What Is Indemnification?
When parties enter into a contract, they often include an indemnification clause to protect one or both parties from potential financial losses and cost implications. This clause creates a contractual obligation in which one party (the indemnifier) agrees to compensate the other (the indemnified) for specific losses or damages. These may include losses arising from third-party claims and/or breaches of contract by the indemnifying party.
As litigation solicitors we don’t get involved in drafting these contracts, but we very frequently litigate this type of contract; looking for, and using, these types of contract clauses for maximum impact, effect, and leverage.
Indemnities can be broadly categorised into two types: those for ‘prevention’ and those for ‘compensation’. The ‘prevention’ type, often phrased as ‘hold harmless’, requires the indemnifier to protect the indemnified party from loss before it occurs. The ‘compensation’ type, typically phrased as ‘indemnify against any loss resulting from…’, obligates the indemnifier to compensate for losses already suffered.
The contract’s terms must clearly define the scope of losses covered to ensure clarity and avoid future disputes, making proper drafting essential.
This blog explains what an indemnification clause is, how it works, key elements to include, and why it’s a critical component of contracts. For specialist advice, contact a member of our commercial litigation, property litigation or construction litigation teams at Helix Law today.
How Indemnity Works
As above, an indemnity is a contractual promise where one party agrees to cover the costs or losses of the other party if something goes wrong. It’s like a safety net that ensures one party won’t be left out of pocket due to specific issues, such as breaches of contract, legal claims, or other defined risks. The indemnity clause spells out what types of losses are covered and who is responsible for covering them. This assists both parties in knowing where they stand and reduces the chance of disputes later.
For example, Party A provides services to Party B, and their contract includes an indemnity clause. If Party B fails to pay Party A’s invoice on time, Party A might have to instruct solicitors and issue proceedings to recover the unpaid amount. With an indemnity clause, Party B would have to pay the original invoice and cover Party A’s legal costs and other expenses related to recovering the money. This ensures Party A isn’t left bearing the financial burden of Party B’s breach.
What does an Indemnity Clause Contain
An indemnification clause is a term included in a contract detailing the indemnity’s scope and conditions. Parties often include it in commercial contracts, such as share purchase agreements, leases, sale/purchase agreements and construction contracts. Guarantees also often include an indemnity clause.
A well-drafted indemnity clause clearly defines each party’s responsibilities and the scope of losses covered, ensuring quick and straightforward implementation while minimizing disputes caused by ambiguity.
Indemnity clauses typically includes the following:
- Parties: Identifies who the indemnity applies to (e.g., the indemnifier and indemnified party).
- Scope: Defines the specific liabilities covered, such as losses from faulty goods or third-party claims.
- Trigger Events: Outlines situations related to the indemnity, such as a breach of contract.
- Exclusions: Lists circumstances where the indemnity does not apply, such as events beyond the parties’ control (e.g., force majeure).
- Extent of Liability: Specifies the amount the indemnifier is responsible for paying, including compensation limits, such as a maximum of PS50,000 per claim or no cap at all.
- Procedure: Sets clear steps for how the indemnified must inform the indemnifier about a claim. This usually means sending a written notice within a set time, for example, 30 days, to allow the indemnifier an opportunity to remedy the situation. These also include deadlines for the indemnifier to respond and make payments. If the indemnified person doesn’t follow these notice rules, they may lose their right to enforce the clause.
The Importance of Indemnification Provisions
Indemnification provisions play a crucial role in contract law by ensuring a fair allocation of risk between parties. The law recognises that imposing a disproportionate burden on one party, especially when they are not at fault, would be unjust. These clauses promote transparency, fair dealing, and stronger business relationships, making them essential for fostering trust and cooperation.
For instance, in construction contracts, a contractor may hesitate to hire subcontractors without indemnification against risks, such as negligence by the subcontractors. Without such protections, parties would be far less willing to enter into agreements.
However, indemnification terms must be drafted carefully to comply with relevant legislation. For example, the Unfair Contract Terms Act 1977 (UCTA 1977) regulates commercial contracts and invalidates overly broad or unreasonable provisions, ensuring such clauses remain fair and enforceable. Usually we find these contract clauses are expressly agreed and included within commercial business to business contracts. They are less common in business to consumer contracts not least because of challenges to validity, and because they are so onerous.
Frequently Asked Questions
What Is the Difference Between an Indemnity Clause and a Guarantee?
While both provide a form of financial protection, they have notable differences. A guarantor is a third party who promises to meet a debtor’s liabilities should they fail to do so themselves. An indemnity involves one party paying a specific form of loss directly to the other. Therefore, an indemnity is a primary obligation, while a guarantee is a secondary obligation.
Final Thoughts
Indemnity clauses are key to managing risk and promoting fairness in contractual relationships. By transferring liability from one party to another, they protect against financial losses caused by specific events. Well-drafted indemnity clauses clarify responsibilities, reduce disputes, and strengthen business relationships.
These clauses typically include essential details such as scope, duration, exclusions, and claims procedures, making them vital for various agreements, from supply contracts to construction projects.
Understanding and implementing/enforcing indemnification clauses requires careful consideration of UK law, including compliance with the Unfair Contract Terms Act 1977. Our commercial, property and construction litigation teams regularly review and advise on contracts and indemnities in the context of contemplated litigation. It can be incredibly helpful, and can entirely shift the commercial position, where there is an express contract indemnity entitling a party to recover their legal and professional costs (for example). Our teams are litigation specialists and act in disputes nationally. We dont get involved in drafting these contracts. Contact Helix Law today if you require assistance in a contract dispute and consider an indemnity might be relevant. We’d love to assist you.
