This article has been written by Saksham Grover, pursuing a Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

The Black’s Law Dictionary defines indemnity as “a duty to make good any loss, damage, or liability incurred by another.” Simply stated, to indemnify someone is to release the person from the responsibility for damage or loss arising from a deal. In addition to this, the term also carries along the right of an injured party to claim reimbursement or compensation for a loss from the other party. 

In such a circumstance, there are two parties involved: one who accepts or pledges to reimburse or incur the loss, known as the “indemnifier,” and the other who suffers the loss, known as the “indemnity holder” or “indemnified.” This is how the loss in such instances steadily moves from one person to the next. A ‘contract of indemnity,’ as defined by Section 124 of the Indian Contract Act, 1872, is a contract in which one party promises to safeguard the other from loss caused by the promisor’s or any other person’s action. However, this definition is restricted and not exhaustive. Thus, the clauses drafted in any agreement may have a wider scope than the actual legal definition. 

The key requirement for indemnification in the section is “any action or conduct of the indemnifier or any other person, let’s say a third party who may not be a party to the contract due to which the indemnity holder has suffered a loss or any damage.” Only those circumstances in which the loss or damage was caused by the promisor’s or a third party’s activity or conduct are covered by Section 124 of the Act. 

Analysis

There is no restriction or exclusionary clause as to which contracts indemnities will apply to and which will not. The applicability of the indemnification provision is mostly determined by both parties’ willingness to enter into such contracts, the type of contract, and the financial credibility of the third party with whom the company has contractual links. There are two scenarios in which having an indemnity provision is beneficial: 

1. When the nature of the transaction makes it likely that a loss will occur; and 
2. Even if a loss does occur, the existing remedies will not be sufficient to compensate for the damage.

However, there are some contracts in which an indemnity clause should not be included, such as:

1. Indemnities paid by a consumer to a firm are often regarded as unfair.
2. In a Confidentiality Agreement, an indemnification clause might potentially enhance the liability of the party receiving the sensitive information and enabling the disclosing party to be compensated for all liabilities, charges, claims, and expenses incurred as a result of the breach, rather than just the loss it suffered.

Indemnification is subject to a variety of exceptions. They usually refer to situations in which the indemnified party’s own activities produce or contribute to the harm that leads to indemnity. An indemnification agreement, for example, may exclude indemnification for claims or losses arising from the indemnified party’s failure due to:

1. Negligence or gross negligence;
2. Improper use of the products;
3. Bad faith failure to comply with its obligations in the agreement. 

Triggering event

It is a tangible or intangible barrier or event that once breached or met, triggers the occurrence of another event. Triggering events are introduced into contracts to avoid or ensure that, following a specific incident, the terms of the original agreement are disregarded or adjusted to suit the party who incorporated the triggering event into the contract. The trigger event can be anything defined by the parties like a breach of contract, a party’s fault or negligence, a specific action, etc.

Claims for damages vs. Indemnity Claims

A claim for indemnity is not the same as a damage claim. In Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, the Bombay High Court stated that the Contract Act is not exhaustive and that common law standards should be applied when interpreting indemnification provisions. Until and unless there is a disagreement with the Contract Act or any judicial decisions made by the Indian courts, the common law principles controlling the implementation of indemnity provisions are enforceable. Third-party claims are covered by an indemnity, but damages can only be recovered from the promisor or the party who made the contract promise.

Another essential point to remember is that indemnification claims can be filed even before a loss has occurred. An indemnification provision allows for the recovery of consequential, indirect, and remote losses, but a damage claim does not allow for this. Section 73 of the Contract Act only allows for compensation for losses “which the parties knew, when they made the contract, were likely to occur from the breach of it” at the time of contracting, which is known as the principle of contemplation of damages between the parties. The term “reasonable foreseeability” refers to the serious likelihood of a loss occurring, and it is frequently employed as a test for damages. Furthermore, the damages sought must be reasonable, which means that damages for loss of profit or opportunity costs are unlikely to be sustained in most cases. ‘Compensation is not to be granted for any remote and indirect loss or harm experienced as a result of the infringement,’ says Section 73. As a result, any claim for distant or indirect losses is strictly excluded.

In the case of an indemnification claim, there is no such restriction. A contract of indemnity, according to Section 124 of the Contract Act, is a contract in which one party promises to safeguard the other from loss caused by the promisor’s or any other person’s action. A claim for damages is subject to the regular restrictions of remoteness outlined previously, whereas a claim for indemnity is not. Thus, unless the indemnified party is specifically excluded in the indemnification clause, consequential, remote, indirect, and third-party losses can all be claimed by the indemnified party. 

Need for Indemnity Clause

As the receiving party, there are significant benefits to including an indemnification provision in a contract; nevertheless, these benefits can only be obtained through plain and unambiguous writing.

1. Management of risk: The purpose of including an indemnity clause in a contract is to ensure that one party is not responsible for any losses incurred if the deal does not come out as intended. Any contract strives to assure a profitable end when the transaction is completed, but in order to do so, one must limit the risk of suffering a loss, which is what an indemnity contract does.  It assures that the loss is absorbed by another party, subject to the contract’s constraints. It’s also possible that a contract is written in such a way that the indemnification provision applies to both parties, in the sense that if one party suffers a loss, the other will compensate them, and vice versa.
2. Unanticipated loss: When a business gets into a contract, it normally includes provisions in case the other party breaches the contract and the business suffers expected losses. The issue emerges if the company begins to suffer unanticipated losses. The indemnification contract’s goal is to ensure that the corporation can recover all damages, especially those that are unanticipated. And it is up to any party’s bargaining ability to determine what provisions should be included in the clause. The goal is to have a safety net in place in case of an unexpected loss so that the company’s financial position is not harmed.
3. Causation: One of the requirements is that the indemnity clause is clear as to whether it applies just in the case of a stated occurrence or also in the case of a non-defined occurrence. It is usually the former circumstance that an indemnity clause is applied to, as the whole point of an indemnity provision is to provide protection against a specific occurrence caused by a specific individual.
4. Degree of Loss: Another important component of having an indemnity clause is figuring out how much money you have lost. Today’s economy is dealing with a high rate of inflation, which means that prices are constantly rising. In such circumstances, its critical to state the amount the party will be obligated to pay to the firm if it suffers a loss, or else the party may be forced to pay a large inflated penalty, even if the contract’s worth is considerably lower.

Conclusion

When properly structured, indemnities can provide a party with remedies that are not typically recoverable. It goes without saying that the wording of an indemnification provision must be precise. However, it is clear that the entire contract should be examined to assess how well the indemnity clause corresponds to the warranties supplied, as well as other pertinent sections. A badly negotiated indemnity clause might have serious implications. Due to ambiguity in the design of an indemnity clause, the indemnity may not be held liable for losses that they believed it to cover. It is critical to write the indemnity terms correctly and accurately. They are significant because they move the loss from one party to another, which may have been caused by the former’s negligence.

References

1. https://www.legalbites.in/need-for-indemnity-to-facilitate-commercial-transaction/.
2. https://www.mondaq.com/uk/contracts-and-commercial-law/715936/the-importance-of-getting-an-indemnity-right-in-a-commercial-agreement.
3. https://www.indialawoffices.com/legal-articles/importance-of-the-indemnity-clause-in-a-commercial-contract.
4. https://www.mondaq.com/india/contracts-and-commercial-law/664102/indemnity-vs-damages.
5. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research_Papers/Law_of_Damages_in_India.pdf.
6. https://www.rocketlawyer.com/gb/en/quick-guides/indemnity.
7. Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri (1942) 44 BOMLR 703 – https://indiankanoon.org/doc/1361099/.

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