An indemnification clause (or "indemnity") is a contract term where one party promises to compensate the other for specified losses or liabilities. It is one of the most powerful (and most negotiated) clauses in a commercial contract, because it shifts risk from one party to another. Here is a plain-English guide for England and Wales.
What an indemnity does
In an indemnity, the indemnifying party agrees to reimburse the indemnified party for losses arising from a defined event, for example: "the Supplier shall indemnify the Customer against all losses arising from any third-party claim that the goods infringe a patent."
The point is to make sure that if a particular risk materialises, the agreed party bears the cost.
Indemnity vs ordinary damages, why it matters
A claim under an indemnity can be more favourable to the indemnified party than an ordinary claim for breach of contract damages:
- with damages, you must prove a breach, that the loss was caused and not too remote, and you must mitigate;
- a well-drafted indemnity can provide a pound-for-pound recovery for the specified loss, potentially without the same hurdles (depending on its exact wording).
That is precisely why indemnities are negotiated hard, they can expose the giver to broad, open-ended liability.
Drafting and interpretation
Courts interpret indemnities according to their words read in context, the modern approach to contract interpretation confirmed by the Supreme Court (in Wood v Capita Insurance Services Ltd [2017] UKSC 24) balances the language used against the commercial context. Ambiguous indemnities can be read narrowly, so precision matters.
Key drafting points:
- Define the trigger precisely, which events/losses are covered (e.g. third-party IP claims, data breaches, specific known risks).
- Scope of losses, direct losses only, or also certain indirect losses? Be explicit.
- Caps and exclusions, a financial cap and carve-outs keep the giver's exposure proportionate.
- Conduct of claims, who controls the defence of a third-party claim, and duties to notify and mitigate.
- The penalty rule: this applies principally to secondary obligations that are triggered by a breach of contract. Many indemnities are drafted as primary obligations (the indemnifying party bears a specified risk, not a consequence of breach) and so may fall outside the penalty rule. Where an indemnity does operate on breach, consider whether it imposes a detriment out of all proportion to any legitimate interest (Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67). Take advice on the specific clause.
Why it's important for your business
- As the party protected by an indemnity, you get a clearer, often stronger, route to recover specific losses.
- As the party giving one, you may take on significant, uncapped liability, so you should cap it, narrow it, and exclude losses you can't control.
- Indemnities also interact with insurance, check your cover lines up with what you indemnify.
Practical tips
- Don't accept broad indemnities without a cap and clear scope.
- Match indemnities to real, specific risks, not as catch-alls.
- Align indemnities with limitation of liability clauses and insurance.
- Have a solicitor draft/review them, small wording changes have big consequences.
Key takeaways
- An indemnity is a promise to reimburse specified losses, shifting risk between the parties.
- It can give a stronger, pound-for-pound recovery than ordinary damages (avoiding some causation/remoteness/mitigation hurdles), depending on wording.
- Draft precisely: define the trigger and scope, add caps and carve-outs, and address conduct of claims.
- Watch the penalty rule (Cavendish Square Holding BV v Makdessi [2015] UKSC 67, mainly relevant to secondary obligations on breach, not necessarily to primary indemnities) and modern interpretation (Wood v Capita Insurance Services Ltd [2017] UKSC 24); align indemnities with insurance.
Sources
- General law of contract on indemnities and damages (causation, remoteness, mitigation) in England & Wales
- Wood v Capita Insurance Services Ltd [2017] UKSC 24 (contractual interpretation); Cavendish Square Holding BV v Makdessi [2015] UKSC 67 (the penalty rule)
- Statutory controls on exclusion/limitation clauses (UCTA 1977 / Consumer Rights Act 2015)
--- This article is general information about the law of England & Wales as at 2026, not legal advice. For advice on your circumstances, consult a qualified solicitor.