

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