Indemnity cap: Overview, definition and example
What is an indemnity cap?
An indemnity cap is a clause in a contract that sets a limit on how much one party must pay the other in case of losses, damages, or liabilities covered by an indemnity. It acts as a financial ceiling, protecting the indemnifying party from unlimited exposure while still providing some assurance to the other party.
Why is an indemnity cap important?
An indemnity cap is important because it balances risk. For the party offering the indemnity, it prevents overwhelming financial liability, which could lead to significant losses. For the party receiving the indemnity, it ensures there is some level of compensation available for covered claims, even if it is capped.
By agreeing on an indemnity cap, both parties have clarity about their maximum financial exposure, reducing the risk of disputes over excessive or unforeseen costs.
Understanding an indemnity cap through an example
Imagine a software company signs a contract with a business client to provide a custom application. The contract includes an indemnity clause stating the software company will cover any losses the client suffers due to a data breach caused by the software. To protect itself, the software company negotiates an indemnity cap of $500,000. If a breach occurs and the client’s losses total $700,000, the software company is only liable to pay up to the agreed $500,000 cap.
This cap ensures the client is compensated to some extent but limits the software company’s financial responsibility.
An example of an indemnity cap clause
“The liability of the Indemnifying Party under this Agreement shall not exceed $500,000 in aggregate for all claims arising from or relating to this Agreement.”
Conclusion
An indemnity cap provides a fair and practical way to limit financial risk in contracts. It gives both parties clarity and security, ensuring the indemnifying party has manageable exposure while still offering the indemnified party some level of protection. By negotiating an appropriate indemnity cap, businesses can reduce uncertainty and foster stronger working relationships.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.