If you’ve ever bought a property or entered into a business contract, chances are that you’ve come across the term 'indemnity'.
A letter of indemnity is often used in property as an important contractual agreement. It's a legal document that assures one party against another, for any potential costs or financial losses.
So, what exactly does a letter of indemnity do, and when is it actually needed?
What Is The Meaning Of Indemnity?
Understanding the literal meaning of ‘indemnity’ is a good place to start explaining this question. In simpler terms, indemnity is a legal or contractual security against a financial loss or burden.
The Cambridge Online Dictionary defines indemnity as “protection against possible damage or loss, especially a promise of payment, or the money paid if there is such a damage or loss”.
As such, this is a word which covers the legal protection against financial liability, as well as any money that needs to be paid out in order to cover those financial losses.
What Is A Letter Of Indemnity?
A letter of indemnity is the legal instrument used in transactions such as property. It's to secure one party (indemnity holder) against potential financial losses, caused by the failure of another party (indemnifier).
Essentially, what this does is enable one party to take on the obligation of any financial losses, assuring the other party against any potential costs. It’s basically a "it’s-not-MY-fault clause" that transfers risk in a contract.
This letter of indemnification plays an important part in contracts, as it gives reassurance that a party won’t lose out financially, if the other side fails to deliver on their contractual obligations.
So, it’s like a hedge against financial loss if someone screws up. Of course, they normally write that a bit more formally, and in politer language.
What’s The Legal Deal With 'Indemnity' In Malaysia?
The concept of indemnity is covered in the Malaysian Contract Act 1950, which defines a contract of indemnity as:
A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called a "contract of indemnity”.
So what happens if someone ‘breaks’ that indemnity? Let’s get legal on this, and dive into the full explanation, as per the Contract Act 1950:
The promisee in the contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor—
(a)all damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies;
(b)all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he did not contravene the orders of the promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or defend the suit; and
(c)all sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contrary to the orders of the promisor, and was one which it would have been prudent for the promisee to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.
Phew, that was quite a mouthful! It essentially means that if your contract has been 'broken' by someone who was supposed to pay you, you can not only still get your payment, you can also get payment for any losses/damages done, as well as for any additional costs incurred.
It’s very important that any indemnity contract is recorded in writing (black and white). You can’t just tell a judge that Ali verbally promised to accept the costs, if the house he built for you fell down, for example.
A proper letter of indemnity should be crafted by a legal professional, or a respected third-party such as a bank or insurance company.
So How Does Indemnity Work In Property?
Given how valuable property is, and the complicated nature of construction, it probably comes as no surprise to find that letters of indemnity are widely used in the industry.
Let’s take one example in construction, where Party A is currently building a shiny new condo development for Party B.
As part of the contract, a letter of indemnity is signed which indemnifies Party B against all financial losses, damages, expenses, and liabilities for work under the contract.
In this scenario, Party A cannot claim financial penalties against Party B, even if Party B is found to be liable for some action.
Likewise, if Party A hits some snag during construction, say they accidentally crash a digger into a nearby car showroom (whoops!) and take out the electricity to the entire block, Party B is indemnified against any costs.
The moral of the story here is: Watch where you’re driving your diggers! And the important thing is that Party B is not financially vulnerable, thanks to that letter of indemnity.
You might be thinking at this point that Party A has got a pretty bad deal? That’s where the banks and insurance companies come into play!
In this scenario, Party A is most likely to have taken out some form of professional indemnity protection product with a bank or financial institution. This acts like an insurance that covers any potential financial costs.
This professional indemnity cover is basically a form of insurance against the kind of financial losses noted above.
Much like a normal insurance, a party such as a property developer would pay an insurance company for this cover, and that company would then pay out a claim for covered events.
What Does A Letter Of Indemnity Look Like?
Indemnity clauses and letters of indemnity can vary significantly depending on industry and use case, but a good letter of indemnity sample will share some important elements:
Name of both parties
Registered address for both parties
Name/affiliation of any potential third party (bank or insurance company)
Signatures of all parties
Detailed description of items and intentions covered
Date of execution
Signatures or stamp
The details of what indemnity is covered should be clearly stated. The scope and impact of cover in a letter of indemnification can vary widely depending on the wording.
That means you want to be VERY careful that you fully understand what you’re indemnifying, and how.
It’s also important to remember (in case you’ve got any bad ideas) that indemnity does not cover intentional, fraudulent, or illegal acts.
If a developer decides to burn down their half-built development for insurance purposes, they can’t somehow claim the builder is responsible and thus be indemnified against any losses.
Take the letter of indemnity sample below, which covers the Memorandum of Transfer in Malaysia on behalf of a dissolved company:
Finally, and this is something we mention a lot at PropertyGuru – make that thing official! Ensure that your letter is witnessed by a respected third party, and ultimately stamped by The Inland Revenue Board (LHDN).
If you want a legal instrument to cover you, it’s best to make that thing as legally airtight as you can!
Want to explore more about best practice for contracts? Here’s our guide to Should You DIY Your Own Legal Document In Malaysia?