You're reviewing a contract and you hit the indemnity clause. It's dense, it's broad, and it quietly asks you to take on responsibility for things that might have nothing to do with you. Most founders sign it without fully understanding what they've agreed to.
This post explains what an indemnity clause actually does, how to spot a one-sided one, and what to push back on before you sign.
What an indemnity clause does
An indemnity is a promise by one party to cover the losses of the other. If something goes wrong and the indemnified party suffers a loss or gets sued, the indemnifying party has to make them whole.
There are two common versions of this in commercial contracts.
The first requires you to cover the other party's liability to third parties. If your client gets sued by one of their customers because of something you did, you have to cover that. This is the most common form in commercial contracts.
The second creates direct liability between the contracting parties themselves. A warranty indemnity is a good example: if you give a warranty about your product or service and it turns out to be false, you have to compensate the other party for the losses that flow from that.
Both are legitimate. The problem is scope.
Why uncapped indemnities are a serious problem
Unlike ordinary damages for breach of contract, an indemnity can create liability that exceeds the contract value entirely. Your liability often arises immediately on the triggering event, and it can cover losses that go well beyond what you were paid.
If an indemnity is broad and uncapped, you could be on the hook for legal costs, third-party claims, and consequential losses that dwarf the commercial value of the deal. For a startup or small business, that exposure can be significant.
Does it cover the other party's own negligence?
This is one of the most important questions to ask when reviewing an indemnity clause, and one that often gets missed.
As a starting point, an indemnity covering damage that arises from the work you perform under the contract will generally be read as covering losses traceable to your own acts or omissions. It will not automatically extend to losses caused by the other party's independent negligence, unless the clause says so clearly.
The problem is that many commercial contracts do say so, often buried in a broad definition of "loss" or "liability" that picks up claims arising from any cause whatsoever.
If that language is in the contract you are reviewing, you are potentially being asked to cover losses you had nothing to do with. That needs to be addressed.
What to push back on
When you are negotiating an indemnity clause, there are five things worth focusing on.
1. A cap on liability. The indemnity should not be unlimited. A common approach is to cap exposure at a fixed dollar amount, a multiple of the contract value, or your insurance coverage. Without a cap, you are accepting open-ended risk.
2. Mutual obligations. A one-sided indemnity running only in favour of the other party is a red flag. In most commercial relationships, both parties carry risk, and the indemnity should reflect that. Push for mutual indemnities so each party covers losses attributable to their own acts or failures.
3. Carve-outs for the other party's negligence. You should not be required to indemnify the other party for losses caused by their own negligence or wilful misconduct. If the clause does not already say this, ask for it.
4. A time limit. Indemnity obligations should not run indefinitely. A defined period after which claims can no longer be made is often found in well-negotiated commercial contracts.
5. Insurance alignment. Before you agree to an indemnity, check whether you can actually insure the risk. An indemnity you cannot insure is a risk sitting directly with you only.
Statutory protections for small businesses
If your business qualifies as a small business under the Australian Consumer Law, you may have additional protection worth knowing about.
Since November 2023, the unfair contract terms regime has applied to any business that either employs fewer than 100 people or has an annual turnover under $10 million. There is no longer a cap on contract value for the regime to apply. Under this regime, an unfair term in a standard form contract is not just voidable, it is unlawful, and businesses that include unfair terms in their standard form contracts can face significant penalties.
A term is unfair if it causes a significant imbalance in the parties' rights and obligations, is not reasonably necessary to protect the legitimate interests of the party it benefits, and would cause detriment if relied on. Courts have applied this to strike down unlimited indemnity clauses where the customer was required to indemnify the supplier even for losses that were not the customer's fault and could have been avoided by the supplier.
For the regime to apply, the contract also needs to be a standard form contract, meaning it was prepared by one party and presented largely on a take-it-or-leave-it basis.
It is worth knowing about, but it only becomes relevant after a dispute arises. The stronger position is to negotiate the clause before signing.
The short version
An indemnity clause is not just boilerplate. It can create liability well beyond what you were paid under the contract, and in the wrong circumstances it can follow you long after the engagement ends.
The things to focus on: whether the clause is capped, whether it is mutual, whether it covers losses you did not cause, and whether you can insure against the risk.
If you want a second set of eyes on an indemnity clause before you sign, speak to a lawyer at Plumlaw. We review commercial contracts for founders and small businesses at a fixed price, with no surprises. Get in touch at plumlaw.co/contact.
This post is general information only and does not constitute legal advice. If you have questions about a specific contract or situation, you should speak to a lawyer at Plumlaw before acting.