indemnity

In this article, Gautam Kumar Swain who is currently pursuing M.A. IN BUSINESS LAWS, from NUJS, Kolkata, discusses Law related to Indemnity in India.

The Phrase Indemnity means “Security against loss or damages”.

Section 124 of the Indian Contract Act’1872 defines Contract of Indemnity as a contract by which one party guarantees to save the other person from loss caused to him by the action of the guarantor himself, or by the action of any other person.

For, e.g. X can agree to stand as a guarantor for his son Y, a student so that if Y is unable to pay his monthly expenses and rent to Z(a PG); X will be required to pay on behalf of Y, thereby compensating for the losses that Z acquired because of action of Y.

The Example of an indemnity clause for the above consideration would read as follows: “Mr. X agrees to indemnify and hold harmless Z against loss or threatened loss or expense because of the liability or potential responsibility of Z for arising out of any claims for damages.”

Nature of Contract of Indemnity

Indemnity clauses are very common in accords between dwellers and property owners. Dwellers agree to indemnify the property owners from costs or damages associated with being injured on the property while the property owners take the responsibility to anything which could probably be hazardous or troubling. For e.g, the property owner stands indemnified from damages if the dweller gets injured in the property accidentally but if some part of the property is dangerous and is quite probable to cause some damages and injuries to the occupant and the owner is intimated time to time about the same; a minor indemnity clause will not prevent the dweller from suing if such disrepair caused the mishap.

Definition of a contract of indemnity sets out both express promises as well as implied promises. Indian Contract Act’1872 bargains with cases of implied indemnity under Sec. 69, Sec. 145 and Sec. 222.

Some special cases of implied indemnity

  1. Under Sec.69 if a party who is interested in payment of money which another is destined by law to pay and therefore himself pays it, he is designated to be indemnified.
  2. Under Sec.145 a party is provided with the right of the surety to claim indemnity from the principal defaulter for all sums which he has lawfully paid towards the guarantee.
  3. Section 222 provides for liability of the principal to indemnify the agent in respect of all amounts paid by him during the legitimate exercise of his power.

Judicial pronouncement on Indemnity

Implied Indemnity was identified in the case of ‘SECRETARY OF STATE vs. THE BANK OF INDIA’ [1938] where an agent presented a government promissory note in his custody to a bank with a false presentation. The bank in good trust put into use the promissory note for a refurbished promissory note which was issued from the Public Debt Office. In the interim time, the real owner of the note sued the Secretary of State for conversion. The Secretary of State, in turn, prosecuted the bank on the basis of implied indemnity where it was held that the express indemnity clause is not necessary for face of implied right to indemnity which is beforehand existing under the Indian Laws.

A contract of indemnity recognizes the parties, and it characterizes the types of losses or damages covered and explain whether legal expenses in the filing of the suit or contesting the suit are included or not. Generally, the contract also specifies the “triggering event”; happening of which will make the indemnifier responsible. The “triggering events” are defined with aids of terms like “arise out of”, “in connection with”, or “occasioned by”, “acts or omissions” or “negligence”.

A Contract of Indemnity is required because a party may not be able to command all visible features of the performance of a promise. The party can be sued for the actions of another where the circumstances of performance were out of his authority and control.

Indemnity is considered as a sub-class of compensation and Contract of Indemnity as a class of contracts. The responsibility to indemnify is a willing responsibility taken by the indemnifier.

The contract of indemnity is an actionable claim provided it is not against public policy or unlawful to be valid.  A right of indemnity lies where one party is required to make good certain losses experienced by the other party. No third person or an intruder to the agreement of indemnity cannot bring legal charges against the indemnified due to the standard of secrecy of contract as settled in the case of NATIONAL PETROLEUM COMPANY vs. POPAT LAL by the Bombay High Court.

Mostly, a contract of insurance is not treated as a contract of indemnity in India. But agreements of marine insurance, fire insurance or motor insurance are regarded to be contracts of indemnity as in a life insurance, the agreement offers a particular sum of money upon the death of policy holder but where a policy is taken by a creditor on the principal debtor, he becomes entitled to a precise amount of money.

IN ‘GAJAN MORESHWAR vs. MORESHWAR MADAN’ 1942 case G.Moreshwar got a piece of land in then Bombay at lease for a long period. He transferred the lease to M.Madan  for a limited period. M.Modan started development over the above-mentioned plot and ordered his supplies from K D Mohan Das. When Mohandas asked for the payment for the material he provided, the accused could not pay up. Upon request of M Madan, G Moreshwar prepared a mortgage deed in favour of K.D. Mohandas. The Interest rate was agreed upon, and G. Moreshwar put a charge over his possessions. A date was pre-decided for the return of principal amount. M. Madan had decided to repay the principal amount along with interest and to get the mortgage deed released before a particular date. But M. Madan as per his assurance did not pay anything to K.D. Mohan Das, and G. Moreshwar had to pay some interest. When after several requests and intimations, M. Madan did not pay the principal amount along with interest and also didn’t get the mortgage deed released, G. Moreshwar legally prosecuted M. Madan for indemnity. The Privy Council held that if indemnity holder has incurred responsibility and the responsibility itself is absolute and without limits, the indemnity holder can ask the indemnifier to take care of the liability and pay it off. Thus, G. Moreshwar was designated to be indemnified by M. Madan against all debt under the loan agreement and deed of charge.

Legitimacy of Indemnity Agreements

A contract of indemnity is one of the varieties of contracts. The principles appropriate to contract in general are also pertinent to such contracts so that rules like free approval or consent, the legality of object, etc. are equally relevant. As in the case of general agreement consent to an agreement shouldn’t be by coercion, fraud, misrepresentation otherwise the contract will voidable at the option of the party whose consent was so caused; the same applies to contract of indemnity also. As per the need of the Contract Act, the element or object of the agreement must be legitimate.

Consequential or remote/indirect losses coverage under Indemnity

A demand for damages under the Contract Act only allows looking for compensation for any loss or damages ‘which the parties knew; when they made the contract, to be likely to result from rupture or breach of it’ at the time of formation of contract; which is usually termed as the ‘Principle of Contemplation of Damages’ between the parties. Reasonable foreseeability is deduced as the genuine possibility of happening of loss and is frequently used for the test for damages or losses. Additionally, the damages claimed should be moderate, and thus damages may not be tenable for loss of profit or opportunity costs.

But, an indemnity claim is not bounded by such limits. Section 124 of the Indian Contract Act specifies that a request for damages or losses is accountable to the ordinary rules of remoteness mentioned above, but a claim for indemnity is not subjected to same rules. So all consequential, remote, indirect and third party losses can be claimed by the indemnified party until and unless notably excluded from the indemnity clause.

Fundamental essentials of Contract of Indemnity

  • It is an absolute promise to reimburse for defined loss or injury used to ensure that an aggrieved party has a precise remedy to correct bugs or defects in goods or services delivered under the Contract.
  • It is an assurance to make restitution for or safeguard against damage, loss or injury.
  • Broadly it includes all contracts of protection, security, guarantee, etc. It is not a secondary but an independent contract.
  • It is a tool for assigning risks contingent responsibility.
  • Indemnity clauses must be clear, to the point, wherever possible it should impose the circumstances under which the compensation will arise. It should be considered in light of any expulsion of liability clauses found anywhere in the agreement and should state what damages will be payable in the occurrence of the clause being favorably conjured.

Enforcement of Contract of Indemnity

  • A contract of indemnity can be invoked according to its terms like the express promise.
  • Damages, legal costs of judgement, the amount paid under the terms of the agreement are some of the claims which Indemnity holder can include in its claims.
  • A Portion of losses or injuries is the extent to which the promise has been indemnified.
  • Indemnifier should ideally be informed of the proper account.
  • There is no burden to show breach or actual losses or damages.

SITUATIONS WHEN CONTRACT OF INDEMNITY CAN BE ENFORCED

In the United Kingdom, under common law, it is necessary for an indemnity holder to first pay for the losses, injuries or damages and then claim for the indemnity. But in India, there is no clear-cut provision which states that when a contract of indemnity is implemented. There have been conflicting legal conclusions throughout. First Indian case where the right to be indemnified was identified was of OSMAL JAMAL & SONS LIMITED vs. GOPAL PURUSHOTHAM [1728]. But at present, a general agreement is formed in favor of the opinion of the equity courts. In K. BHATTACHARJEE vs. NOMO KUMAR [1899], SHYAM LAL vs. ABDUL SALAL [1931] and G. MORESHWAR vs. M. MADAN cases, it was decided that the indemnified can constrain the indemnifier to place him in a position to meet liability that may be built upon him without waiting until the indemnified has cleared the same.

Indemnity requires that the party who will be indemnified shall not at any time be called upon to pay. Therefore, the liability of the indemnifier starts the moment the loss or damages in the form of liability to the indemnified becomes absolute and without limit.

Losses or damages on the breach of contract of indemnity holder or rights of the indemnity-holder under Sec.125 of Indian Contract Act’1872 are as follows,

  • The Promisee in a contract of indemnity, acting within the capacity of his control, is designated to recover from the promisor all losses or damages which he may be constrained to pay in any suit in respect of any substance to which the promise to indemnify applies.

For e.g. if X contracts to repay or indemnify Y against the outcome of any proceedings which Z may take against Y in respect of a particular action. If Z does start legal proceedings against Y and as a result of outcome Y had to pay some damages to Z; X will be responsible for reimbursing the damages that Y had incurred in the case.

  • All costs or expenses which he may be forced to pay in any such suit if, in bringing or protecting it, he did not contradict the orders of the promisor, and acted as it would have been sensible for him to act in the absence of any contract of indemnity, or if the promisor empowered him to bring or protect the suit.
  • All sums which he may have paid under the terms of any agreements of any such suit, if the agreement was not in contradict to the orders of the promisor, and was one which it would have been sensible for the promisee to create in the absence of any contract of indemnity, or if the promisor empowered him to adjusts the suit.

Rights of Indemnifier

Rights of indemnifier were excluded from Indian Contract Act’1872. In JASWANT SINGH vs. SECTION OF STATE, it was concluded that the rights of the indemnified are akin to the rights of a surety under Section 141 where the indemnifier becomes entitled to the advantage of all securities that the creditor has against the principal debtor whether the principal debtor was apprehensive about the same or not. Where a person agrees to repay, he will, upon such compensation, be labeled to succeed to all the ways and means by which the person initially repaid might have secured himself against any loss or damages; or have arranged for compensation for his loss or damages.

Once the indemnifier pays for the losses or damages caused, he automatically steps into the shoes of indemnified and therefore, he will have all the rights with which the earliest indemnifier secured himself against loss or damage.

LIQUIDATED DAMAGES vs. CAPPED INDEMNITY CLAUSE:

Section 74 of Indian Contract Act deals with the idea of liquidated damages and states that , If a sum is mentioned in the contract as the amount to be paid in case of such breach, or if the contract holds any other clause by means of penalty, the party objecting of the breach is designated, whether or not actual damages or losses is confirmed to have been caused thereby to receive from the party who has breached the contract, a justifiable settlement or compensation not surpassing the amount so decided or as the case may be, the penalty decided for”. In such a case, there is no need of leading proof for verifying the losses or damages, unless the Court arrives at the outcome that no loss or damage are likely to occur because of such breach or the happening of such an event. In Fateh Chand vs. Balkishan Das, the Supreme Court held that in all cases where there is a need in the kind of penalty, the court has jurisdiction to award such sum only as it accepts to be fair and reasonable, but not exceeding the amount mentioned in the contract.

But a capped indemnity clause functions on a different footing as the idea of reasonability, foreseeability, and remoteness relevant to a damage claim is not relevant to judgment of an indemnity claim. Therefore, the parties are more hopeful to claim more through a capped indemnity clause rather than a liquidated damage clause.

EXCLUSIVE REMEDY INDEMNIFICATION CLAUSE WITH LIMITATION OF LIABILITY

To legally decide the extent of liability, parties can agree to limit their disclosure to a well drafted and substantially finite indemnity provision largely invulnerable from the judgment of the courts. An illustration is as follows:

  1. Exclusive Remedy Clause: It should state that “indemnity provided under this clause shall be its alone remedy in relation to the activities intended under this agreement to the exclusion of all other rights and remedies” ; and
  2. Limitation of Liability: It states that the total liability under the agreement shall be limited to the amount and conditions mentioned for the indemnity.

At present, there is no clear law that exists on above points. But as per above construct, the courts are likely to hold that damages as a remedy is ruled out and the only solution is looking for indemnity subject to the limitations set out which becomes critical in situations where an indemnified party may try to demand for losses or damages, over and above the indemnity limit on grounds of equity or reasonableness.

NEGOTIATING AN INDEMNITY CLAUSE

  • FROM AN INDEMNIFIED PARTY’S OUTLOOK
  1. It is substantial to avert usage of terms “make good” or “compensate” as the courts can depict it as covering claims only due to actual loss or damages suffered by the indemnified party and not cover situations where the liability was accrued, but no payment has been made. Therefore using the term “Hold Harmless” will cover both the cases. Also, use of term “protect from liability” guarantees that the indemnifier has and added the responsibility of duty to defend cast upon him which needs the indemnifying party to protect the indemnified against covered third-party claims and likely first party claims depending on the language included in the provision.
  2. Indemnification is a decent cure, and it should not be merely used as a sword but should also include the responsibility to protect the indemnified party. Therefore, the clause can provide that the right to defend the indemnified party by the indemnifying party shall be invoked at any time when any third party makes any claim.
  3. The term “Losses includes” should replace the term “Losses means” as all consequential, indirect and remote losses can be claimed under the indemnity clause.
  4. Terms like “result of” and “connection of” should be replaced by the term “arising out of” which is given a widespread perception by the courts.
  5. As the indemnity payments are made due to the breach of representations and promises or breach of covenants in agreement, it can be arguably stated that the indemnifying party absorbs the tax outcomes of any indemnifiable loss. Indemnity payments are assumed as other income and are subjected to 30% tax. Therefore, the indemnity payments should be made in such a way that the actual payment should equal payment due under indemnity claims plus the amount of taxes payable.
  6. It is important for an indemnity clause to be drafted in a way so that an indemnity payment claim gets automatically triggered on the issue of a claim notice. Further, it should also be stated that any late in making any claims or giving a notice does not let free the indemnifying party of such responsibility.
  7. It can be stated that in case the claim amount is conflicted by the indemnifying party and arbitration or any other method of resolving dispute as mentioned in the agreement is called upon by the indemnifying party, then the claim amount should be deposited forthright with the arbitrator which in turn only ensure that the indemnifying party has the ability to pay if a successful award is decided in favour of the indemnified party.
  8. Any wilful carelessness, breach or fraud committed by the indemnifying party can be considered to be expelled from the indemnity cap if the same is pre-decided.
  • FROM AN INDEMNIFYING PARTY’S OUTLOOK
  1. Baskets or deductibles are drafted to support an indemnifying party with a promise that it will not be troubled by impractical claims. Generally, in case of a deductible, the indemnifying party is only responsible for the amount over and excess the deductible limit whereas, in the case of a basket, the indemnifying party is liable for the full amount once the basket limit is hit.
  2. Limitations of liability clause are given intensely strict meaning since it is an excusable clause. Some of the exclusions which can be considered by the parties are as:
  3. Actual or Constructive knowledge qualifier: The indemnifying party can acknowledge forbidding claims for breach of the agreement to the magnitude the facts, matters, information or conditions relating to the claim is known to the indemnified party.
  4. Net Financial Benefit: The indemnifying party can consider etching out a specific exclusion that it will not be responsible for any net quantifiable financial benefit that could arise to the indemnified party from any loss or damages suffered.
  5. Contingent Liability exclusion: It should be clearly stated that the indemnifying party will not be responsible in respect of any liability which is contingent unless such contingent liability becomes due and payable.
  6. As the indemnity is a continuity obligation, it should be clearly mentioned that the indemnified party is not designated to recover more than once in respect of the same matter or the same event which has promoted the loss. It should also be stated that the indemnifying party will not be liable in respect of any claim to the extent such losses or damages are covered by a policy of insurance or can be recoverable from a third person.
  7. It can be mentioned that the indemnifying party shall not be held responsible in respect of any claim if proper allowance, provisions or reserve is made in the accounts.
  8. Unless precisely mentioned in the indemnity clause, there shouldn’t be any particular responsibility cast upon the indemnified party to diminish losses. Therefore, the indemnifying party can discuss and provide for a duty to reduce in the indemnity clause.
  9. It is recommended to include “limitation of remedy” clause which takes into its extent both the limitation of liability and exclusive remedy clause and leaves no scope for any uncertainty in interpretation as contracts have limitation of liability clauses which simply limit the liability of the indemnifier; but doesn’t rule out other legal solution to be followed against the indemnified.
  10. Survival clause should be tailor made so that it can survive the termination of the agreement.

CONCLUSION

Indemnity is a legal discharge from the penalties or liabilities incurred by any course of action. In simpler words, indemnity needs that one party should indemnify the other if certain costs mentioned in the contract of indemnity are acquired by another party.  For example, car rental companies lay down that the person hiring the car will be responsible for the damage or losses caused to the car because of reckless or negligible driving by the person himself and he or she will have to indemnify the car rental company.

Recently, indemnity contracts are being executed quite frequently in the IT industry. There are some conditions or situations in which continuation of an indemnity does make a meaningful change for some whereas for other it does make little changes or no changes at all. A new concept known as “Indemnity Lottery” can be found in the law of contract that states that in civil cases of indemnity, results can never be predicted.

A simple indemnity clause can never be an answer to liability issues. The law leans disfavour ably towards for those who try to prevent liability or look for dispensation from liability for their actions. The fundamental reason is that a careless party should not be able to completely shift all claim and damages made against him to another, non-negligent party. For e.g. A ticket to an amusement park claims that a person entering into park can’t hold management responsible for any accident of his/her due to malfunctioning of rides or any other events. But seldom, such a defense works in the court of law because it is not based on a contract.

References:

  1. Kanwarn.wordpress.com
  2. www.nisithdesai.com
  3. www.lawteacher.net
  4. www.legalservicesindia.com
  5. Wikipedia

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1 COMMENT

  1. Amazed at your concise explanation on this little discussed topic. By the way you have helped 7897 people until now..Kudos to that!!! It was extremely helpful in my understanding.
    Detailed and precise!
    Thank you.
    Shahzad Quadri
    Advocate.
    Legal Advisor : Legalpreneur

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