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What is a letter of indemnity in export? Know the purpose and working
A legally binding contract that ensures specific terms will be fulfilled in a deal between two parties involved in international trade. Learn more in the blog.
In international trade, contracting parties need to agree to specific conditions to ensure smooth transactions. To safeguard against potential breaches of agreement, third-party organizations such as banks or insurance companies often step in to guarantee payments. This assurance comes in the form of a letter of indemnity (LOI), a legally binding contract that ensures the fulfillment of agreed-upon terms. In this blog post, we will discuss what an LOI is, and its purpose, format, and role in exports.
What is a letter of indemnity (LOI)?
A letter of indemnity (LOI) is a legal agreement that protects one or both parties in a contract from losses if the other party fails to meet their obligations. This protection is provided by a third party, like banks or insurance companies. The third party insures the agreement, taking on responsibility for any losses or damages, so the parties involved are shielded from liability. LOIs are used in many business transactions, including global trade, loans, and corporate mergers.1
Purpose of letter of indemnity (LOI)
A letter of indemnity serves the following key purposes in international trade:
● Protects against financial loss: An LOI ensures that one or both parties in a contract are protected from financial losses if the other party fails to meet their obligations.
● Builds trust and confidence: By involving a third party an LOI helps build trust and confidence between the contracting parties, as they know there is a safety net in place.
● Reduces liability risks: An LOI reduces the risk of liability for the parties involved, as the third party assumes responsibility for any potential losses or damages.
● Protects against financial loss: An LOI ensures that one or both parties in a contract are protected from financial losses if the other party fails to meet their obligations.
● Builds trust and confidence: By involving a third party an LOI helps build trust and confidence between the contracting parties, as they know there is a safety net in place.
● Reduces liability risks: An LOI reduces the risk of liability for the parties involved, as the third party assumes responsibility for any potential losses or damages.
Who issues a letter of indemnity?
Typically, third-party organizations such as banks or insurance firms issue LOIs, promising to reimburse one party financially in the event that the other party defaults on its duties.
How to obtain a letter of indemnity?
A financial institution typically drafts and prepares LOIs. The party that guarantees a transaction can be either an insurance company or a bank. Traders can obtain letters of indemnity from banks, insurance companies, or other providers.2
How does a letter of indemnity (LOI) work?
When two parties enter a shipping contract, each has specific obligations to fulfill. If one party breaches the contract or its terms, the other party may suffer losses, such as financial loss or damaged goods. An LOI acts as a protection mechanism, ensuring that the innocent party isn't held responsible for these losses. For instance, in international shipping, the carrier might issue an LOI to the shipper to safeguard the consignment from potential damage, especially on risky routes.
If an accident occurs, the carrier isn’t held responsible for any harm to the goods. This way, both parties can proceed with confidence, knowing they are protected against potential risks.
If an accident occurs, the carrier isn’t held responsible for any harm to the goods. This way, both parties can proceed with confidence, knowing they are protected against potential risks.
Letter of indemnity (LOI) example
Imagine that Company A is shipping valuable jewellery from India to the United States. The shipment route passes through a region known for rough seas, increasing the risk of damage to the cargo. To mitigate this risk, the parties obtain a letter of indemnity which ensures that if the jewellery is damaged during transit, the carrier will not be held liable for losses.
Instead, the third-party insurer who provided the LOI will cover the financial damages. This arrangement allows both parties to proceed with the shipment — Company A is confident that any potential losses will be covered, and the carrier is reassured that it will be protected from liability.
Instead, the third-party insurer who provided the LOI will cover the financial damages. This arrangement allows both parties to proceed with the shipment — Company A is confident that any potential losses will be covered, and the carrier is reassured that it will be protected from liability.
How to fill a letter of indemnity?
Some essential points that need to be filled in a letter of indemnity are as follows:
● The parties' names and addresses.
● The third party's name and association.
● A description of the goods being sent or the purpose of the LOI.
● The date the contract was signed, and the signatures of the parties.3
● The parties' names and addresses.
● The third party's name and association.
● A description of the goods being sent or the purpose of the LOI.
● The date the contract was signed, and the signatures of the parties.3
How to write a letter of indemnity?
The following process outlines some of the key steps involved in writing a letter of indemnity:
Step 1:
Begin by writing the date of execution at the top of the document. Clearly label the document as a "Letter of Indemnity" for clarity.
Step 2:
Include a clause stating that the agreement is subject to the laws of the specific state where legal actions related to the agreement would occur.
Step 3:
Start by acknowledging the existing contract with the other party.
Step 4:
Describe potential circumstances that could prevent the fulfillment of the contract.
Step 5:
Outline specific plans to prevent losses for involved parties. Offer alternative solutions whenever possible.4
Letter of indemnity (LOI) and bill of lading (BOL)
A bill of lading is a legal document outlining the terms for transporting goods between the shipper and the carrier. It serves as a receipt and a record of the items shipped, ensuring they are tracked throughout the transportation process.
In contrast, a letter of indemnity (LOI) is a legal agreement that protects one or both parties in a contract from losses if the other party fails to meet their obligations. This protection, provided by third parties like banks or insurance companies, ensures financial security and mitigates risks. While a bill of lading tracks shipments, an LOI offers financial protection.
In contrast, a letter of indemnity (LOI) is a legal agreement that protects one or both parties in a contract from losses if the other party fails to meet their obligations. This protection, provided by third parties like banks or insurance companies, ensures financial security and mitigates risks. While a bill of lading tracks shipments, an LOI offers financial protection.
Letter of indemnity v/s bank guarantee
A bank guarantee is a promise where a guarantor (usually a bank) agrees to be responsible for a client’s obligations to another party if the client fails to fulfill them.
In contrast, a letter of indemnity (LOI) is a promise where an insurer assumes liability for losses or damages caused by the insured party and agrees to cover the costs. Unlike a bank guarantee, an indemnity creates a primary obligation, meaning the insurer must compensate for losses independently of the borrower's performance.5
In contrast, a letter of indemnity (LOI) is a promise where an insurer assumes liability for losses or damages caused by the insured party and agrees to cover the costs. Unlike a bank guarantee, an indemnity creates a primary obligation, meaning the insurer must compensate for losses independently of the borrower's performance.5
Conclusion
In conclusion, a letter of indemnity (LOI) is a crucial tool in international trade, providing protection against financial losses and liability risks. It ensures that all parties involved can proceed with transactions confidently, knowing they are safeguarded. Understanding the distinction between LOIs and other legal instruments like bills of lading and bank guarantees is essential for effective risk management.
For e-commerce exporters, LOIs are especially relevant as they help mitigate risks in an increasingly complex and globalized market. For more assistance on compliance, documentation, or other aspects of e-commerce exports, Indian exporters can leverage the tools and services offered by e-commerce export programs like Amazon Global Selling.
For e-commerce exporters, LOIs are especially relevant as they help mitigate risks in an increasingly complex and globalized market. For more assistance on compliance, documentation, or other aspects of e-commerce exports, Indian exporters can leverage the tools and services offered by e-commerce export programs like Amazon Global Selling.
Amazon Global Selling: Easy e-commerce exports and hassle-free shipping
If you are a business owner and you want to sell your products to the world, Amazon Global Selling enables you to list and sell ‘Made in India’ products on 18 Amazon global marketplaces. As an e-commerce exports program, Amazon Global Selling provides support and guidance at every step of your export journey, connecting you to Amazon’s Service Provider Network for tailored compliance, payments, and logistics support.
Registered sellers can choose to ship their products by themselves through Merchant Fulfilled Network (MFN) or they can opt for Fulfillment by Amazon (FBA) and outsource order fulfillment to Amazon including packing, storage, delivery, and returns. Amazon Global Selling simplifies the process of international shipping to the world, helping businesses navigate customs and reach a vast audience.
Registered sellers can choose to ship their products by themselves through Merchant Fulfilled Network (MFN) or they can opt for Fulfillment by Amazon (FBA) and outsource order fulfillment to Amazon including packing, storage, delivery, and returns. Amazon Global Selling simplifies the process of international shipping to the world, helping businesses navigate customs and reach a vast audience.
Frequently Asked Questions
What is a letter of indemnity bond?
A letter of indemnity bond is a financial guarantee that protects against potential losses or damages if contractual obligations are not met. It involves a third party, typically a bank or insurer, ensuring compensation for any incurred losses.
Why is a letter of indemnity required?
A letter of indemnity is required in international trade to protect parties from financial losses if the other party fails to fulfill their contractual obligations. It provides assurance and mitigates risks, ensuring smooth and secure international transactions.
What are the risks of a letter of indemnity?
A letter of indemnity (LOI) is designed to manage risks, but using one can also introduce certain risks. For an LOI to be legally enforceable, it must be properly executed, clearly defining what is covered and specifying the obligations of all parties. The effectiveness and enforceability of an LOI depend on its precise wording and the jurisdiction in which it's executed.
What is the difference between a letter of undertaking and a letter of indemnity?
A letter of undertaking (LOU) is a written commitment by a financial institution to meet a client's obligation to a trading partner if the client defaults on payment. In contrast, a letter of indemnity (LOI) is a legal agreement that protects one or both parties in a contract from losses if the other party fails to fulfill their obligations, with protection provided by a third party like banks or insurance companies.
What is a letter of indemnity insurance?
Letter of indemnity insurance is a policy that protects against financial losses if contract terms are not fulfilled, with an insurer guaranteeing compensation for any losses incurred.
Who signs a letter of indemnity?
All LOIs must be signed by a witness. However, when dealing with costly assets, it is better to have a banker, insurance carrier representative, or other professional sign the document rather than just a witness.6
Published on July 10, 2024.
Sources:
1. https://cleartax.in/glossary/letter-of-indemnity/
2. https://www.investopedia.com/terms/l/letterofindemnity.asp#toc-who-can-issue-an-loi
3. https://www.credlix.com/blogs/all-about-letter-of-indemnity-its-meaning-process-sample-format-and-more
4. https://www.thebalancemoney.com/how-to-write-a-letter-of-indemnity-4169303#toc-a-certificate-of-indemnity-example
5. https://www.tradefinanceglobal.com/legal/guarantees-indemnities/
6. https://www.credlix.com/blogs/all-about-letter-of-indemnity-its-meaning-process-sample-format-and-more
Sources:
1. https://cleartax.in/glossary/letter-of-indemnity/
2. https://www.investopedia.com/terms/l/letterofindemnity.asp#toc-who-can-issue-an-loi
3. https://www.credlix.com/blogs/all-about-letter-of-indemnity-its-meaning-process-sample-format-and-more
4. https://www.thebalancemoney.com/how-to-write-a-letter-of-indemnity-4169303#toc-a-certificate-of-indemnity-example
5. https://www.tradefinanceglobal.com/legal/guarantees-indemnities/
6. https://www.credlix.com/blogs/all-about-letter-of-indemnity-its-meaning-process-sample-format-and-more
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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
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