What should you check in an indemnity clause?

What an indemnity actually is

An indemnity is a promise by one party to compensate the other for particular losses. It is different from ordinary contractual damages in two ways that matter commercially.

First, it can be broader. A claim for breach of contract requires a breach and the usual limits on recoverable loss. An indemnity can be drafted to cover loss without proving breach at all.

Second, it is often carved out of the liability cap. So a contract with a comfortable cap can still expose you to uncapped liability through the indemnity, and that is easy to miss if you read the cap and stop there.

The checks worth doing

Which direction does it run?

Read both ways. Many supplier contracts have a broad indemnity from you to them and nothing coming back. That asymmetry is the first thing to question.

Is it inside or outside the cap?

Find out explicitly. If the indemnity sits outside the liability cap, the cap is doing less work than it appears to.

What triggers it?

An indemnity for third party intellectual property claims arising from the supplier's product is reasonable and common. An indemnity for any loss arising from your use of the service is extremely broad and worth narrowing.

Is it limited to matters you control?

You should not be indemnifying a supplier for consequences of their own negligence or their own product's defects.

Does it cover legal costs?

Indemnities often extend to costs and expenses. On a long-running claim, that can exceed the underlying loss.

Who controls the defence?

If you are indemnifying, you generally want the right to conduct or at least participate in the defence, rather than paying for decisions someone else makes.

The unfair contract terms angle

In a standard form contract with a small business, a one-way indemnity is exactly the kind of term the unfair contract terms regime looks at. The test asks whether the term creates a significant imbalance, whether it is reasonably necessary to protect the supplier's legitimate interests, and whether it would cause detriment.

A supplier can usually justify an indemnity that protects it from misuse of its product by the customer. It is much harder to justify one that shifts the consequences of the supplier's own failures onto the customer.

That does not make a one-way indemnity automatically unlawful. It makes it a term you have a reasoned basis to push back on.

Common questions

What is the difference between an indemnity and a liability cap?

A liability cap limits how much a party can be made to pay. An indemnity is a promise to cover particular losses, and it is frequently carved out of the cap. That means a contract with a reasonable cap can still carry uncapped exposure through its indemnity clause.

Should indemnities be mutual?

Usually. The common position in ordinary supplier contracts is that each side indemnifies the other for third party claims arising from its own breach or intellectual property. A one-way indemnity running only from customer to supplier is worth questioning, and in a standard form contract with a small business it is the kind of asymmetry the unfair contract terms regime examines.

Is a one-way indemnity unlawful in Australia?

Not automatically. In a standard form contract with a consumer or small business it may be an unfair contract term, but only if all three limbs are satisfied: significant imbalance, not reasonably necessary to protect the advantaged party's legitimate interests, and detriment. It gives you a reasoned basis to negotiate rather than a guaranteed outcome.