Buying a Franchise: Limit Your Indemnity Obligations in the Contract

Before buying a franchise, check any clause requiring you to indemnify the franchisor against claims brought by others. The wording may be brief, but its impact can extend well beyond the cost of opening an outlet. In a franchise relationship, responsibility should reflect what caused the problem and what each party controls, rather than automatically placing every risk on the outlet owner.

1. Identify the obligations hidden in the clause

An indemnity clause may appear under headings such as “liability”, “release from claims” or “legal protection”. It may require the franchisee to pay losses, legal fees and settlements relating to the outlet’s activities.

Distinguish these obligations from penalties for breach of contract. Penalties usually relate to a specific breach of the agreement. By contrast, an obligation to indemnify against third-party claims may arise when a customer or another party brings a claim, even before it is clear who is actually at fault.

When reading the draft contract, highlight four points:

• What triggers the obligation: must you be at fault, or is a claim connected with the outlet enough?
• Who is protected: only the franchisor, or also its affiliated companies, directors and suppliers?
• Which costs are covered: do they include direct losses, legal defence costs and settlement payments?
• When payment is due: after liability has been established, or as soon as the franchisor requests payment?

Be wary of wording such as “all losses arising from any cause whatsoever”. Ask for written examples of how it would apply, rather than relying on verbal assurances about the clause’s scope.

2. Separate the outlet’s mistakes from the franchisor’s

Test the clause against plausible incidents in your chosen business. For example, a customer might complain about an unsafe product. The cause could be incorrect storage at the outlet, a defective product from a designated supplier, or handling instructions that prove inadequate.

These three situations should not be treated identically when allocating contractual liability. Draw up a simple list showing the incident, the party controlling the process, the evidence needed and the party you propose should bear the costs.

If the problem stems from an outlet employee’s actions, your liability needs to be assessed against the facts and applicable law. Conversely, ask for losses caused by the franchisor’s own mistakes to be excluded from your obligation to indemnify it. Where both parties contributed to the problem, propose allocating liability according to each party’s proven share of fault.

Also check any promotional materials you are required to use. If the franchisor drafts claims about a product’s benefits, who checks their accuracy and handles claims arising from that content? Do not agree that using official materials automatically makes the outlet responsible for every consequence.

The allocation of liability in the contract does not automatically remove customers’ rights. Customers may still have rights under applicable law. Clauses between the franchise parties primarily determine how the ultimate financial burden is shared between them.

3. Negotiate claims-handling procedures and cost limits

The scale of the risk depends not only on who pays, but also on who makes decisions. A clause allowing the franchisor to appoint legal advisers and approve settlements without involving you can create costs that are difficult to control.

Propose a written procedure covering:

• Notification of claims within an agreed period, accompanied by supporting documents.
• An opportunity for both parties to examine the facts and preserve evidence.
• Agreement on who leads the defence and how legal advisers are selected.
• Consent before any settlement that imposes costs on the other party or admits fault on its behalf.
• A review of whether costs are reasonable before reimbursement is requested.

Next, discuss a financial cap or a method for determining the limit of liability. Do not assume there is a standard cap that automatically applies to every franchise contract. The amount needs to be negotiated in light of the business risks and reviewed by a legal adviser, including consideration of any liabilities that cannot legally be limited.

Also check whether the obligations continue after the contract ends. Ask for clarity on the events covered, the notification process and how the clause relates to statutory time limits for bringing claims. Avoid obligations with no clear scope in terms of time or events.

4. Use the legal framework to review the contract

Indonesia specifically regulates franchising through Government Regulation No. 35 of 2024 on Franchising, which replaced Government Regulation No. 42 of 2007. This framework governs franchise operations, including written agreements and the provision of an offering prospectus at least 14 calendar days before the agreement is signed.

These requirements do not guarantee that every indemnity provision in a contract is balanced. The validity of an agreement also depends on general contract law provisions, including Article 1320 of the Indonesian Civil Code, which sets out the conditions for a valid agreement.

Ask a legal adviser to review the indemnity clause alongside the provisions on limitation of liability and claims handling. Make sure the negotiated terms appear in the document you sign, not merely in an explanatory email from a salesperson.

Practical step: before committing, test one example involving an outlet mistake, one involving a franchisor mistake and one involving shared fault. Do not sign until it is clear who handles the claim, who approves the costs and who ultimately pays.