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As a supplier of services, your contracts must protect your business from risk. However, you will likely face customer contract negotiations during your business journey. When negotiating commercial contracts, a customer may ask you to agree to an unlimited indemnity obligation. Indemnities can be high risk, and your business needs to understand their meaning and implications. This article explores what an indemnity is, the risks you could face by giving an unlimited indemnity, and how taking legal advice can help protect your business when you face this customer request.
What is an Indemnity, and When May a Customer Request One?
An indemnity is a contractual promise in which one party agrees to compensate another for specific losses or damages. This provision allocates risk and offers security, ensuring the indemnified party is not financially burdened by unforeseen losses that arise under the contract. Typically, an indemnity obligation kicks in upon a specific trigger event, such as when the supplier commits a breach of contract or the customer faces a third-party claim.
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Customers may request an indemnity clause to protect themselves from risks associated with your products or services. Indemnities are a risk management tool that transfers potential dangers to you and minimises the customer’s exposure to unforeseen liabilities.
Indemnities provide a customer business with several advantages. For instance, they may be able to offer customers compensation from the supplier in specific circumstances without needing to prove fault, offering a more straightforward and quicker route for recovering losses compared to breach of contract claims.
Examples
While indemnities are negotiation points and could cover a range of scenarios, here are some common examples of where a customer may request an indemnity:
- Intellectual Property Indemnity: If you create materials that customers will use in their business, they may request indemnity for any losses arising from intellectual property issues or breaches. For example, if you develop content for a customer and it turns out that your business has infringed or copied a third party’s content, the customer might receive an infringement claim. The customer might request indemnification to recover any losses they suffer under such claims; and
- Data Protection Indemnity: If a customer shares personal data with you to deliver services under a contract, they may request an indemnity to cover their losses for any data protection law breaches your business commits. For instance, if your business causes a personal data breach and the customer suffers losses as a result.
In these events, the customer will want to avoid the financial burden of problems for which you are at fault. Indemnities can offer robust contractual protection as the customer may be able to recover all losses from your business on a pound-for-pound basis.
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What Are the Risks of an Unlimited Indemnity?
You should use extreme caution if a customer requests an unlimited indemnity, as it exposes your business to significant risks. An unlimited indemnity means there is no cap on the amount you might pay if a claim arises, which can be financially destructive if the claim is substantial.
For example, a data protection breach causing extensive damage could result in indemnity claims running into millions of pounds, threatening your business’s financial stability. Without a predefined limit, estimating potential liability accurately is challenging, and multiple claims could be hugely detrimental to your business.
How Can You Handle Unlimited Indemnity Requests?
You can take a range of steps to address an unlimited indemnity request. The relevant steps will depend on the circumstances. For example:
- Assess the Risk: Evaluate the riskiness of the indemnity. It would help to consider the likelihood and potential impact of it being triggered;
- Negotiate Terms: Consider negotiating a middle ground. Rather than agreeing to an unlimited indemnity, propose a cap on the indemnity amount. This means your liability will be fixed and not unlimited. For example, you could propose an upper limit or cap on the indemnity, a multiple of the contract project value. You could also seek to negotiate the indemnity to carve out certain losses, such as indirect losses. This may also help limit your potential financial exposure in case of a customer indemnity claim; and
- Legal Advice: Seek legal advice on the indemnity provisions and whether they are fair, reasonable or appropriate under the relevant contract. A contracts lawyer will quickly be able to tell you if an indemnity is too broad or demanding for a particular project and the level of risk it could carry. A lawyer can also amend the unlimited indemnity provisions and negotiate them on your behalf to reach a reasonable middle-ground solution. Suppose you consider accepting unlimited indemnity to get your deal over the line. In that case, you should take legal advice to discuss the potential implications with your lawyer and make an informed decision before agreeing to the customer’s request.
Key Takeaways
An indemnity is an agreement to compensate a party for certain losses upon a trigger event occurring. Agreeing to an unlimited indemnity is a significant decision that can have severe financial implications for your business. It is essential to fully understand the risks involved and seek legal advice to ensure you are comfortable with indemnity obligations and what they could mean in practice for your business. Depending on the circumstances, you could approach an unlimited indemnity request in various ways, including rejecting or negotiating it to make it less demanding. A lawyer can guide you on the best action for your business.
LegalVision’s experienced commercial contract lawyers can assist as part of our LegalVision membership if you need support understanding the risks of an unlimited indemnity request. For a low monthly fee, you will have unlimited 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
1. What is an indemnity clause?
It is a promise made by a contractual party to compensate the other party for a particular type of loss which they suffer from under the contract if a trigger event occurs.
2. Can I limit my liability in an indemnity clause?
You can seek to limit your liability by negotiating terms that cap the indemnity at a specific amount. You could also seek to exclude certain types of losses from the indemnity obligation, which could help limit the amount you may need to pay under it.
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