Introduction

An indemnity clause is a contractual transfer of risk between two contractual parties generally to prevent loss or compensate for a loss that may occur as a result of a specified event in a specific agreement.  

The term ‘Indemnity’ is elastic and may be used more generally to describe any arrangement under which a party is not to suffer loss. In its widest sense, "indemnity" means recompense for a loss or liability. Indemnities find their basis in common law, typically the common law of contract and the common law of agency.

Legal Background

Section 124 of the Indian Contract Act, 1872 (“Act”) defined a contract of indemnity as “A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person.”

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.

Sections 69, 145, and 222 of the Act provide for implied indemnity. While Sections 124 and 125 are promises of indemnity in the strict sense. The principal concern addressed in Sections 124 and 125 is with promises to indemnify against claims by or liabilities to third parties

Need for an Indemnification Clause

Contractual indemnities are used for a variety of purposes:

  • Secure contractual performance: As a contract clause to secure performance of another person to a contract;
  • Financial protection: To transfer the financial risk of a named event from one party to the other party, where it might not ordinarily or otherwise lie;
  • Remedy for reliance: In response to some state of affairs that a party relies on to enter into a contract. They negate the need for a misrepresentation claim where the primary remedy is rescission. That remedy may not suit the indemnified party;
  • Remove the burden of proof for breach of contract.

Application of an Indemnification Clause in a Contract

To understand this in a broader context, it shall be necessary to understand what all can be covered as a breach of a contract leading a party to indemnify the other party. In most cases, indemnity is usually clearly set out to avoid any future discrepancies.

Indemnities are often drafted too widely to cover anything and everything that would help a party to recover any kind of damage and save themselves from the same. An indemnification obligation shall always be capped to a certain amount or limit in an agreement, which would otherwise make the indemnifier onerous for circumstances that would otherwise not be a part of any indemnity. It is very important in today’s time to draft the indemnity clause in a contract, the indemnity clause must be carefully examined by the parties because the interpretation of the indemnity and how it will be operated may be very different to which the parties agree. Ambiguity in drafting this clause should be avoided. An indemnity clause is always based on the type of contract one is dealing under. A very common language that is added by the parties is seeking third-party claims, everyone today wants to recover themselves from such claims henceforth this should be very critically examined and mentioned specifically to keep the agreement agreeable to both the parties.

One of the most basic elements of an indemnity clause is when the language states the following: “ The party shall indemnify, defend and hold harmless the other party.” When we talk about liability caps what we need to understand is that having an open indemnity clause will always be harmful to the indemnifying party and puts immense liability which may go beyond its imagination. Hence to curb such situations one must always and always have a Liability cap, which shall also include the period under which indemnification can be sought. To give an example: A comes into a contract with B, and further A breaches the contract, in this instance when we say time is also essential we mean the time to file a suit for indemnification. Let say for this breach B goes and files a suit four years after the breach occurred then in such situations the suit shall not be acceptable to keep it straight and simple. The period after which the suit was filed is not a reasonable time this long a delay shall not be supported.

Enforcement of Indemnity Contracts

An indemnity may be invoked according to the terms of the agreement like an express promise. The courts in India have time and again taken the position that an indemnity holder is entitled to sue the indemnifier even before incurring any actual damage or loss and that an indemnity is not necessarily given by repayment after payment. Hence, an indemnified party can call upon the indemnifier to make the payment once the liability has accrued. The concept of accrual of loss or liability and the attendant obligation to indemnify can be contractually agreed upon between the parties.

S. 124 does not limit or restrict an indemnity claim to anything that is only reasonably foreseen or to the ordinary rules of remoteness. Thus, consequential, remote, indirect, and third-party losses can all be claimed by the indemnified party unless specifically excluded in the indemnity clause.

In light of principles of equity and also given that an indemnity may become almost ineffective if the holder is first required to suffer from damage to be able to claim indemnity, it has been held by courts that if the liability of the indemnifier becomes absolute, indemnity arises, however, upon the court’s satisfaction of the clear existence of an enforceable claim.

The exercise of the discretion to grant relief requires a balance to be struck between the severity of the protection and the perceived threat of dissipation of assets.

Conclusion

It should be understood from the above-made statements that an indemnity clause is one of the most important clauses and should be dealt with utmost care as this includes all the risks involved with the parties' obligations to perform under a contract. Indemnity is a legal exemption from the penalties or liabilities incurred by any course of action. Indemnification is a promise, protecting one party from financial loss. This is something stated as a requirement that one party hold harmless the other.

Disclaimer: This article has been prepared for general guidance and information as a guide to understanding the concept of an indemnity clause in any agreement and does not constitute professional advice or a legal opinion and are the personal views of the author. The matters described herein are general in nature and have not been evaluated based on applicable laws. This article is based on information available in the public domain and has not been verified for its accuracy. You should not act upon the information contained in this note without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this note. Treelife Consulting and its employees accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of the author / Treelife Consulting, this note may not be quoted in whole or in part or otherwise referred to any person or in any documents.

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