The term indemnify means to save a person from legal consequences by the conduct of one of the parties or an outside force. A letter of indemnity (LOI) or an indemnity bond is also referred to as a contract of indemnity. The purpose of such a document is to guarantee that obligations in a contract or business transaction will be met even if one or both of the parties fails to take on the responsibility. Most often, a bank or insurance company fulfills the terms that a party does not.
Typically, an attorney for the entity that will step in to fulfill the obligation for the original party who writes the LOI. The LOI explains the situations in which the original party bound by the contractual agreement will be held harmless, meaning that they will not be responsible for legal consequences. The other parties to the contract should have their own contract attorney review the LOI, since the first draft may not be fair to all parties.
Letter of Indemnity in Shipping
In shipping, an LOI releases a party from liabilities that may be caused by the conduct of the original parties to the contract or an unforeseen cause. For example, when goods are shipped, a carrier can issue an LOI to a shipper to protect goods from potential damage. This is particularly true if the goods are traveling in a risky way, such as by sea during a storm.
Importance of Bill of Lading in International Trade
A bill of lading is a list of the type, number and destination of a shipment of goods. It takes the form of a receipt and is given by a shipping company to the person consigning the goods. A consignment is when the person providing the goods ships or entrusts the goods to another party, the consignee. A bill of lading must always be present with the shipped products. It must be signed by an authorized officer from the carrier, shipper and receiver.
An LOI can give extra protection to the seller of the goods when the goods follow a different path than usual. For example, if the goods must be delivered to a different port than the one mentioned on the [bill of lading](https://www.investopedia.com/terms/b/billoflading.asp#:~:text=A%20bill%20of%20lading%20(BL,goods%20at%20a%20predetermined%20destination.), the LOI ensures against a risk to the number and quality of the goods. An LOI is also helpful if split bills of lading are used. A split bill of lading is a document that specifies the goods in a cargo that was originally shipped under a single set of bills of lading or a single bill of lading.
What an LOI Should Contain
An LOI should identify the names and addresses of parties to the contract, the goods covered by the contract and whether time is of the essence. It should also contain the date the agreement is signed and executed. Further, the LOI should mention which state’s laws will govern the agreement. An LOI should mention that a contract is already in place and that the original parties to the contract have accepted its terms.
The LOI should spell out what could happen if one or both of the parties breaches the contract and how that party would assume the obligations. This clarifies the original intent of the parties to the contract. The LOI should explain how a bank or insurance company would take steps to fulfill the obligations of the entity that was originally supposed to undertake them.
Indemnity Letter vs. Bank Guarantee
A bank guarantee is a guarantee by a lending institution to pay for damages if a borrower defaults on an obligation such as a loan. A bank guarantee can serve the same purpose as an LOI, but it is typically more specific to a financial institution and what specific measures a bank can offer in the event of financial loss. For example, in a rental security agreement, the bank agrees to pay the rental company what they are owed if the customer fails to pay such costs.
In a bank guarantee, an agreement like a loan contract that comes with a guarantee usually has higher costs and interest rates than an agreement without a guarantee. There are four basic types of guarantees. These are a shipping guarantee given to a carrier for a shipment that arrives before documents come; a loan guarantee to handle an obligation if the borrower defaults; an advanced payment guarantee to offer collateral to reimburse advance payment if the seller fails to supply the goods stated in the contract; and a confirmed payment guarantee where the bank pays a certain amount to a beneficiary on behalf of the bank’s client by a certain date.
Good Faith and Fair Dealing
A court may not allow a party to recover damages from an LOI if that party contributed to the reason that another party fails to fulfill its obligations. Parties that enter into contracts with one another are supposed to engage in good faith and fair dealing. For example, California Commercial Code Section 7703 provides that a carrier loses its lien on any goods that it voluntarily delivers or unjustifiably refuses to deliver.
Statute of Limitations for LOIs
The statute of limitations (SOL) is the time in which a party has to bring a lawsuit for a particular incident. The SOL related to contracts for goods and related LOIs varies according to state. In California, the SOL for breach of a written contract is four years from the date the contract was broken and for breach of an oral contract it is two years from the date the contract was broken. The SOL for property damage is three years from the date the damage occurred.
The SOL for a breach of an LOI would be four years, since an LOI is a type of written contract. In the event that a party to the contract suffers financial damage for multiple reasons, the party should bring a lawsuit with multiple causes of action. The party should bring the lawsuit as soon as possible to allow more time for negotiations and a settlement to evolve. Bringing a lawsuit early also helps to preserve evidence, including attempts to subpoena witnesses.
Acting as a Surety
A surety is an entity who answers for the debt of another party. There are ways beyond being named as a surety in an LOI for the surety to assist original parties to a contract. For example, a surety may sign a warranty bond to provide collateral in place of ordered goods if the goods are not provided at all or in the condition they were promised to be in under the contract. When a surety provides a letter of credit to a party, this letter is not a form of a suretyship obligation.
- California Civil Code: Section 2772, Definition of Indemnity
- California Civil Code: Section 2778, Obligations Arising From Particular Transactions, Indemnity
- California Commercial Code: Sections 7301 to 7309, Bills of Lading, Special Provisions
- Investopedia: Bill of Lading
- Investopedia: Bank Guarantee
- Investopedia: Bank Guarantee vs. Letter of Credit
- California Courts: Statute of Limitations
- California Civil Code: Section 2787, Definition of Suretyship
- A letter of indemnity is normally only one or two paragraphs long. Do not include filler words.
Jessica Zimmer is a journalist and attorney based in northern California. She has practiced in a wide variety of fields, including criminal defense, property law, immigration, employment law, and family law.