Indemnity: Definition, Types & Importance Of Indemnity in Business

September 4, 2023


In the insurance sector, indemnity refers to a comprehensive form of damage or loss compensation. The use of the term “indemnity” in legal sectors might also indicate exemption from damage liability. Thus, it is a contractual agreement taking place between two parties. Here, a single party accepts paying for the other party’s loss and damages. 

A common example of indemnity is an insurance contract where the indemnitor or insurer compensates the other party in return for their paid premiums. With it, the indemnitor insures the policyholder that promises to cover the loss of the entire business. Let’s know more about it in complete detail.

How Does Indemnity Function? 

How Does Indemnity Function

The indemnity clause is usually standard in maximum insurance agreements. But the type of insurance covered and its extent depends completely on every specific agreement. The indemnity agreement is also known as a “period of indemnity” or a time duration where the payment remains valid. Consequently, a lot of contracts include an indemnity letter. 

The letter guarantees that both parties can meet the stipulations mentioned in the contract. Thus, it is very common in agreements between a business and an individual. But, it might also be applicable on a larger scale to relationships between the government and business or between two governments. 

In certain situations, a business or government is liable to cover the costs of bigger issues on the public’s behalf. For instance, a natural disaster or an outbreak. For instance, in 2014-2015, the U.S. Agriculture Department spent almost $200 million on indemnity payments for farmers who killed their birds Ultimately, they stopped the spread of the virus.

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Types Of Indemnity

Types Of Indemnity

Generally, we categorize indemnity into two primary types. Based on the results, it might either be implied or expressed. 

1. Expressed Indemnity

We might also refer to express indemnity as its written form. All the terms, as well as conditions mentioned in the clause, are usually presented in a written format. Hence, each term and condition should be clearly mentioned and expressed in the contract. In a written indemnity clause, the liabilities of each party should be clearly spelled out. 

One might have to take the help of a lawyer to draft the indemnity agreement and subsequently review it. Or the attorney might also assist in interpreting legal jargon that is unclear. Some of the most usual indemnity types are insurance contracts. 

Suppose a brand operates in the construction domain. They have to present their indemnity requirements in the construction contract itself. Agency contracts are just another zone that needs well-written indemnity contracts. The expressed agreement in any such contracts will be completely binding. 

If any of the parties causes any breach, there might be legal warrants raised. It is impeccable for both parties that the contract should be well-read and well-understood. Also, they have to adhere to the terms and conditions before setting out their foot. 

2. Implied Indemnity

The second type of agreement is implied indemnity, which consists of obligations from both involved parties. Here, the only difference is that the agreement does not come in a written format. Rather, it emanates from results or the two parties’ conduct. The conduct and facts of the parties included usually depict the extent of the obligation. 

For example, in a master-server bond, the master should compensate his servant if the latter suffers injuries. But the injuries should be a result of the servant abiding by the instructions of his master. 

In maximum cases associated with implied indemnity, the reference should come out of the precedent crafted in the 1872 case of Adamson vs Jarvis. Here, the court gave a verdict that the master can indemnify his servant if he undergoes injuries while following the implied instructions. 

What Is The Importance Of Indemnity In Business? 

When it comes to commercial backdrops, indemnity is a bit different than the common ones. The use of indemnity clauses is excessively common in commercial contracts. It is inserted in the business clause with the purpose of allocating or shifting the cost or risk from Party A to Party B. 

It is safe to say that business transaction taking between two parties are incurred by the second party only under some circumstances. The transaction is carried out only after one party obligates to pay these expenses. To indemnify an individual means to absorb the losses the party bears. The true importance of indemnity in business is to safeguard the party against any lawsuits. 

Often, the indemnity clause lists out certain actions under which the party might be insured against:

  • All proceedings or actions, damages, demands, liabilities, as well as lawsuits.
  • Every liability, claim, expense, damage, or loss caused by a particular contract.
  • Injury, damage, accidental death, or loss from any person or property to any omissions, acts, default, breach, or neglect. 

Indemnity In Insurance: The Only Mandatory Rule

As stated above, indemnity is an insurance compensation. In insurance, there is a rule that one party says yes to compensate the other one for his potential damage or loss. In an insurance policy, the insurer provides compensation to the insured in exchange for the paid premiums. 

The indemnity rule or principle states that any insurance policy must not confer any perk that is higher in value than the insured’s losses. Both insurance and indemnity protect against economic losses as it aims to restore the financial status of the parties.

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Summing It Up

Regardless of your business size and type, an indemnity agreement is of utmost importance. However, the most important consideration here is the legal representation that actually binds the two parties together. Moreover, each business must aim to protect itself from claims that can sabotage its goodwill in the long run.  

Well, now that you know what indemnity stands for, make an attempt to incorporate all the necessary steps to prevent your business from being indemnified. Is there something you would like us to add here? Do comment below and communicate your thoughts to us.

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Mony Shah

With an adept skill of curating content on multiple genres, Mony has harnessed success as a Content Writer quickly. Find her sharing profound thoughts and opinions on finance, insurance and lifestyle niches.

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