What Is a Letter of Indemnity?

A letter of indemnity (LOI) is a contractual document that guarantees certain provisions will be met, between two parties. Such letters are traditionally drafted by third-party institutions like banks or insurance companies, which agree to pay financial restitution to one of the parties, should the other party fail to live up to its obligations. In other words, the chief function of an LOI is to ensure that Party A won't ultimately suffer any losses if Party B falls delinquent. The concept of indemnity has to do with holding someone harmless, and a letter of indemnity outlines the specific measures that will be used to hold a party harmless.

Understanding Letters of Indemnity

A letter of indemnity states that any damages caused by the first party to the second party, or to the second party's belongings, are the responsibility of and are facilitated by the third party, as per the contractual agreement. In that sense, LOIs, which are often referred to as "indemnity bonds" or "bonds of indemnity," are similar to insurance policies.

Letters of indemnity are used during various types of business transactions. In cases where items of value are being transported by second parties like moving companies or delivery services, LOIs ensure the party who owns the valuables will be compensated, if his possessions are lost, damaged, or stolen during transport. LOIs are generally signed when the valuable items in question are presented to the recipient, prior to a bill of lading, which is a document issued by a carrier, acknowledging the receipt of cargo.

Letters of indemnity can also be used when a second party borrows something of value from the first party, such as a car or a power tool. In this case, the first party (the owner) can present the second party (the borrower) with a letter of indemnity stating that any damages are the sole responsibility of the borrower. LOIs should always be signed by a witness, but in cases involving inordinately valuable items, it's preferable to have an insurance carrier representative, a banker, or another professional operative sign the document, in lieu of a simple witness.

Requirements for a Letter of Indemnity

Letters of indemnity should include the names and addresses of both parties involved, plus the name and affiliation of the third party. Detailed descriptions of the items and intentions are also required, as are the signatures of the parties and the date of the contract's execution.

Letter of Indemnity Example

Let’s say you hire a professional painter to paint your house. You sign a contract with them to paint your home using a specific brand, color, and type of paint. However, after the contract is signed and the terms agreed upon, the painter discovers that the specific type of paint has been discontinued. The painter could write you a letter of indemnity, in which he or she will promise to obtain acceptable paint, or return your deposit and cancel the contract. The letter of indemnity establishes that you won’t pay the consequences for the painter’s being unable to uphold his or her part of the contract.