An indemnity clause, described

In one line. An indemnity is a promise by one side to cover the other side's losses from a named kind of problem, and reading one is mostly a matter of finding out which problems were named.

It is the clause people scroll past and then hear about later. The heading is dry, the sentence is long, and it is usually written in one breath with three sub-clauses hanging off it.

It is also one of the few clauses that can put money on the table that has nothing to do with the value of the deal, which is why it repays a slow read.

What does indemnity mean in simple terms?

To indemnify someone is to promise to make good their loss.

In a contract, it is a promise about a defined situation: if this particular thing happens, and it costs you money, that cost is mine. The clause names the situation, names who covers whom, and names what kinds of cost are covered — damages paid to a third party, legal fees, settlements, sometimes fines.

Two features distinguish it from the ordinary machinery of a contract. It usually runs one way, from one named side to the other, rather than being mutual. And it is commonly written to apply whether or not anyone was careless, which is why it is a different thing from a promise to do the work properly.

What is the point of an indemnity clause?

The clause moves a risk from the side that would otherwise carry it to the side that agrees to.

The risks that get moved this way are fairly consistent across contracts. A claim by someone outside the deal that the work infringes their intellectual property. A claim arising from a breach of confidentiality or a data incident. A claim from an injury on site, or from property damage. A claim caused by one side breaking the law in a way that lands on the other.

What they have in common is that the loss usually comes from a third party, which is the shape most indemnities are written for: someone outside the contract makes a claim, and the clause decides which of the two sides inside the contract ends up paying for it.

The direction is worth reading before the wording. In a master services agreement the supplier commonly indemnifies the client for intellectual property claims about the work, and the client commonly indemnifies the supplier for claims arising from materials the client supplied. A consulting agreement handed over by a large client is more likely to run in one direction only, and that is a negotiating point rather than a fact of nature.

What it carves out

Most indemnities are narrowed by their own text, and the carve-outs are where the clause becomes readable.

The trigger. Does it apply to any claim, or only to a claim that is finally established? Any claim is much wider, because unfounded claims still cost money to answer.

Contribution. Is the cover reduced where the other side caused part of the problem themselves?

Conduct of the claim. Who takes charge of defending it, who can settle, and whether the indemnified side has to co-operate. This is a practical clause that decides who is in the room.

Notice. How quickly a claim has to be passed on, and what happens if it is not.

Excluded categories. Claims from the other side's own modifications, use outside the agreement, or combination with something not supplied — standard in intellectual property indemnities.

Loss types. Whether indirect and consequential losses are in or out, and whether legal costs are covered on a full basis.

Caps, and where they sit

Contracts usually limit total liability, and the interesting question is always whether the indemnity sits inside that limit or outside it.

An indemnity capped at the same figure as everything else is a risk with a known ceiling. An indemnity carved out of the cap is a promise with no stated ceiling at all, and it is common to see the intellectual property and confidentiality indemnities placed outside — sometimes reasonably, given what those claims can cost, and sometimes because that is what the first draft said.

Look for the limitation of liability clause, then look for the list of what it does not apply to. That list is the real map of where the risk in the contract has been put, and an indemnity is only as large as the cap above it allows.

Whether a particular indemnity is one to accept is a question about your deal, your exposure and the law the contract names — which law reads the words matters here as much as anywhere. Ask a lawyer if the number involved would hurt.

At the door. contracts.io makes paper, not legal advice. Describe the arrangement in one sentence and read back a master services agreement or a consulting agreement in plain language, with the governing law named from the full list — England and Wales, New York, Singapore and the rest. If you are on the receiving end of somebody else's paper, the parts a contract usually names is a decent order to read it in.