What is a Letter of Indemnity?

Definition: A letter of indemnity is a guarantee provided by a third party on behalf of certain entity to cover for potential financial damages caused by contract breaches against the other party or parties involved in the agreement. It is a written document where the third party assumes the responsibility to cover for losses incurred if certain contractual stipulations are not complied.

What Does Letter of Indemnity Mean?

This type of letters are similar to insurance policies in the sense that they cover for potential losses experienced by one of the parties involved in a certain agreement. A regular contract has two parties that agree to certain provisions. Letters of indemnity are requested by one of the parties to guarantee the other that there will be no potential uncovered losses he might suffer due to contractual stipulations breaches.

The issuer of these letters is often a financial institution, either an insurance company or a bank, and they serve as a guarantor for the transaction being executed. In business, these letters are employed often in big contractual agreements, where high sums of money are involved, in bidding processes for contracts in the public and private sector or in shipping operations.

Example

Swiss Chocolate LLC and Rocker Cocoa Co. are two global companies and key players of the cocoa industry. Swiss Chocolate has unveiled his intention to buy Rocker Cocoa a few weeks ago and they already sent a letter of intention with their initial offering. Rocker Cocoa’s Board of Directors reviewed the letter and asked for a letter of indemnity to move further with the process, since normally takeover procedures are not always completed and many resources are employed during the process to make sure the deal is done properly.

Swiss Chocolate agreed to this condition and hired Manhattan First Bank to issue the letter. This letter states that in the event that the deal is not properly completed, Swiss Chocolate will have to pay for all legal and operational expenses caused by the failed takeover process and if they don’t comply with the payment, Manhattan First Bank has the responsibility to take charge and cover for them.