This article is written by Prabha Dabral from IMS Unison University, Dehradun. The article discusses the concept of indemnity in detail. It revolves around the meaning, types, and contents of the letter of indemnity and its format, and other details.
It has been published by Rachit Garg.
Table of Contents
Introduction
Let’s say you have a construction business. You enter into a contract with party ‘A’ to construct an office building on his plot. You have also taken the deposit for it. After some time, you realise that the construction could not be completed due to the absence of enough workers. In this case, ‘A’ is clearly at no fault. He has fulfilled his part of the bargain by submitting the deposit to you. So here comes the concept of indemnity, through which ‘A’s rights can be protected.
You can write a contract of indemnity assuring ‘A’ that he will not suffer any loss that may occur or arise out of the operations of the business. You will either return the deposit or find somebody else to do the work. The letter of indemnity here plays a part in reassuring party ‘A’ that, in case he suffers any loss, the liability will be that of the construction business. It means that he will be compensated because they could not fulfil the terms of the contract.
In the above scenario, the provision that protects ‘A’s rights is known as the “letter of indemnity”. And in this article, you will learn more about the concept.
What is a letter of indemnity
Merriam Webster defines the term ‘indemnity’ as a protection against a loss, damage, or injury. This concept is explained under Section 124 of the Indian Contract Act, 1872. It says that a contract by which a party promises to compensate the other party for any loss or damage incurred during the transaction is referred to as a contract of indemnity.
The best example that clearly explains this is an insurance policy. Here, the insurance company creates a contract with its clients stating that they will bear all the losses incurred by the client in relation to a specific situation. Car insurance is one of them.
In simple terms, a letter of indemnity (or LOI) is a document in which one party (i.e. the promisor) guarantees the other party that certain provisions will be met between them. And if, in any case, the other party faces any loss or damage due to the conduct of the promisor or any third party, then the suffering party will be compensated. It basically protects the promisee against some unexpected loss.
This contractual document is generally drafted by a third-party institution like a bank or an insurance company. And these third-party institutions pay the financial compensation, on behalf of the promisor, to the losing party in a loss.
Some examples to understand it better
A letter of indemnity is used in business dealings like global trade and commerce. For example, moving companies and delivery services have the job of transporting valuable items from one place to another. In a situation where the valuable items are lost, damaged, or stolen during their transport, a letter of indemnity ensures that the person who owns the valuable items will be compensated.
Here is another example of the usage of letter of indemnity. Suppose ‘A’ borrows a valuable item from ‘B’. So, here, B (i.e., the owner) can present ‘A’ (the borrower) with a letter of indemnity. The letter states that any damages done to the item are solely the responsibility of the borrower, i.e., ‘A’. This letter is then signed by a witness. The witness can be an insurance carrier representative, i.e., a banker.
Parties involved
Two parties are involved in the contract of indemnity. They are as follows
- The promisor (i.e. the indemnifier)
This is the party that promises that it will bear the loss.
- The promisee (i.e. the indemnity holder or the indemnified)
This is the party whose loss is compensated.
In the above-stated example,
- ‘A’ (i.e. the borrower) is the promisor as he promises to bear the loss, if any, done to the valuable item. Hence he is the indemnifier.
- ‘B’ (i.e. the owner) is the promisee as to who will be compensated. Hence he is the indemnity holder or the indemnified.
Who can issue LOI
As we have already discussed in this article, the LOI is usually issued by a third-party institution like a bank, an insurance company, or a shipping company. But if necessary, any person or organisation can also issue LOI. When they issue the LOI, it becomes their responsibility to compensate either of the two parties in case the other party fails to fulfil the terms of the contract.
Who signs LOI
In general cases, the signature of a witness is required in the document. But in some cases, it is considered better for the insurance carrier representative or a banker to sign this document.
Where can one obtain LOI
LOI is generally prepared and drafted by a financial institution. It can be a bank or an insurance company that acts as the guarantor in a transaction. Hence, one can obtain it from a bank, an insurance agency, or a provider.
The rights of the indemnity holder or indemnified
In the letter of indemnity, the majority of the rights are in favour of the indemnity holder.
Section 125 of the Indian Contract Act, 1972, talks about certain rights that the indemnity holder has. The indemnity holder, or promisee, can claim the following rights against the indemnifier if they are sued.
- The right to recover the damages
All the damages must be paid by the indemnifier to the indemnity holder as per the terms of the LOI. This is what the main motive of the letter of indemnity is.
- The right to recover the costs incurred [Section 125(2)]
If some cost is incurred in a suit for indemnity, it can be recovered from the indemnifier. The indemnity holder is entitled to compel him to pay the costs that have been incurred in a suit. Provided that the suit is in respect of any matter where the indemnity contract applies.
- Right to recover the sum paid in compromise [Section 125(3)]
The indemnity holder is also entitled to recover the sums paid under any terms of compromise in a suit. For example, sometimes the parties decide to compromise by opting for an out of court settlement. The cost paid by the indemnity holder in this compromise can also be recovered from the indemnifier. Provided that the cost can be recovered only if such a compromise is not against the order of the indemnifier.
The rights of the indemnifier
There is no such provision regarding the rights of an indemnifier. But there have been certain judicial pronouncements that say that the rights of the indemnifier are similar to the rights of the surety. One such judgement was held in the case of Jaswant Singh v. The State (1965).
Hence the following are the rights of an indemnifier as per Section 141 of the Indian Contract Act.
- Sue on behalf of the indemnity holder
After the indemnity holder is indemnified, the indemnifier can sue the third party on behalf of the indemnity holder. Suppose your car gets damaged by a third party, and you have car insurance. After the insurance company has compensated you, it can sue the third party on your behalf for the losses.
- Regain the rights delegated to the indemnity holder
After the indemnifier has paid the damages under an indemnity, he regains the rights that were delegated to the indemnity holder. Provided that he has paid the damages to the indemnity holder.
- Refrain to compensate when he is not liable
When some damage has occurred that was not mentioned in the indemnity contract. The indemnifier is not liable to pay for such damages.
Need for a letter of indemnity
The LOI is basically required to protect a person or a business from such claims for which they are not directly responsible. It outlines those measures and clauses that are there so that the aggrieved party does not suffer any harm.
The primary purpose of this document is to ensure that both parties to the contract fulfil the requirements stated in it to avoid any losses in a transaction. And since it is a legal contract, it has some value. The idea of drafting the LOI is to avoid any losses happening to one party because of the mistake of the other party. This document uses extensive steps to protect the innocent party from any losses incurred during the transaction.
Moreover, LOI can be used in shipping as well. Here, the document exempts a party from any liability arising from the other party. For example, when the goods are being transported through a risky or dangerous route. In this case, the carrier (i.e., the company that transports the goods on the shipper’s behalf) can issue a letter of indemnity to the shipper (i.e., the company that owns the goods that are being shipped) for the protection of the goods. This means that in the event of a mishap, the carrier will not be responsible for any damage to the goods.
Essentials of letter of indemnity
- Parties to a contract
There are supposed to be two or more parties to the letter of indemnity. One of them is the indemnifier, and the other is the indemnified, or the indemnity holder. Both parties are required to have the capacity to contract. That means either of the parties must not be a minor or a lunatic.
- Must fulfil the essentials of a valid contract
The letter of indemnity is a special kind of contract. Since it is a contract, the general principles of what constitutes a contract are applicable to it. Hence, it will be valid only when it fulfils all the requirements as required for any contract in general.
- Promise to pay for the losses
The main objective of the letter of indemnity is to protect a party from any unexpected loss incurred during the transaction. For this, there must be a promise made between the two parties. When a party accepts the condition made by the other party, it is a promise as per the Indian Contract Act.
So, there must be a promise to secure the promisee from any loss or damage. The loss might occur due to the promisor or by any other person. So, a promise must be made between the two parties.
- Express or implied
As per contract law, the letter of indemnity is of two types. It can be expressed or implied. Express contracts are those made by words spoken or written in the form of a contract. For example, insurance contracts, construction contracts, etc.
Implied contracts are those that are invoked by the conduct of the two parties. It is not a written contract. For example, the master-servant relationship. Here, the master is responsible for indemnifying his/her servant if there is some loss incurred while working as per the master’s instructions.
In the following situation, the bartender and an intoxicated customer got involved in a fight, which resulted in the customer throwing a glass at the barman. In response, the bartender threw the piece of glass at him, which hit the customer’ eye. The customer filed a complaint against the hotel under which the bartender was employed. So here, the hotel cannot deny responsibility for the actions of the bartender as they have a master-servant relationship between them.
- Lawful object and consideration
Just like a general contract, the letter of indemnity also requires a lawful object and consideration. The purpose for drafting an LOI must not be prohibited by law, otherwise, it would be considered an unlawful consideration. In other words, LOIs drafted for some illegal acts will be considered invalid. For example, if ‘A’ issues an LOI, it will be illegal if it is drafted for the protection of a car that has been stolen by him.
Content of a letter of indemnity
An LOI contains detailed steps for preventive measures to be taken by both parties to the contract. Along with this, it contains the following content, also.
Details of both parties
The LOI must have the details of both parties to the contract. The details include their legal name, complete official and residential address with the pin code, affiliation, and the name of the third party involved.
Signature and date of execution
Both parties must sign it, and the date of execution should be mentioned in the document.
Jurisdiction
The jurisdiction must be mentioned to avoid any ambiguity. The document must contain a statement stating the specific state whose laws will govern the document.
Acceptance of the terms and conditions
The document must mention the confirmation by the parties. It must highlight the point that both parties have accepted the terms of the contract.
Goals of the agreement
The goals of the agreement must be mentioned in detail, along with the specifications (if any). The document should clearly state what action could be taken to ensure the other party does not suffer any loss. The document should mention all these specifications.
Mention the repercussions clearly
It should be mentioned clearly what might happen if any of the parties fails to fulfil their obligations. It should not create any ambiguity later.
Sample letter of indemnity
The structure of the letter of indemnity must include the following key details. They are as follows
- Name and address of both parties;
- Name and the affiliation of the third party;
- Description of the items that are shipped or for which the LOI is being drafted;
- Signature of the parties; and
- The date on which the contract was executed.
Here is the sample of the LOI (bank format)
Letter of Indemnity
Date:
[Name of the contact] [Address] [Address 2] [City, State] [Postal code]Object: Letter of indemnification
Dear [Name of the contact]
For good and valuable consideration, we, [Your company name (Example, ABC)], hereby undertake and agree to indemnify you and your heirs and legal representatives, respectively from and against any expenses incurred by you regarding any action or suit brought or commenced against you or to which you are made a party by reason of being a director of ABC, except such expenses are occasioned by your own fault.
The term ‘expenses’, as used in this letter of indemnity, shall include all liabilities and costs whatsoever, including fines, penalties, lawyer’s fees and the settlement amount.
This letter of indemnity shall be governed in accordance with the laws of the [State].
Signed and dated in [City, State], this [Day] of [Month, Year].
[Your name] [Title] [Phone number] [Email ID of company] [Company name, i.e. ABC] [Address]Tel: [phone number]/ Fax: [Fax number] [Website address]
Comparing LOI with an insurance policy
Though LOI is similar to an insurance policy in that they both cover losses experienced by the parties, they differ in many other ways.
LOI is not just a contract. In a regular contract, there is a requirement for both parties to agree to certain provisions. But an LOI can be requested by one of the parties. The request is to guarantee the other party that all the losses incurred due to contractual breaches will not be left uncovered.
Here are the pointers to understand the difference better
| S.No. | Letter of indemnity | Insurance policy |
| 1. | A letter of indemnity is an agreement in which one party takes financial responsibility for the liabilities of the other party. | In the context of insurance, indemnity is a contractual obligation in which one party has to provide compensation to the other party in the event of any loss. |
| 2. | These are mostly used in legal contracts to have protection against being held responsible for an accident. | These are mostly used in commercial contracts. |
| 3. | One can be indemnified without insurance | But one can not have insurance without indemnity. |
Comparing LOI with bank guarantee
Here is the difference between them
| S. No. | Letter of indemnity | Bank guarantee |
| 1. | LOI involves paying compensation to the other is responsible for a loss in a transaction to which you are a party yourself. | A bank guarantee involves a lending institution that stands as a guarantor and promises to cover all the losses in case the borrower fails to do so. |
| 2. | Any person or organisation can issue a letter of indemnity. | A bank guarantee can only be issued by a bank. |
| 3. | These are mostly used in legal contracts to have protection against being held responsible for an accident. | These are generally used for international transactions. |
What is a bill of lading (BOL)
A bill of lading, or BOL, is a legal document between a carrier (i.e., the transportation company) and a shipper regarding the goods that are being shipped. This document is generally issued by the carrier to the shipper. It also acts as a receipt for the carrier’s delivery of the goods to their destination.
It is basically a document required to move a cargo shipment that represents the terms and conditions agreed upon for the transportation of goods.
For example, ‘A’ is a spice distribution company. It entered into a contract with a supplier company called ‘B’ to import some of the spices. Now, company ‘B’ takes this order of shipment to carrier ‘C’. And ‘C’ issues the bill of lading to keep the record of the receipt of the goods from ‘B’.
What is a letter of indemnity bond
It is a form of surety provided while undertaking that one party will indemnify the other in the event of possible losses. The bond assures that its holder will be duly compensated in case there are any losses. In simple terms, an indemnity bond is a legal agreement through which a party promises to bear a loss in the event of a breach of contract.
What is a letter of indemnity in shipping
In shipping agreements, a letter of indemnity protects the cargo owner from any possible losses. In case, the goods are damaged or the parties to the contract (i.e. transport company) breach the contract, LoI renders the cargo owner harmless.
Case laws
Mohit Kumar Saha vs. New India Assurance Co. (1997)
Facts of the case
In this case, there was an insurance policy signed between the two parties. The petitioner signed an insurance policy with the insurance company regarding his truck. One day, his truck was loaded with fish feed and got stolen on the same day. A claim was lodged for the stolen truck against the insurance company.
Issues involved in the case
What amount does the respondent owe the petitioner for the stolen truck?
Judgement of the Court
The Calcutta High Court held that the insurance company is liable to pay the full value of the vehicle. Paying a lesser value for it will be considered arbitrary.
State Bank of India and anr. vs. Mula Sahakari Sakhar Karkhana (2006)
Facts of the case
In this case, a letter of indemnity was signed between the two parties. One of them is a cooperative society (i.e., a business organisation with the aim to help people), and the second party is a company named Pentagon. They entered into an agreement for the installation of a paper mill. As per the agreement, the company furnished a guarantee regarding the machinery it supplied.
Later, some disputes and differences arose between the two parties. Due to these differences, the cooperative society terminated the contract with the company and invoked a bank guarantee against it.
Issues involved in the case
Whether the company is liable to pay for the bank guarantee?
Judgement of the Court
The Supreme Court held that the term of the contract clearly states that it is not a contract of guarantee but a contract of indemnity. According to this, an indemnity holder should be indemnified against all losses or damages. Hence, in this case, the company is liable to pay.
Conclusion
To conclude, a letter of indemnity is a guarantee given by a third party to compensate for any financial damage to the parties involved. Here, the third party takes responsibility on behalf of the parties to the contract and says that it will cover losses incurred if certain obligations have not been complied with.
One can say that a contract of indemnity is a special kind of contract furnished to pay compensation to the party in a loss. What makes it special is that the obligation taken on by the indemnifier to indemnify the promisee is voluntary.
Frequently asked questions (FAQs)
Is LOI different from an insurance policy?
The terms of an LOI can be compared with the clauses of an insurance policy. But unlike an insurance policy, the letter of indemnity can be used for different kinds of business transactions.
Is LOI a legally binding document?
Yes, it is a legal document. The signatories of the LOI are bound by its terms and conditions.
What does ‘indemnity’ mean?
In its most literal sense, indemnity means security or protection against a loss. This protection is provided in the form of a contract between the two parties.
Can we change the terms of the LOI?
Yes, we can change the terms of the LOI. It can be done with the mutual consent of both parties.
References
- https://www.merriam-webster.com/dictionary/indemnity
- https://www.myaccountingcourse.com/accounting-dictionary/letter-of-indemnity
- https://indiankanoon.org/doc/1518031/
- https://legodesk.com/legopedia/contract-of-indemnity/
- https://blog.ipleaders.in/all-you-need-to-know-about-contract-of-indemnity/?amp=1
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