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This article is written by Hemal Shah, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

Indemnity and damages are two closely related concepts in terms of transactions and settlements, but they bear entirely separate principles and applications. They are options that can be claimed for violation of the contract by the aggrieved party.[1] To understand exactly what an indemnity and damages cover, let’s have a thorough discussion on what a commercial agreement consists of and the transactions that are incurred in order to capture what indemnity shall look in different agreement.

Usually, commercial agreements are a contract written between corporate organisations or agreements controlling the business arrangement between parties involved in or engaged in business with each other.[2] Examples of the Commercial Agreement include the following but not limiting such agreements:

  • Licensing and Franchising Agreement
  • Loan and Finance Agreement (inclusive of Intercompany loan agreement)
  • Supply and Distribution Agreement (Order fulfilment Agreement)
  • Shareholders and Joint-Venture Agreements

“In old English law, Indemnity was defined as a pledge to save a harmless person from the effects of an act. Such a pledge may be expressed or suggested by the conditions of the situation.” It is pertinent to mention here that it gave a very broad scope of indemnity and thus any party could levy charges even under malicious conditions. In layman terms, there are list of circumstances in failure of which the other party is required to pay compensation in order to cover the losses incurred by other party.[3]

Indemnity and damages – are they the same

Indemnity is an obligation to make good any financial loss, damage or liability that may be incurred by harm. Section 124 of the Indian Contract Act, 1872 (hereinafter referred to as the Act”), which specifies that a contract by which one party agrees to save the other from the loss caused to him by the actions of the promisor himself or by the conduct of some other person.” Therefore, Section 125 provides the promising party with a redress in a restitution contract within the limits of his jurisdiction.[4]

Damage is granted pursuant to Section 74 of the Act which states that – When a contract has been infringed, whether a sum is stated in the contract as the amount to be paid in the event of such violation, or whether the contract includes some other clause by way of penalty, the party complaining about the infringement shall be entitled to obtain from the party, whether or not any damage or injury has been found to have been incurred thereby.

Furthermore, Section 73 of the Act provided that when a contract has been infringed, the party suffering such violation is entitled to claim compensation from the party infringing the contract for any harm or injury incurred to it by the infringement which, inevitably, occurred in the ordinary course of the infringement or which the parties knew would be likely to result from the infringement when the contract was concluded. In addition, liability for any distant and indirect loss or harm incurred as a result of the violation shall not be given.

Basic demarcation between indemnity and damages

  • Indemnity Claim may be made before breach of contract, while the claim for damages may only be brought after breach of contract.
  • Section 73 of the Act creates a duty on the plaintiffs to minimise their damages and states that they cannot seek injuries arising from their failure to mitigate them, while Section 124 of the Act does not position the indemnified party under any such requirement.
  • Indemnity may be sought for the harm resulting from the proceedings brought by a third party to the contract, while liability may be claimed solely for the loss resulting from the conduct of the parties after the violation of the contract.
  • According to the indemnity provision, liability can be sought for injuries incurred by a lawsuit brought by a third party which may not actually arise from a breach of contract, while compensation may be claimed only if a party to the contract has violated the contract.
  • The key concept behind the rule of indemnity is to bring a person back in the position he was before the damage happened. Therefore, if a party is paid, he will never make a benefit or loss from it, he will be returned to his original position, while in the case of punitive losses, the compensation may be awarded more than or less than the actual loss incurred or the actual loss occurred.[5]

What should an ideal clause of indemnity for commercial agreement contain

  • Evaluate whether there is a need for an allowance at all or not. Is it supposed to give rise to greater immunity for liability than would usually be required for breach of guarantee or breach of contract? If not, there is no need for compensation.
  • Pay particular attention to the drafting of the compensation and do not regard it as a provision of the “boilerplate”.
  • If the indemnifier is you, when entering into an indemnity clause:
  1. Consider the imposition of an express responsibility to reduce damages, and
  2. Limit the period within which lawsuits under the indemnity provision may be brought. 
  • If the indemnified party is you:
  1. Avoid drafting the clause as it risks achieving the impact of being read down to exclude even some expected liabilities, and
  2. In addition, consider the inclusion of compensation for breach of contract and negligence.
  • Ensure that an alternate remedy is also provided other than the indemnity. Both the parties should take an equal effort to downsize the indemnity and the losses attached to the same for the farewell of the parties.

Ideal clause

Note- The reader is requested to take appropriate legal guidance before framing such clauses and under no circumstances, shall this clause be termed as legal advice in any form or manner and the author shall not either directly or indirectly be liable for any loss caused.

Party A agrees to defend, indemnify, and hold Party B and its Directors, staff, employees, officers and agents harmless and indemnified from and against all claims, suits, demands, liabilities, costs, charges, damages, penalties and expenses, including reasonable attorneys’ costs and fees which Party may suffer on account of (a) any breach, act or omission by Party A its staff and employees and/or arises from the provision, quality and/or supply of the Products, (b) any non-compliance provisions of any Applicable Laws, (c) death, injury, loss or damage to any person or loss or damage to property resulting or claimed to result in whole or in part, (d) claims made by employees or representatives of Party A.

The indemnification rights of Party B under this Agreement are independent of, and in addition to, such other rights and remedies as Party B may have under the Applicable Laws or in equity or otherwise, including the right to seek specific performance, rescission, restitution or other injunctive relief, none of which rights or remedies shall be affected or diminished hereby.

When does the commencement of liability arise

In general, it seems like, contrary to the description provided in section 124, an indemnity holder cannot keep the indemnifier responsible unless a real loss has been incurred. In situations where the loss is inevitable and he is not in the position to absorb the loss, this is a great drawback for the indemnity holder.

Bombay’s high court noted in the celebrated case of Gajanan Moreshwar vs. Moreshwar Madan, AIR 1942[6], that the indemnity contract had very little meaning if the holder of the indemnity did not impose his indemnity until the loss was actually paid. He had to wait for the verdict and pay the costs in advance before suing the indemnifier if a suit was filed against him. He would not be able to afford the costs for the verdict and may not sue the compensator.

Can remote or indirect losses be covered

The Contract Act only requires, under a lawsuit for damages, to demand liability for any injury ‘which the parties knew would be likely to occur from the violation of the contract when they made the contract’ at the time of entering into the contract, which is generally referred to as the concept of consideration of damages between the parties. Fair predictability is known to be the extreme probability of failure occurrence and is also the measure used for damages.

Furthermore, the damages sought must be fair and thus, damages for loss of benefit or opportunity costs would not normally be sustainable. In fact, Section 73 specifies that, “Compensation shall not be provided for any distant and indirect injury or harm caused as a result of the violation.” Thus any demand for remote or indirect damages is expressly exempt.[7]

For an indemnity claim, no such limitation applies. Section 124 of the Contract Act defines an indemnity contract as a contract by which one party promises to save the other from the loss caused to him by the behaviour of the promisor himself or any other person. A claim for damages is subject to the ordinary rules of remoteness discussed, whereas a claim for compensation is not subjugated. Consequential, distant, indirect and third-party damages may however, all be asserted by the indemnified party unless the indemnity provision explicitly prohibits them. [8]

Important questions to ponder before framing the clause

  • Is the benefit in favour of one party to the deal, or is the compensation mutual?
  • Is the responsibility to pay applied beyond the parties to the contract? The associated parties of the indemnified faction, for instance?
  • Are there any liability exemptions?
  • Are there any liability restrictions, and are those constraints appropriate?
  • Does the indemnified party have to pay damages and obligations in the indemnity until requesting recourse?
  • Is there a time limit for all of the indemnities to be exercised (particularly in a share sale agreement)?[9]
  • Will your benefits protect you under the reimbursement clause for the threats that have been transferred to you?

Conclusion

It might seem burdensome to prepare a simple and successful indemnity provision and consider similar issues. The implications of a badly written indemnity clause, however are dire, particularly where the balance of the clause does not level the field of play. A well-drafted compensation provision lets parties escape contractual conflicts and the expenses involved with the court’s understanding of the nature and responsibility of the indemnity.

References

[1] https://www.mondaq.com/india/contracts-and-commercial-law/664102/indemnity-vs-damages#:~:text=Indemnity%20can%20be%20claimed%20for,parties%20upon%20breach%20of%20contract.&text=The%20main%20principle%20behind%20indemnity,was%20before%20the%20loss%20occurred

[2] https://centralawyers.ca/practice-areas/commercial-law/commercial-agreements/

[3] http://law.uok.edu.in/Files/5ce6c765-c013-446c-b6ac-b9de496f8751/Custom/ C not ra ct%20of%20%20indemnity%20and%20Guarantee%20(2)%20(3%20files%20merged).pdf

[4] https://www.mondaq.com/india/contracts-and-commercial-law/664102/indemnity-vs-damages#:~:text=Indemnity%20can%20be%20claimed%20for,parties%20upon%20breach%20of%20contract.&text=The%20main%20principle%20behind%20indemnity,was%20before%20the%20loss%20occurred

[5] https://www.mondaq.com/india/contracts-and-commercial-law/664102/indemnity-vs-damages#:~:text=Indemnity%20can%20be%20claimed%20for,parties%20upon%20breach%20of%20contract.&text=The%20main%20principle%20behind%20indemnity,was%20before%20the%20loss%20occurred

[6] http://law.uok.edu.in/Files/5ce6c765-c013-446c-b6ac-b9de496f8751/Custom/C o ntr a ct%20of%20%20indemnity%20and%20Guarantee%20(2)%20(3%20files%20merged).pdf

[7] https://www.mondaq.com/india/contracts-and-commercial-law/482908/revisiting-the-indemnity-vs-damages-debate

[8] https://www.mondaq.com/india/contracts-and-commercial-law/482908/revisiting-the-indemnity-vs-damages-debate

[9] https://www.mondaq.com/australia/contracts-and-commercial-law/535580/there39s-an-indemnity-clause-in-the-draft-contract-what-are-you-going-to-do-about-it


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