Indemnity in contract law – what startups need to know

As the owner of a small startup, a significant amount of your time will be spent negotiating, approving and signing contracts.

Every aspect of your business will be shaped in some respect by the terms of the contracts you sign – whether that’s contracts with your suppliers, your customers, your employees, or your shareholders. 

In light of this, understanding the core concepts of contract law will make your life easier. One of the most important is the concept of indemnity.

In this article, we’ll delve into the topic of indemnity clauses in more detail, to give you a good overview of these vital contract terms, how they operate and why you need to be careful how you use them.

What is an indemnity?

An indemnity is a clause in a contract that requires one party (Party A) to pay the other (Party B) for losses, damages, expenses and costs incurred due to certain agreed events arising in the future, and as a result of those events, claims being brought against Party B.

Indemnities are vital in commercial contracts as they allow the agreed allocation of risks within a contract.

As such, they can provide comfort to a business (Party B) in taking on certain contractual responsibilities or activities knowing that, should they face liabilities as a result, they can call in the indemnity and seek financial protection from Party A.

An example would be if Party A hires a cleaning service (Party B) to clean their offices, and then someone slipped and hurt themselves. An indemnity clause would ensure that Party A was not open to blame and that Party B is fully responsible for paying for legal costs etc.

How are indemnities typically used?

Theoretically, indemnities could be used in respect of any contractual liability, but in practice, it’s more common for them to be employed in certain high-risk areas, such as the following:

  • Intellectual property rights – in contracts that involve IPR, such as software licencing agreements or app development contracts, it’s commonplace for the customer to seek the benefit of an IPR indemnity from the service provider. If IPR infringement later comes to light and the customer faces claims from the lawful IPR owner, the service provider will indemnify the customer against that liability.
  • Data protection – in situations where a business is processing personal data as part of their services for a customer, then it is common for there to be an indemnity included in the contract to protect the customer from liability in respect of any data protection breaches that may arise.
  • Share/asset purchase agreements – where a buyer and a seller of a business agree on the terms of a purchase agreement, they will usually agree on a series of indemnities to allocate risks between them. The parties’ respective bargaining positions will usually determine the scope and extent of these indemnities. They will usually be across areas such as litigation liabilities, employment claims, intellectual property rights and taxation.

Does the wording of the indemnity matter?

Very much so. One indemnity can be very different (and far more onerous) than the next. Your lawyer must scrutinise the precise wording of each indemnity to check that it’s in your best interests to accept. A minor change in the wording of an indemnity clause can fundamentally extend or restrict its scope and effect.

It’s also important to check how the indemnity clauses interact with the limitation of liability clauses in the contract, in particular, to check whether they are kept inside or outside of the relevant financial caps, and also whether they are time-limited or restricted in some other way.

Wrapping up

If you require legal advice concerning negotiating indemnities or with contracts more generally, whether drafting, reviewing or in an advisory capacity, LawBite is here to help.

Appointing an expert lawyer to assist you gives you the peace of mind to know that all your commercial law needs will be met. LawBite has experienced, friendly lawyers who can help you with all commercial, corporate and employment legal matters.

About the author

Ashley Gurr is one of the many experienced contract lawyers at LawBite. He has represented SME clients for many years in the fields of commercial property, general commercial and employment law.