Indemnity

An indemnity is an undertaking by one party (an "indemnifying party") to compensate another (an "indemnified party") for losses the indemnified party suffers beyond those arising as a direct consequence of the indemnifying party's failure to perform its obligations under the contract containing the indemnity.

Indemnities are therefore generally viewed as onerous obligations. A request for one will often be met with a sharp intake of breath.

Usage

They are often used:

• to protect agents and custodians in a transaction who are dealing with assets but do not have principal risk or reward in the transaction, but none the less could be opened to significant liability as a consequence of their role;
• as a means of protecting an indemnified party against consequential loss that it could not otherwise recover against the indemnifying party.
• In the context of a trust to negate the trustee equivalent of “ultra vires” for a corporation, where the trustee acts outside the scope of the powers conferred on it by the trust deed. In that case an indemnity allows the trustee (who would in such a case be personally liable for its actions) to be indemnified for that liability out of the trust’s assets. This is important not just for the trustee, but also third party counterparties: it negates any potential “Ultra Vires” effect against a bona fide third party without notice of the breach of trust. Such an indemnity is standard (the trustee would almost certainly require it as a condition for accepting its appointment), and would usually be produced as an ordinary part of due diligence in the context of an ISDA Master Agreement negotiation. (the trustee would almost certainly require it as a condition for accepting its appointment), and it is not unreasonable or difficult for the trustee to provide us with this evidence.

Scope of losses

• Direct losses as a result of Breach: Needless to say, an indemnity is not required from a party to recover direct losses suffered as a result of breach of contract by that party: the innocent party has an ordinary action available for breach of contract.
• Other losses suffered by the Indemnified Party: Indemnities may cover "consequential losses" incurred by a party arising out of a breach of contract by the indemnifying party, or they may be quite unrelated to any action of the indemnifying party. However, the latter case opens the indemnifying party up to significant and indeterminate liability and it would be well advised to resist giving such an indemnity.

See also

• consequential loss
• indemnifying party
• indemnified party

Common Restrictions

Generally indemnities are limited to things that are actually in control of the indemnifying party (and things it is obliged to do under the contract). In the agency context it is reasonable for a principal to indemnify an agent for losses it suffers as a result of non-negligently performing its obligations under the contract upon the instructions of the principal.

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