Letter
of Indemnity
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 contract.
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. 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 might be wondering why you need to write
an actual letter, rather than just talking to the person about the issue. It's
important to remember that a letter of indemnity is also a written contract, which means your assurance can be taken
to court if you fail to deliver on the promises made in that letter. Just
talking about the issue and making verbal promises will not be enough if the
other party decides to take you to court.
Examples of
Letters of Indemnity
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.)
When a Letter
of Indemnity Might Be Needed
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 mortgage holder assuring
that the insurance proceeds will go towards 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 be written in this case to assure the customer that they would not suffer
a loss if something is missing.
What to
Include in a Letter of Indemnity
- 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.
- 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 that 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.
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