Template:Indemnity description

An indemnity is nothing more than a contractual promise to pay an ascertainable amount of money should a defined circumstance arise, but boy do people get bent out of shape about it. There is much misapprehension. Much Fear. Much Loathing. Much ignorance.

An indemnity isn't better than a contractual right of suit. It isn't quicker. It doesn't have different accounting or capital consequences. It isn't, of itself, more severe. Nor is it inherently more broad or of less determinate scope. The sky won't fall in if you give an indemnity. It won't fall in if you don't get one from your counterparty either.

Why all the anxiety?

An indemnity allocates unwanted, potentially unquantifiable, "third party" risks in the contract away from the person to whom they would naturally fall. The question in your mind should always be:

• Why shouldn't this loss fall in its natural place?
• How open-ended is the loss likely to be? could this, in the immortal words of Cardozo J, open the floodgates leading to "liability in an indeterminate amount for an indeterminate time to an indeterminate class" (Ultramares Corporation v. Touche 174 N.E. 441 (1932)

Unlike most contractual promises, an indemnity addresses a contingency that neither party wants: An unexpected financial loss; an adverse change in tax treatment; the commencement of legal action by a third party against one or other party to the contract as a result of its performance.

It addresses, in other words, undesirable outcomes that, by their nature, cannot amount to actual breaches of contract by the indemnifying party.

Example:

A enters a derivative contract with B. To hedge itself B, buys security X. B's investment in X is subject to an unexpected tax charge. A has indemnified B against all tax liabilities arising on its hedging activities.

• A did not breach the contract
• B does not need to (and indeed cannot) claim breach of contract,
• B can call on the indemnity to require A to make a payment equal to the tax charge under the indemnity.
• If A neglects to make the indemnity payment, B has an action in breach of contract.

At its extremity you can only enforce an indemnity payment by taking legal action for breach of contract: namely the failure to pay under an indemnity claim.

Claiming under an indemnity: For these reasons, an indemnified party does not need to prove breach of contract: it need only show that the prescribed undesirable contingency has arisen, and that it has correctly ascertained amount which its counterparty has indemnified it as a result.

It it can work out what is payable from the terms of the indemnity clause itself. Since it isn't necessarily triggered by a breach of contract, nor is the value of indemnity necessarily constrained by ordinary contract law principles for ascertaining damages. (That is not to say you don't have to prove loss, though: beware indemnities that look like penalty clauses.)

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

Indemnities are generally viewed as onerous obligations. A request for one will often be met with a sharp intake of breath, particularly from the legal department.

An indemnity is nonetheless a useful back-up to a guarantee because:

• The Statute of Frauds does not apply to an indemnity.
• The invalidity of an underlying obligation does not invalidate an indemnity.
• Variation of the terms of an underlying obligation will not discharge an indemnity whereas it might a guarantee (unless you have a good waiver of defences clause)