What Is Indemnity?

Indemnity is when an individual or business receives compensation for loss or damages. From a legal perspective, it may also refer to gaining immunity from any liability or damages. Indemnity is based on a contractual agreement in which one party agrees to pay for any damages or losses that are caused to another party. For example, in an insurance contract, one party agrees to pay the other party for losses or damages in return for a premium payment that is paid to the insurer.

Indemnity clauses are usually included in insurance agreements. They specify what is covered, what is not covered, and the extent of coverage. An indemnity agreement will usually contain language about a period of indemnity, which is a specific period in which the indemnity will remain valid. Also, many agreements will include a letter of indemnity, which ensures that the obligations of both parties will be met. Guarantees that haven't been achieved will require an indemnity payment.

Indemnity is frequently used in contracts between:

  • Businesses and individuals
  • Businesses and the government
  • Governments and other countries

Occasionally, a business, industry, or government entity needs to subsidize the costs of a major issue on behalf of the public. For example, in 2014 and 2015, the government made $200 million in indemnity disbursements following the bird flu infection that nearly caused the collapse of the entire poultry industry.

The purpose of an indemnification clause is:

  • To protect one party from any losses or damages that are caused by another party
  • Hold harmless the distressed party
  • Defend the distressed party against any third-party lawsuits

Under the current legal theories of tort and breach of contract, the indemnified party can often recover from the damages or losses suffered under the current legal theories of tort and breach of contract. Typically, the costs of defending against third-party claims are covered by the indemnifying party unless it was previously established in the contract that those costs would be also be covered.

An indemnification clause is useful in setting parameters around:

  • Scope
  • Time periods
  • Maximum liability
  • Insurance covenants

To simplify, an indemnity clause is a way to transfer the risk from one individual or group to another party.

What Is Indemnity Insurance?

Companies or individuals protect themselves against indemnity claims by purchasing indemnity insurance. For example, when a holder is found at fault for causing an indemnity, this insurance will protect the holder from paying the entire amount of the indemnity. Lawsuits are so frequent that many businesses make carrying indemnity insurance a requirement.

Some businesses will purchase deferred compensation indemnity insurance, which will protect the funds that they would be expecting in the future. The number of past claims and the specific agreement will influence the overall cost and the items covered. For example, a property lease will typically include an indemnity clause. The tenant is usually responsible for damages and losses due to fines, negligence, lawyer fees, etc.

Acts of Indemnity

Individuals or businesses that have acted illegally may not be subject to damages or penalties if protected by indemnity. This unique exemption will usually only apply to government officials or police officers. In these positions, the individual may need to break the law in order to accomplish the tasks of his position. A good example would be an illegal act that's committed for the public common good.

Avoiding Common Pitfalls of Indemnification

Indemnification is used to allocate risk and is commonly litigated and negotiated by attorneys. The complexities surrounding indemnification are often overlooked and misjudged. It's only after signing a contract that a party realizes that they may incur much more risk and liability than they initially thought.

It is recommended that all parties fully understand the indemnity coverage that's provided in the contract. The best way to avoid indemnification-related downfalls include:

  • Insufficiently defining or excluding indemnification procedures
  • Failing to sufficiently address or overlooking direct claims
  • Including a conflicting limitation of liability arrangement
  • Failing to include or overlooking an individual remedy arrangement

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