Protection against a financial liability
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
What is Indemnity?
The word indemnity means security or protection against a financial liability. It typically occurs in the form of a contractual agreement made between parties in which one party agrees to pay for losses or damages suffered by the other party. In corporate law, an indemnity agreement serves to hold Board Directors and company executives free from personal liability if the company becomes sued or suffers damages.
A typical example is an insurance company wherein the insurer or indemnitor agrees to compensate the insured or indemnitee for any damages or losses he/she may incur during a period of time. Premium payments made by the insured are required to bind the agreement, so the insurer can return or compensate for the damages or losses.
Indemnification may be compensated in the form of cash, by way of repairs or replacement, or by other means which the parties have agreed upon.
Indemnity Agreements for Board Directors
In order to attract high-quality professionals to serve as members of a Board of Directors, it is commonplace to have anindemnification agreement. The indemnification agreement protects the Board Directors against liabilities, losses, and lawsuits that may result from serving on the board of the company.
Essentially, the way it works is that the company agrees to indemnify the directors and hold them harmless from liabilities that may result from the business being sued or held responsible for a major loss.
It is common for company bylaws to contain provisions such as indemnification, but many Directors may wish to go one step further and have a specific agreement that cannot be changed or removed for any reason. The Agreement is a bilateral contract directly between the Director and the Corporation.
Learn about the Directors’ indemnification provisions in the Companies Act of 2006 here.
Example of Indemnity in Business
The owner of a commercial property has been paying an insurance premium to an insurance company so that she can recover the costs for any loss or damage if a future bad event were to happen to the establishment. If the building sustains significant structural damages from fire, then the insurance company will indemnify the owner for the costs to repair by way of reimbursing the owner or by reconstructing the damaged areas using its own authorized contractors.
What are the Types of Indemnity?
#1 Express indemnity
This is a written agreement to indemnify, where the terms and conditions by which the concerned parties must abide are usually indicated. These include insurance indemnity contracts, construction contracts, agency contracts, etc.
#2 Implied indemnity
This is an obligation to indemnify that arises, not from a written agreement, but more from circ*mstances or the conduct of parties involved. One practical example is an agent-principal business relationship. When the principal refuses to accept the goods that the agent supplies him, the agent can sell them to others; however, if the agent sustains a loss while selling, the principal is obligated to pay for it.
What is the Importance of Indemnity in Business?
Indemnity is prevalent in most agreements that involve an individual and a business; however, it also applies to businesses and governments, or between governments of different countries. This provides financial protection to cover costs in the event of negligence, mistakes, accidents, or some unavoidable circ*mstances that could highly impact the flow of the business.
Indemnity insurance is one way to be protected against claims or lawsuits. This insurance protects the holder from paying the full amount of a settlement, even if it is his fault. Many businesses require indemnity for their directors and executives because lawsuits are common. It covers court costs, lawyer’s fees, and settlements.
Typical examples of indemnity insurance are:
- Malpractice insurance
- Errors and Omissions (E&O) insurance
- Directors or Officers (D&O) insurance
Additional Resources
CFI was founded with a simple purpose: to help anyone become a world-class financial analyst. To fulfill that purpose, CFI has created many valuable resources to help you along that path, including:
FAQs
For example, in the case of home insurance, the homeowner pays insurance premiums to the insurance company in exchange for the assurance that the homeowner will be indemnified if the house sustains damage from fire, natural disasters, or other perils specified in the insurance agreement.
What do you mean by indemnity? ›
The word indemnity means security or protection against a financial liability. It typically occurs in the form of a contractual agreement made between parties in which one party agrees to pay for losses or damages suffered by the other party.
Should I agree to an indemnification clause? ›
The indemnification clause is a crucial element in commercial contracts as it helps mitigate the risks and consequences associated with potential breaches of contracts. This clause also ensures that the parties are fairly compensated for their losses and helps maintain a stable and predictable business relationship.
What is an indemnity statement? ›
An indemnity clause is a contractual clause providing that one party is responsible for any losses or damages arising from a certain event or set of circ*mstances. In effect, the indemnity clause shifts the risk of that event occurring from the indemnified party to the indemnifying party.
Is indemnity good or bad? ›
There's nothing inherently wrong with having an indemnity that can apply to claims between the parties—if that's what the parties intend. But if the parties want the indemnity to apply only to third-party claims, they can say so in the contract.
What are the three 3 methods of indemnity? ›
There are three main types of express indemnity clauses: broad form, intermediate form, and limited form.
What is indemnity in a sentence? ›
The government paid the family an indemnity for the missing pictures. In case of loss of the vessel, the ship owner receives no indemnity for loss, but acquires immunity from payment of the loan.
What best describes indemnity? ›
Indemnity is a type of insurance that covers a wide range of damages and losses. In the indemnity clause, one party commits to compensate another party for any prospective loss or damage.
What is right to indemnity in simple words? ›
2. Right to Indemnity: As per section 145, in every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the the principal debtor whatever sum he has rightfully paid under the guarantee but no sums which he has paid wrong fully.
Does indemnification mean you can't sue? ›
Does indemnification relieve the person being indemnified by any third parties? No this is a huge misconception. Ppl think that they get an indemnification, that they are somehow shielded and third parties can't sue them, they can only sue the person indemnifying.
Ensure that the indemnification provision is mutual and not one-sided. This means both parties should be responsible for their respective actions, not just one party. Limits of liability. Consider negotiating a maximum amount of indemnity you are willing to accept or a cap on how much liability a party can have.
Why ask for an indemnity? ›
If there is a risk against which the solicitor believes the purchaser should be protected, one way of minimising the risk is to obtain an indemnity policy. It can be a cheaper and quicker alternative to investigating the risk further.
What is an example of indemnity? ›
Typical examples of indemnity insurance include professional insurance policies like malpractice insurance and errors and omissions insurance (E&O). These special insurance policies indemnify or reimburse professionals against claims made as they conduct their business.
Why is indemnity needed? ›
Indemnification is protection against loss or damage. When a contract is breached, the parties look to its indemnity clause to determine the compensation due to the aggrieved party by the nonperformer. The point is to restore the damaged party to where they would have been if not for the nonperformance.
What is indemnification in simple terms? ›
To indemnify, also known as indemnity or indemnification, means compensating a person for damages or losses they have incurred or will incur related to a specified accident, incident, or event.
What is an example of indemnity in a sentence? ›
The government paid the family an indemnity for the missing pictures. In case of loss of the vessel, the ship owner receives no indemnity for loss, but acquires immunity from payment of the loan.
What are some examples of principle of indemnity? ›
An insurance contract is a common example, in which the insurer agrees to reimburse the other (the insured) for any damages or losses, in return for premiums paid to the insurer by the insured. This means the insurer indemnifies the policyholder or insured, promising to compensate him for any insured loss or damage.
What is appropriate indemnity? ›
Appropriate cover is an indemnity arrangement which is appropriate to your role and scope of practice. It must take into account the nature and extent of the risks of practising in your role. Below we set out the likely arrangements depending on where you work.
