Indemnity Clauses in Commercial Contracts

What indemnity is, and how it differs from penalties and damages

Indemnity is one party’s (the indemnifier’s) undertaking to pay the other (the indemnified party) when a defined event occurs, typically when the indemnified party suffers loss due to a third party’s acts or the indemnifier’s breach of undertakings. The core distinction: indemnity does not require proving “breach of contract” in the traditional sense — it triggers when the agreed event occurs, even if neither party breached (e.g. the seller indemnifies the buyer for all back taxes relating to the pre-transfer period).

Under Vietnamese law, three often-confused remedies must be distinguished:

Important note: the label given to the clause does not determine its legal nature. A fixed sum payable upon breach — even if called indemnity — may be treated as a breach penalty and regulated accordingly (including the 8% cap on the breached obligation’s value under Article 301 of the Commercial Law 2005 for commercial contracts). Conversely, a true indemnity — payment based on actual loss when the event occurs — is interpreted as a damages agreement by its nature.

When to use an indemnity clause

Indemnity delivers the most value in four situations:

• Protection against third-party risks: the seller indemnifies the buyer for all third-party IP claims over the goods — a risk the buyer cannot control;
• Protection against the counterparty’s “past”: in M&A, the seller indemnifies the buyer for all tax liabilities and hidden debts arising before closing;
• Breach of representations & warranties: when a counterparty’s statement proves untrue, indemnity allows recovery without fully proving the elements of ordinary damages;
• Hard-to-quantify risks: legal costs, administrative fines caused by the counterparty’s acts — amounts hard to foresee at signing.

The rule: indemnity is used to transfer risk to the party best able to control or understand it.

Structure of a tight indemnity clause

A complete indemnity clause has six components:

1. Trigger events. List specifically: which representations/warranties breached; which categories of third-party claims; tax and administrative obligations from which period. The more specific, the fewer disputes. Avoid “all damage arising from the contract” — too broad and almost certain to cause argument.

2. Scope of indemnifiable loss. State what is included: direct damage, legal costs, administrative fines, remediation costs. And equally important: what is excluded — are indirect damage, lost profits, punitive damages indemnifiable?

3. Cap. Most indemnities in M&A and large contracts are capped — usually a ratio of the contract value or purchase price. No cap means unlimited risk, which no experienced indemnifier will ever accept.

4. Minimum threshold (de minimis / basket). Set the minimum loss for an indemnity claim (e.g. only claims above VND 50 million, or aggregate loss exceeding 1% of contract value) — to avoid trivial disputes.

5. Claim period (survival period). How long after the contract ends does the indemnity right survive? For tax obligations, usually longer (tied to the tax recovery limitation period); for general undertakings, usually 12–24 months.

6. Claims procedure. Notice deadlines when events occur, duty to cooperate, and especially: who controls the defence of third-party claims — the indemnifier usually wants control (since it pays), the indemnified party wants consultation rights.

Indemnity in M&A: distinctive points

In business acquisitions, indemnity is the tool for allocating “past–present–future” risk between seller and buyer. The buyer cannot diligence every corner of the target, so indemnity fills the gap between what was diligenced and what may emerge.

Three distinctive M&A indemnity groups: general indemnity for breaches of representations and warranties in the sale contract; tax indemnity — the seller indemnifies all tax obligations from the pre-closing period (usually the longest survival, tied to the tax recovery limitation); and indemnity for known issues — when diligence uncovers a specific risk (e.g. an ongoing land dispute), the parties agree a bespoke indemnity mechanism for that risk instead of leaving it in the general indemnity.

The enforcement mechanism for indemnity matters as much as the clause: retaining part of the purchase price in an escrow account during the survival period — because collecting indemnity from a seller who has been paid in full and “disappeared” is extremely difficult. See security measures for obligations in transactions.

Liability caps and their relationship with indemnity

Liability cap — a party’s overall liability ceiling in the contract — and indemnity are two clauses that must be designed in sync. A common mistake: the contract has a liability cap but the indemnity is “not subject to the cap” without saying so — in a dispute, the parties argue over whether indemnity sits inside the cap.

Three common models: indemnity subject to the general cap — all payment obligations (including indemnity) sit under one aggregate ceiling; indemnity with its own cap — indemnity bears a separate cap (usually higher than the general cap) because the risk nature differs; and certain indemnities uncapped — only for “fundamental” obligations such as wilful fraud or confidentiality breaches. Any model works, as long as it is stated in writing.

Indemnity in contracts with foreign elements

For FDI enterprises, indemnity is often drafted on the parent company’s template (English or Singapore law) then applied in Vietnam — three points to note:

First, governing law. If the contract chooses foreign law, indemnity is interpreted under that law; if Vietnamese law applies, the dispute resolution body classifies the clause by its nature, not its label — as analysed in section 1.

Second, language. Bilingual contracts must ensure “indemnity” is translated and defined consistently. Avoid the Vietnamese version translating “indemnity” with the same word the English version reserves for “damages” — that mismatch can be exploited in disputes.

Third, enforceability. An uncapped indemnity drafted per common-law practice may face enforcement difficulties in Vietnam if deemed unreasonable. Have a Vietnamese lawyer review foreign templates before signing.

Common mistakes in drafting indemnity clauses

Five recurring mistakes: a one-sentence generic clause (“the breaching party shall indemnify all damage”) — no triggers, scope, or limits; forgotten exclusions — unstated whether indirect damage and lost profits are indemnifiable; no cap or threshold — the indemnifier bears unlimited risk while the indemnified party gets bogged down in trivial disputes; no procedure — when events occur, the parties argue over notice deadlines and who controls third-party claim defence; and conflict with the liability cap — as analysed in section 5.

The golden rule: a good indemnity clause is one both parties understand identically on “when, what, how much, for how long”. A contract review before signing can catch most of these gaps.

How FLAT LAW FIRM helps

FLAT LAW FIRM advises on indemnity clause structures suited to each transaction type and the enterprise’s risk appetite:

• Drafting and reviewing indemnity clauses: triggers, scope, exclusions, caps, thresholds, survival periods;
• Designing indemnity in sync with liability caps, breach penalties, and damages;
• Advising on M&A-specific indemnity: tax indemnity, escrow, known-risk mechanisms;
• Reviewing foreign-law templates and adapting them to Vietnamese law;
• Representing clients in disputes arising from indemnity clauses.

If your enterprise is negotiating a high-value contract, contact FLAT LAW FIRM for advice on the right structure.

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