Letter of Indemnity and Release

A. Letter of Indemnity

A letter of indemnity is a contractual and legal commitment to take responsibility for the losses of another person. 

It is commonly used in commercial transactions for one party to assure the other party that if a certain event happens, the indemnified person will not suffer financial losses. The person giving the indemnity is known as the "indemnifier" and the person protected under the indemnity is known as the "indemnified". As it is a legal document and may end up being used as the basis of a claim in court,  it is very important to get the language of the letter of indemnity right and complete. In addition, it is frequently executed as a deed and one will need to ensure the formalities of a deed are being followed.

Difference between a Letter of Indemnity and a Guarantee

People are often confused between a letter of indemnity and a guarantee. A letter of indemnity is a primary obligation to compensate the indemnified person in case of a loss, whereas a guarantee is a secondary obligation to pay or fulfill the debt or obligation of another person in the event of a default by the person responsible for the debt or obligation. A letter of indemnity does not depend on whether a third party performs its obligations, so long as the indemnified person suffered loss resulting from a certain event, the indemnifier is liable for compensation. 

When to use a letter of indemnity/indemnity clause?

The principal purpose of an indemnity is to assure the other party that they will be protected from harm and compensated for any loss/damage suffered. When both parties agree on a contract, they have obligations to perform under the contract. Usually, one party agrees to pay the other party, and the other party agrees to provide the product or service. If one party breaches the contract (does not do what they agree to do), the other party may suffer losses, either by losing payment or not receiving the goods or services. It is also usual for certain service providers (e.g. financial institutions) to ask for an indemnity from the customers for things that they cannot control, like an indemnity in relation to receiving instructions by fax.

Another usual purpose of a letter of indemnity is to indemnify another party for tax purposes (e.g. value-added tax, withholding tax, or sales tax), in particular in relation to a cross-border transaction. One might also provide an indemnity for the performance of an affiliate or a subsidiary. The indemnity clause can be included as part of the contract or under a separate letter of indemnity.

Sample Indemnity Clause to Indemnify the other party in breach

If either party lawfully exercises any right to terminate or rescind this [Agreement/Transaction Document/Deed] under any of its provisions or under the general law, then (in addition to any right or remedy which that party may have against the other party for breach of such [Agreement/Transaction Document/Deed][or in respect of breach of any warranty contained in this [Agreement/Transaction Document/Deed]) the other party shall be liable to indemnify that party (on an after-tax basis) for all costs, charges, and expenses incurred by it in connection with the negotiation, preparation and termination or rescission of this [Agreement/Transaction Document/Deed]. 

Deed of Indemnity

It is usual for a letter of indemnity to be executed as a deed. For a contract to be valid, one needs to demonstrate that something of benefit to the indemnifier or something which is a detriment to the indemnified. The advantage of executing the letter of indemnity as a deed is that there is no need to show adequate consideration (something of value has been given for the indemnity) to enforce a gratuitous promise under the deed. It is also easier to get a default judgment in court with an indemnity.

The following formalities should be observed for the letter of indemnity to be a deed:

• make it clear on its face that it is intended to be a deed - see specimen execution clauses below
• be validly executed as a deed 
  
  • for execution by an individual - it should be signed by the individual in the presence of a witness who attests the signature
  • for execution by a company - it should be in accordance with the articles of association, usually, this means execution by 2 directors (or a director and a secretary) or a director with the company seal. 
• a deed must be delivered to become effective - it does not necessarily mean physical delivery, but the inclusion of the following language - "duly delivered on the date" with a signature is usually sufficient.

Please refer to our guide on the execution of documents and deeds for more information.

Tips for drafting a Letter of Indemnity

• Identify the indemnifier and the indemnified person.
• Clearly state that it is a "letter of indemnity" or a "deed of indemnity".
• Be specific about what is covered under the indemnity. If too wide, it may not be acceptable to the indemnifier, and conversely if too narrow, it may not be acceptable to the indemnified. 
• Whether the indemnity is unlimited in relation to all loss suffered by the indemnified or whether there is a cap on the amount.
• The letter of indemnity should be properly executed by the individual or the company. In particular, please observe the formalities if the letter of indemnity is executed as a deed.

B. Letter of Release

A letter of release is to release a party from certain obligations in a contract. It closely relates to a termination letter where a contract is terminated (including a contract of employment) and the parties are released from obligations under a contract. For example, the parties may agree that from the termination date:

(a) the agreement is terminated:

(b) the parties release and discharge each other from the obligations under the agreement, including without limitation all claims and demands in relation to them; 

(c) the parties will not be entitled to exercise and enjoy any further rights under the agreement.