An indemnity clause is a promise by one party to a contract to compensate the other for specified losses, claims or liabilities. If the promised event happens, the party giving the indemnity, called the indemnifier, must make the party receiving it, called the indemnified party, whole for the losses the clause covers.
Indemnities appear in almost every commercial agreement an Australian small business signs: customer terms, supplier contracts, software licences, venue hire agreements, subcontracts and settlement deeds. Used carefully, an indemnity allocates risk to the party best placed to control or insure it. Used carelessly, it can create an open-ended obligation that insurance will not back.
This guide covers:
- What an indemnity is: the promise, the parties, and how it differs from damages and from a guarantee.
- The essential elements: the trigger, the covered losses and the limits that shape every clause.
- A worked example: how an indemnity plays out when a third-party claim lands.
- Common misconceptions: what courts, insurers and regulators will and will not accept.
- When to get help: what a commercial lawyer actually does with an indemnity clause.
What an indemnity clause actually is
An indemnity is a primary obligation to compensate. It does not depend on a breach of contract having occurred, or on the usual rules about remoteness of damage that limit ordinary damages claims. The clause simply promises that if a defined event happens, the indemnifier pays the resulting losses. That is why indemnities can cover things an ordinary damages claim cannot, such as the other party's legal costs of defending a third-party claim or a settlement paid to that third party.
Australian courts treat indemnities as special provisions with special rules of interpretation. In Andar Transport Pty Ltd v Brambles Ltd (2004) 217 CLR 424, the High Court considered an indemnity in a service contract between a laundry company and a small transport operator. The High Court held that the indemnity was limited to claims for which the laundry company was vicariously liable to third parties, and did not extend to the driver's own injury claim. Where the wording was ambiguous, it was read down in favour of the party giving the indemnity.
The practical lesson for a small business is direct. If you are the indemnifier, ambiguity is your friend: a court will construe the clause against the party relying on it. If you are the indemnified party, a vague clause may fail you precisely when you need it. Either way, the wording on the page, not the commercial intention, decides who pays.
An indemnity is also different from a guarantee. A guarantee is a secondary promise to answer for another party's default if that party fails to pay. An indemnity is primary: if the promised event occurs, the indemnifier pays straight away, without the indemnified party first exhausting claims against anyone else. This is why lenders and landlords often ask for a deed of guarantee and indemnity from company directors: the indemnity gives them a direct claim that bypasses the usual hurdles of a guarantee.
The essential elements of an indemnity clause
Every indemnity has four moving parts, and most disputes turn on how precisely each one is drafted.
The promise
The clause must identify who is indemnifying whom. A one-sided indemnity might run only from the supplier to the customer; a mutual indemnity runs both ways, with each party covering losses caused by its own breach or negligence. The promise also needs to state whether it survives the end of the contract, because indemnities are often relied on years after the agreement has finished.
The trigger
The trigger is the event that turns the clause on: a breach of contract, negligence, a third-party claim, infringement of intellectual property, or damage to property. The safest triggers tie the indemnity to events the indemnifier can control. The dangerous ones are catch-alls such as "arising out of or in connection with this agreement", which give a court a wide field and are frequently the subject of litigation about what the parties actually meant.
The covered losses
The clause should say what losses are covered: damages awarded against the indemnified party, settlement amounts, and legal costs of defending the claim. Indemnities commonly extend to the indemnified party's costs of enforcing the indemnity itself. Fines and statutory penalties are a different category. Courts are reluctant to enforce indemnities that shift liability for criminal fines or exemplary damages as a matter of public policy, and some statutes prohibit them outright. For example, s 272A of the Work Health and Safety Act 2011 (Cth) makes it an offence to enter into a contract of insurance or a grant of indemnity covering liability for a monetary penalty under that Act, and voids any such term.
The limits and exclusions
Finally, the clause should state its boundaries: a cap on the indemnifier's total liability, a time limit for claims, and exclusions such as losses caused by the other party's own negligence or wilful misconduct, or indirect losses. If the other party contributed to the loss, an indemnity can still require you to pay the whole amount unless the clause provides for a proportionate reduction. Whether the proportionate liability regimes in the Civil Liability Acts apply to an indemnity claim is not always straightforward, so the point should be addressed expressly in the drafting rather than assumed.
An indemnity at work: the booking software example
BrightBooking Pty Ltd is a 12-person Melbourne software business that sells a booking platform to 40 fitness studios. Its standard customer agreement says BrightBooking "indemnifies the customer from and against all claims, losses, damages and costs arising out of or in connection with the Services".
A component supplier that built part of the platform alleges the platform infringes its copyright and sues both BrightBooking and one of the studios. The studio's insurer writes to BrightBooking demanding that it pay the studio's defence costs under the indemnity.
Three things determine whether BrightBooking must pay. First, the trigger. The claim is a third-party claim, the kind of loss indemnities are designed to cover, but "arising out of or in connection with" is broad wording. Under Andar Transport, a court reads ambiguous indemnity language down in favour of the indemnifier, so BrightBooking can argue the claim arises from the supplier's alleged rights, not from the studio's use of the platform. If the clause instead said "caused by BrightBooking's breach of this agreement", the studio would first have to prove a breach, a much narrower trigger. Second, the scope. Costs of defending a claim are usually covered, but BrightBooking should check whether the clause also covers the studio's own legal costs of pursuing the indemnity. Third, the insurance. BrightBooking's professional indemnity policy, like many business policies, excludes liability assumed under contract that goes beyond what the law would impose anyway. If the indemnity is broader than BrightBooking's common-law liability, the defence costs may be uninsured.
None of this means BrightBooking should pay on demand. It means the demand should be tested against the wording, the trigger and the insurance position before any cheque is written, and that is exactly the kind of assessment a commercial lawyer makes quickly.
Common misconceptions about indemnity clauses
Indemnity clauses attract more than their share of folklore, and the misconceptions below are the ones most likely to cost a small business money:
- "An indemnity is just a damages clause by another name": It is not. Damages for breach are limited by remoteness, mitigation and causation, and require a proven breach. An indemnity is a promise to pay defined losses, and can recover defence costs and settlement amounts that a damages claim would not. Courts also apply special rules of interpretation to indemnities, as Andar Transport shows.
- "The broader the wording, the better protected I am": If you are the indemnified party, broad wording can be read down against you when it matters. If you are the indemnifier, broad wording such as "in connection with" can expose you to losses you never priced. Precision beats breadth in both directions.
- "My insurance covers whatever I sign up to": Many liability policies exclude contractual liability, meaning liability assumed under a contract that goes beyond what the law would impose anyway. An indemnity that expands your liability can therefore sit outside your cover. The clause and the policy need to be read together.
- "An indemnity is the same as a waiver or a release": A release or waiver aims to stop claims being brought at all. An indemnity allocates who pays for claims that do arise. They are different tools, sometimes combined in a deed of waiver, release and indemnity, and each needs its own careful drafting.
- "I can be indemnified for fines and penalties like any other loss": Generally not. Indemnities that shift liability for criminal fines or exemplary damages may be unenforceable as a matter of public policy, and indemnities for monetary penalties under work health and safety laws are expressly void under s 272A of the Work Health and Safety Act 2011 (Cth).
- "Boilerplate indemnities in standard form contracts are untouchable": Since 9 November 2023, the unfair contract terms regime in the Competition and Consumer Act 2010 (Cth) (the ACL) is far more potent. An unfair term in a standard form consumer or small business contract is void, and proposing or relying on one is itself a contravention carrying penalties of up to $50 million for a body corporate.
When a lawyer should review an indemnity
An indemnity does not operate in isolation, and the value of legal review is that it tests the clause against everything around it.
A lawyer will first construe the indemnity against the rest of the contract: the liability cap, the exclusion of consequential loss, set-off rights, confidentiality and dispute resolution clauses. Inconsistencies here are common and expensive. An indemnity can unintentionally bypass a carefully negotiated cap unless the contract says indemnified amounts count towards it.
Second, a lawyer checks the trigger and scope against your insurance. If the indemnity promises more than your policy covers, the difference is uninsured risk that should be priced, negotiated away, or accepted consciously.
Third, for businesses that trade on standard terms, a lawyer assesses the unfair contract terms regime. A term is unfair if it causes a significant imbalance in the parties' rights, is not reasonably necessary to protect the legitimate interests of the advantaged party, and would cause detriment. Under the ACL, a term is presumed not to be reasonably necessary unless the business proves otherwise, and a contract is presumed to be standard form if a party alleges it is. The regime covers small business contracts where one party has fewer than 100 employees or turnover under $10 million. Since the 2023 reforms, an overly one-sided indemnity in standard terms is not just unenforceable: it is a compliance risk with substantial penalties attached.
Finally, a lawyer negotiates the process terms that stop costs spiralling: prompt notice of claims, the right to control the defence and approve settlements, and cooperation obligations. These are often worth more than the loss cap itself.
The question to ask before you sign any indemnity
Every indemnity you sign comes down to one question: if the promised event happens tomorrow, who actually pays? For each clause, ask what losses you are promising to cover, whether you control the events that trigger them, and whether your insurer will stand behind the promise. If you are the indemnified party, ask whether the wording is precise enough to survive the read-down that courts apply to ambiguous indemnities. The clause that looked like boilerplate on the way in can become the clause that decides whether your business or the other party's pays for the claim. That is why the wording, not the handshake, is what counts.