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Perspectives
International Business Law

Indemnity: how the supplier can reduce its liability

The "indemnity" clause is critical in commercial contracts and often used incorrectly. How to dial it back from the supplier side.

Peter Poleacov 7 min

Indemnity: how the supplier can reduce its liability

Purpose

If one party breaches a contractual obligation, the other party can in principle claim damages, subject to the relevant requirements.

A contractual "indemnity" clause goes further and expands the liability of the indemnifying party (typically the supplier). The conditions and consequences depend on the individual negotiation.

Scope

The indemnity is a primary obligation; it does not depend on proving a breach of a contractual duty. That gives it several advantages over a damages claim for breach of contract:

  • Compensation is typically triggered by the occurrence of a loss, without the need to prove fault. This can also bypass the rules on causation and mitigation, which would otherwise make recovery harder.

  • Where the indemnity is broadly drafted, it can allow broader recovery of losses such as legal costs and other related expenses than a damages claim for breach of contract would.

  • Damages claims are seen as harder to fend off, and the indemnifying party is more likely to pay under an indemnity without litigation.

Note

Every indemnity clause should therefore be examined critically and, at least from the indemnifying party's side, narrowed wherever possible (see the example below). Depending on the wording, further restrictions are needed (see below).

Case law

Under recent U.S. case law, an indemnity clause as a rule only covers damages claims by third parties, not damages claims by the contracting party itself.1 That has to be borne in mind when drafting the clause, because contracting parties increasingly try to push the typical indemnity well beyond its core scope.

The corresponding limitation of liability clause matters here too. The indemnified party often tries to structure the limitation of liability so that it does not cover the indemnity. The consequence would be that liability under the indemnity is unlimited. From the indemnifying party's perspective, the limitation of liability should therefore expressly cover the indemnity.

Example of a standard indemnity clause

"The Supplier shall indemnify, defend, and hold harmless the Customer, its affiliates, officers, directors, employees, agents, and subcontractors ("Indemnitees") against all claims, demands, suits, liabilities, costs, expenses (including legal fees), damages, and losses suffered or incurred by the Indemnitees arising out of or in connection with:

a) Supplier's breach or negligent performance or non-performance of this Agreement; or

b) Any actual or alleged infringement of a third-party's intellectual property rights from the Customer's use of the delivered products and performed services."

Example of a revised standard indemnity clause from the indemnifying party's perspective

(Notes: deletions are struck through, insertions are highlighted, superscript numbers refer to the footnotes at the end.)

"The Supplier shall indemnify, defend, and hold harmless2 the Customer, its affiliates, officers, directors, employees, agents, and subcontractors ("Indemnitees")3 against all claims, demands, suits, liabilities, costs, expenses (including reasonably incurred4 legal fees), damages, and losses, provided these are reasonably foreseeable at the time of the conclusion of the agreement,5 suffered or incurred by the Indemnitees Customer arising out of or in connection with a third-party claim against the Customer caused directly by6:

a) Supplier's breach or negligent performance or non-performance of this Agreement The Supplier's culpable breach of its confidentiality obligations according to section [insert reference] of this agreement7; or

b) Any actual or alleged infringement of a third-party's intellectual property rights by the Customer's use of the delivered products and performed services.

This indemnity shall not apply to the extent that a claim under it results from the Customer's negligence or willful misconduct.8

The Customer may not claim indemnity if it fails to take reasonable steps to mitigate its losses.9

Indemnification shall be the Customer's sole remedy for matters covered by the indemnity."

Model clause from the indemnifying party's perspective

The Supplier shall indemnify the Customer against all claims, demands, suits, liabilities, costs, expenses (including reasonably incurred legal fees), damages, and losses, provided these are reasonably foreseeable at the time of the conclusion of the agreement, suffered or incurred by the Customer arising out of a third party claim against Customer caused directly by:

a) the Supplier's culpable breach of its confidentiality obligations according to section [insert reference] of this agreement; or

b) Any infringement of a third party's intellectual property rights out of the Customer's use of the technology.

This indemnity shall not apply to the extent that a claim under it results from the Customer's negligence or willful misconduct.

The Customer may not claim indemnity if it fails to take reasonable steps to mitigate its losses.

Indemnification shall be the Customer's sole remedy for matters covered by the indemnity.

Additional protection for the indemnifying party

The indemnifying party can reduce its risk further through a number of other mechanisms. In particular, the following conditions can be included in the contract:

  • the indemnified party has to notify the indemnifying party of any claim without undue delay;

  • the indemnified party must not acknowledge the claim or settle with the third party;

  • the indemnifying party has sole control over how the claim is handled;

  • the indemnified party has to support the indemnifying party in the defence (at its own cost);

  • a minimum amount has to be reached before the indemnification obligation is triggered ("basket");

  • no indemnification if and to the extent that:

  • the contract product (or service) has been modified;

  • the contract product (or service) has been used together with other products (or services) not approved by the indemnifying party;

  • the contract product (or service) has been used contrary to the indemnifying party's instructions;

  • the indemnity is limited to specific types of intellectual property, for example to patents rather than to intellectual property in general; and

  • the indemnity is limited in subject matter (e.g. only certain types of intellectual property), geography (e.g. EU), and time (e.g. one year after delivery).

Recommendation

From the indemnified party's perspective, an indemnity makes sense. From the indemnifying party's perspective, it has to be cut down to a reasonable level to avoid unlimited (and unforeseeable) liability.

Footnotes

  1. Cf. Sarn Energy LLC v. Tatra Defence Vehicle A.S., C.A. No.: N17C-06-355 EMD CCLD, 2019 WL 6525256 (Del. Super. October 31, 2019); Winshall v. Viacom International, Inc., C.A. No.: N15C-06-137 EMD CCLD, 2019 WL 5787989 (Del. Super. November 6, 2019); contra Collab9. LLC v. En Pointe Technologies Sales, LLC, C.A. No. N16C-12-032 MMJ CCLD, C.A. No. N19C-02-141 MMJ CCLD, 2019 WL 4454412 (Del. Super. September 17, 2019). ↩

  2. Narrows the indemnifying party's obligations. The term "defend" includes the indemnifying party's duty to defend its contracting party in litigation with a third party. The term "hold harmless" is generally understood to prevent the indemnifying party from asserting claims against its contracting party (debated). ↩

  3. Narrows the very broad personal scope of the indemnity clause. ↩

  4. Under U.S. procedural law, the prevailing party is not entitled to recover its attorneys' fees even if it wins (the so-called "American Rule"). For that reason, attorneys' fees are listed as recoverable losses in indemnity clauses. They should at least be limited to a reasonable amount. On "reasonable" attorneys' fees, see also Euro-Asian Oil SA v. Credit Suisse AG [2017] EWHC B7 (Comm) (23 January 2017). ↩

  5. Caps liability at reasonably foreseeable losses and excludes consequential damages. Without this addition, it is debated whether the "test of remoteness" (also called "test of reasonableness"), first stated in Hadley & Anor v Baxendale & Ors [1854] EWHC Exch J70 (23 February 1854), also applies to an indemnity clause. See also Glenn D. West and Sara Duran, Reassessing the "Consequences" of Consequential Damage Waivers in Acquisition Agreements (2008), 63 Bus. Law. 777 (2008), ssrn.com/abstract=2660962. ↩

  6. Requires causation between the indemnifying party's breach and the third party's claim. The common phrase "directly or indirectly" should be avoided. The same goes for the unqualified use of "arising out of or in connection with", which sweeps in consequential damages as well. ↩

  7. An indemnity covering any breach should be avoided. Alongside the usual scope of an indemnity (infringement of IP rights), it should — if at all — only cover breaches of confidentiality obligations. Fault should also be included as an additional element (the common-law systems that dominate many English-speaking jurisdictions do not require fault). ↩

  8. Carve-out for contributory fault (cf. Section 254(1) BGB if German law applies). ↩

  9. Further carve-out for contributory fault (cf. Section 254(2) sentence 1 alternative 2 BGB if German law applies). ↩

Reference: Poleacov, P. (2025). Indemnity: how the supplier can reduce its liability. INN.LAW. https://inn.law/en/perspectives/indemnity/