Summary
- An indemnity requires one party to compensate another for losses arising from specified events.
- A broad clause may cover refunds, lost profits and legal costs.
- Short payment deadlines can create significant cash flow pressure when an indemnity claim arises.
- This guide explains indemnity clauses for businesses entering commercial contracts in the United Kingdom.
- LegalVision’s commercial contracts lawyers advise businesses on narrowing triggers, limiting recoverable losses, negotiating caps and setting payment terms.
Tips for Businesses
Require prompt written notice of each claim and retain control over any defence or settlement. Check whether the general liability cap applies to indemnities. Compare potential exposure with the contract value and available insurance. Record internal approval for any uncapped exception. Speak to a contract lawyers at LegalVision about narrowing and capping an indemnity clause.
An indemnity clause in a UK commercial contract requires one party to compensate another for losses arising from specified events. The clause should identify each trigger, covered loss, payment condition and financial limit. Broad wording can expose a business to lost profits, legal costs and liabilities above the contract value. A liability cap may not protect the business if the contract excludes indemnity claims from that cap. Businesses should also check whether their insurance covers the contractual risk before signing.
This article explains when an indemnity may apply, the possible financial exposure, payment conditions, claim risk, liability caps and insurance.
1. When Could the Indemnity Clause Arise?
Some indemnity clauses are narrow and only apply within a limited range of specified events. This will likely avoid scenarios in which a minor, innocuous breach leads to accusations of contract breach. For example, non-perishable goods arriving one day late due to a postage strike are unlikely to trigger an indemnity clause. However, some indemnity clauses can be wide. This will depend to an extent on negotiations between your business and the other company.
2. How Much Money Could Your Business Owe?
Breach of indemnity clauses can be expensive. For example, suppose your business supplies £10,000 worth of goods on a 12-month contract to another company and, upon the 6-month mark, your company breaches the written agreement by failing to provide goods. The other company’s directors usually make £15,000 profit on reselling your goods each month. As such, they are furious, terminate the agreement and start a contract claim against you.
Your business could potentially face:
- contract termination (costing you six months’ worth of £10,000 orders);
- a request for lost profit (of £15,000 per month for the remainder of the contract); and
- payment of their legal fees and legal costs.
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3. What Are the Conditions for Payment?
It is essential to determine indemnity payment conditions. Firstly, you should determine how quickly your business must make payments. Some companies will try to negotiate clauses requiring ‘immediate payment’ or ‘within 14 days’. If the sums are in the thousands, your business may not have that cash at such short notice. As such, it is worth ensuring any indemnity clause allows enough time for payment.
4. Are the Other Party Litigious?
Realistically, the behaviour of the other company (the indemnified party) regarding whether to commence formal legal action will depend on their decision-making and the existing business relationship between you and them. While it is never easy to predict someone else’s behaviour, especially when they are a new business contact, you can aim to get a sense of them during any initial negotiations.
If they seem level-headed and pragmatic, you could potentially resolve a technical breach with them informally without recourse to legal action or terminating the contract. Thereby, you can be less concerned they will aggressively use an indemnity clause against your business.
“The biggest indemnity risk often sits outside the clause itself. A carefully negotiated liability cap offers no protection if the contract carves indemnities out of the cap. Insurance may not cover the resulting obligation.”
Key Takeaways
On the one hand, indemnity clauses exist to ensure that your business takes the terms of a commercial contract seriously and avoids committing a breach of contract. On the other hand, the financial consequences of a contract breach can be severe relative to the breach itself. Therefore, it is a good idea to have a lawyer negotiate or advise on these clauses before committing your business to them. A lawyer will often try to narrow the scope of the indemnity clause. This will ensure parties may only penalise major breaches or negligence rather than minor, unintentional breaches.
If you need help with indemnity clauses, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have limited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Is it possible to sign a commercial contract without an indemnity clause?
Yes. Parties can sign a commercial contract without an indemnity clause. However, many companies request indemnities to protect themselves against specified losses. The parties can refuse, narrow or replace the proposed indemnity through negotiation.
Why are some indemnity clauses wider than others?
The contract wording, allocated risks, bargaining power and negotiations determine an indemnity’s breadth. A broad clause may cover refunds, lost profits and legal costs. A narrow clause may apply only to clearly specified events.
Can you cap an indemnity clause?
Yes. Parties can negotiate an overall liability cap or a separate indemnity sub-cap. The contract can also exclude indirect losses or limit the indemnity to direct losses. Check whether the general liability cap expressly covers indemnity claims.
Does business insurance cover a contractual indemnity?
Business insurance covers a contractual indemnity only when the policy includes the relevant liability. Check the named insured, policy limit, insuring clause, exclusions, notification duties and consent requirements. Do not assume a policy covers every obligation accepted under a contract.
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