A letter of indemnity is used in business transactions to assure one party that they will not suffer financial loss if the other party cannot fulfill part of the agreement.
How a Letter of Indemnity Works
When two parties agree to a contract they both have obligations. Usually, one party agrees to pay the other party, who agrees to provide products or services. If one party breaches the contract (doesn't do what they agreed to do), the other party may suffer a loss, either losing the payment or not receiving the goods or services.
The concept of indemnity is about holding someone harmless and not having that person or business suffer a loss. To indemnify someone is to compensate them for losses from a specific incident.
A letter of indemnity is written to reassure the other party with specific measures that will hold them harmless. Since the letter is in writing, it is an additional assurance to the other party.
You can also include indemnity language in a contract. For example, a typical indemnity clause in a contract for a construction project might state that Party A will do stated work at its own risk and Party A indemnifies Party B against all loss, damages, expense, and liability for work done on that contract. In other words, Party A is agreeing that even if Party B is found liable for some action, Party B isn't responsible for compensating Party A for liability for that action.
You might be wondering why you need to write an actual letter, rather than just talking to the person about the issue. An indemnity letter is a contract, and it must be in writing if you want to take it to court to make the other party deliver on its promises. Just talking about the issue, shaking hands, and making verbal promises will not be enough if the other party decides to take you to court.
Letters of Indemnity in Your Business
Let's say you have a painting business and you have signed a contract to paint an office building and you have already received a deposit. Then you find out that the paint you agreed on is out of stock and there is no guarantee that the paint will be available any time soon.
You could write a letter of indemnity assuring the other business that you will find acceptable paint, return their deposit, or find someone else to do the work. The letter, as noted above, is a reassurance that the customer won't suffer a loss because you couldn't fulfill your part of the bargain.
In another common example, you may agree to use a credit card to buy services for someone else. (This might happen if you buy airline tickets for someone.) The credit card company may question the transaction because it doesn't want the liability if you refuse to pay. You might need to write a letter of indemnity to the credit card company stating that you agree to pay the charges.
In another more personal example, your neighbor might want to borrow your truck to do some moving. You are concerned that the truck might be damaged or that the items being moved might be damaged and you might have liability. You could ask your neighbor to sign a letter of indemnity stating that you would be held harmless and that the neighbor would pay for all damage in case the truck or the items are damaged. (Yes, insurance might come into this example, but you might not want to have to file an insurance claim.)
Other Common Letters of Indemnity
Often a letter of indemnity is written by a third party, often a bank or insurance company. If a business has a loss on a piece of property and the insurance company has agreed to pay the claim, the insurance company may write a letter of indemnity to the lender assuring that the insurance proceeds will go towards the repair of the property.
Letters of indemnity are common in shipping. A shipment may arrive at a customer's location but no bill of lading is available to check against the list of items in the shipment. The customer may be reluctant to accept the shipment because they have no way of knowing if it's complete. A letter of indemnity would assure the customer that they would not suffer a loss if something is missing.
Who Signs and Witnesses a Letter of Indemnity
The two parties should sign the document, of course.
If a letter of indemnity relates to a business matter, make sure that your business - not you personally - is named in the letter. Sign with your title in the company (for example, sign as "Carla Carerra, President") to make it clear that the company is a party to the agreement.
It's also a good idea to have witnesses or to get a notary public to verify the signatures. The verification would be important if you need to take the document to court.
If the indemnity involves a high-value item, like a piece of jewelry or an antique, it's a good idea to get an insurance company representative to verify the value, or to have an appraisal. For example, if you are shipping some artwork, get an appraised value and make the signed appraisal part of the document.
A Certificate of Indemnity Example
Here's an example of a certificate of indemnity (similar to a letter of indemnity): This document from the Federal Council on the Arts and the Humanities and owners of specific (listed) artwork agree to indemnify an exhibitor against loss or damage to items while on exhibition. There is also a specific limit to the amount of indemnity and an effective date and termination date.
What to Include in a Letter of Indemnity
- First, include the date the document is being executed (signed). Title the letter as a "Letter of Indemnity" to make it clear what the document is about.
- Include a statement that the agreement will be governed by the laws of the specific state (where the agreement would be taken to court).
- Begin the letter confirming the contract already in place with the other party. Include the circumstances—"We agreed that ..."— and emphasize your acceptance of the terms of the contract.
- Include the language "For good and valuable consideration..." This language makes it clear that there is payment by one party in return for the agreement to hold harmless by the other. In a contract, both parties must give something - money (valuable consideration) in return for a promise.
- Explain what might happen to cause you not to complete the contract. You don't need to go into a lengthy explanation, just a brief sentence or two is fine.
- Describe what you will do to make sure the other party doesn't suffer a loss. Be specific. Offer alternatives.
- Emphasize your commitment that the other party will not have to pay more or suffer any kind of loss if you can't fulfill the contract.
You may be tempted to use a free contract form or write the contract yourself. But these free forms are dangerous to use because the language must be detailed and specific. (See this example from the Securities and Exchange Commission database). It's much better to pay an attorney to help you prepare the form.